The concept
The payback interval is the amount of time it takes to break even on a given marketing investment. When managing cash in a startup or other early-stage business, the time value of money plays an especially important role, given the level of operating risk under which most young businesses operate. This can be especially true with regards to paid marketing. The faster that the money you spend turns into new customers and new orders, the faster you can redeploy that money into more marketing and thus more growth. Marketing spend that takes less time to pay back the initial investment can have a significant positive effect on the business, even though the total return may be lower per investment.
The example
Let’s say it’s January, and you are deciding between spending $1000 on search advertising or social network advertising, for a business with 50% profit margin per order. After running some experiments, you are able to product the below table:
| Month | Search Revenue | Cumulative Search Revenue | Cumulative Search Profit | Social Revenue | Cumulative Social Revenue | Cumulative Social Profit |
|---|---|---|---|---|---|---|
| Jan | 1000 | 1000 | 500 | 100 | 100 | 50 |
| Feb | 600 | 1600 | 800 | 100 | 200 | 100 |
| Mar | 400 | 2000 | 1000 | 200 | 400 | 200 |
| Apr | 200 | 2200 | 1100 | 200 | 600 | 300 |
| May | 200 | 2400 | 1200 | 400 | 1000 | 500 |
| Jun | 200 | 2600 | 1300 | 400 | 1400 | 700 |
| Jul | 100 | 2700 | 1350 | 800 | 2200 | 1100 |
| Aug | 100 | 2800 | 1400 | 1000 | 3200 | 1600 |
| Sep | 100 | 2900 | 1450 | 600 | 3800 | 1900 |
| Oct | 100 | 3000 | 1500 | 200 | 4000 | 2000 |
| Nov | 100 | 3100 | 1550 | 100 | 4100 | 2050 |
| Dec | 100 | 3200 | 1600 | 100 | 4200 | 2100 |
As you can see, you got $2100 back in Social ($1100 net of $1000 investment) after a year and only $1600 ($600 net) in Search, a difference of 31% (83%). But you achieved profitability in Search by March and in Social by July, less than half the time.
The math
Let’s put together a table of cumulative profit for each ad type, net of the $1000 initial investment. Let’s also add some columns for reinvested $1000 investments, that you can only make when you get your initial $1000 back from the prior investment.
Here is the cumulative profit table for Search:
| Month | 1st investment | 2nd investment | 3rd investment | 4th investment | 5th investment | 6th investment |
|---|---|---|---|---|---|---|
| Jan | ($500) | |||||
| Feb | ($200) | |||||
| Mar | $0 | ($500) | ||||
| Apr | $100 | ($200) | ||||
| May | $200 | $0 | ($500) | |||
| Jun | $300 | $100 | ($200) | |||
| Jul | $350 | $200 | $0 | ($500) | ||
| Aug | $400 | $300 | $100 | ($200) | ||
| Sep | $450 | $350 | $200 | $0 | ($500) | |
| Oct | $500 | $400 | $300 | $100 | ($200) | |
| Nov | $550 | $450 | $350 | $200 | $0 | ($500) |
| Dec | $600 | $500 | $400 | $300 | $100 | ($200) |
Here is the cumulative profit table for Social:
| Month | 1st investment | 2nd investment |
|---|---|---|
| Jan | ($950) | |
| Feb | ($900) | |
| Mar | ($800) | |
| Apr | ($700) | |
| May | ($500) | |
| Jun | ($300) | |
| Jul | $100 | ($950) |
| Aug | $600 | ($900) |
| Sep | $900 | ($800) |
| Oct | $1,000 | ($700) |
| Nov | $1,050 | ($500) |
| Dec | $1,100 | ($300) |
As you can see, because the payback interval for Search is so much faster than the interval for Social, you are able to reinvest so many more times (6 vs. 2 over the course of a year). As a result, the cumulative return by December for Search is more than double that of Social ($1700 vs. $800), despite Social’s superior cumulative return per investment ($1100 vs. $600).
Conclusion
Shorter payback intervals allow you to grow your business at an accelerated rate relative to longer intervals. The earlier the business is in its life cycle, the more impactful the acceleration. For mature businesses with cash reserves, there is some benefit to diversifying into greater returns, but for most young businesses, payback is key.