By: Jake Baadsgaard
(Jacob is a passionate entrepreneur on a mission to help businesses achieve online marketing success)
Over the years, I’ve had the pleasure of meeting and working with thousands of entrepreneurs. By and large, most of these men and women were smart, passionate and building companies around real market opportunities.
However, many (if not most) of their businesses were struggling or failing.
After starting a few businesses of my own, I started to wonder, why are some companies runaway successes when so many others crash and burn?
For a while, the answer eluded me, but eventually, I discovered that—whether they realized it or not—successful entrepreneurs follow a simple rule:
Every dollar spent on growth must produce 5 dollars in revenue.
I call this the 5X rule. Successful, growing businesses make 5 times what they spend on marketing, advertising, sales or any other growth channel.
Why the Rule Works
To help explain why this rule is such a good predictor of business success, let’s run through a quick hypothetical scenario.
Say you inherited a small, deep sea fishing guide business from your father. Your boat is small, so you can only take one client out at a time, but you charge $150 per trip.
Up till now, you’ve been running your business based on direct sales, repeat business and word-of-mouth, which nets you 20 sales and $3,000 of revenue per month.
Of course, you have to pay about $75 for fuel, boat repairs, bait and other trip-related costs every time you head out to sea, so you really only end up with $1,500 of profit every month.
Or at least, that’s what you thought when you inherited the business.
On closer inspection, you discovered that this was a lifestyle business for your dad. He was an old seadog with a pension and he didn’t care if he was making money—he just loved catching fish!
And, as it turns out, it costs you around $2,000 every month to rent an office and your spot on the dock.
With $3,000 of revenue and $3,500 of costs, your business is losing $500 a month.
So, if you want your business to survive and grow, something has to change.
Unfortunately, you can’t afford to buy a bigger boat and if you increase your prices, your current customers will leave. However, it occurs to you that most people like to book fishing trips online these days, so maybe you could drive a lot more business if you started advertising online.
Here’s how your advertising efforts might pan out:
You Spend $1.00 and Make $1.00
In this scenario, your online advertising investment produces one $150 sale for every $150 you spend.
At first glance, this looks like a break even situation, but it really isn’t.
Remember, each trip costs you $75, so if you spend as much on acquiring a new sale as you make from the sale, you lose $75 on every transaction.
In a 1X-type situation like this, more sales actually equals less money for your business:
You Spend $1.00 and Make $2.00
But what if you make $150 for every $75 you spend? That will balance out the cost of a trip, so you’ll be breaking even, right?
Well, technically that’s true, but remember, you didn’t start advertising to break even, you started because you need to dig your business out of a $500/month hole.
If you only break even on your advertising costs, you’ll never make any headway against that deficit.
View source version on Forbes.