Understanding why CPA-pricing is sometimes used and why you should likely avoid it.
At Pearmill — a tech-enabled performance agency — we’ve dealt with many scenarios where our client wanted to use a Cost Per Acquisition (CPA) pricing model. (Note: if you don’t know what CPA pricing is, there’s a brief explanation at the end of the article)
Having been on the brand side (when I was the Head of Growth at Checkout 51), and now being on the agency side — where we’ve helped brands like Frank & Oak, Cover, and many more — we’ve come to realize that CPA pricing is almost never the right choice.
Why you shouldn’t use CPA pricing.
The main argument against CPA pricing is the alignment of incentives — the advertiser and the agency’s goals aren’t fully aligned in the long-term, and this leads to miscommunication and wasted performance that we believe can be avoided with better pricing models.
Ineffective Long-Term Spend
With CPA pricing, the advertiser’s marketing spend does not get more effective over time — which is typically the goal of performance marketing. If the agency does a great job at getting valuable users for cheap, the efficiencies aren’t passed on to the advertiser. As the cost of acquisition goes lower and lower, the agency makes more and more money, and you don’t see any of those performance gains on your end since you’re paying a CPA price.
Short-Term Focus
Instead of the agency’s focus being purely on performance — it’s split between how much money it can make in relation to the performance they can get. The allure of more revenue or the concern of not making enough can be distracting for an agency.
This sometimes results in efforts that garner short-term gains that aren’t necessarily sustainable in the medium/long-term.
Minimal Experimentation
CPA pricing penalizes experimentation. If there are campaigns that are already crushing the set goals — it’s unlikely the agency will want to continue setting up other experiments to maintain the good performance since it could reduce the margin. Eventually, well-performing campaigns will be depleted, and the cost of acquisition for those will go up. Without constant experimentation, the advertiser and agency will be caught scrambling trying to spin up new campaigns.
I’ve personally experienced this when we agreed to a CPA pricing model with a client. We were $70 below their ceiling CPA per user. This meant we were making a great amount of money from the campaigns, but we became afraid to test other things because it would reduce the margin and result in lower fees for us.
We realized that this was bad behaviour for us, and for our client, and we actually convinced them to switch to percent-of-ad-spend pricing — even though it meant less money for us in the short term.
The ideal environment you want to set up for your agency is one that doesn’t penalize your them for trying new things out. Taking that penalty away fosters more initiative, and ambitious thinking — even if the campaigns are already performing well.
What makes CPA pricing so attractive?
Both sides of the table have some incentives to opt-in to CPA model, though we believe them to be short-term — they’re worth understanding and considering when hiring an agency.
Advertiser’s incentives
For the advertiser, it’s all about budgeting your growth in the most precise way possible and getting a strong assurance that the agency is able to keep you growing steadily at a stable CPA.
Since you somewhat know what your maximum CPA will be, you can model out your product’s growth and what rate you’re able to sustain with your budget.
And since the agency makes their money from arbitrage in the CPA price, you can assume they’re pressured to achieve the goal and maintain strong campaigns that meet the goals.
Note: in practice, this could all get fuzzy as agencies aren’t always capable of maintaining a steady CPA as your budget scales.
Agency’s incentives
For the agency, there’s a huge potential revenue upside and cost savings on ad operations and creative work.
Depending on the terms of the deal, the agency could be making a lot of money if there’s enough budget for it and they’re able to get very cheap users.
For example, if the flat CPA is set to $100 and the agency figures out a way to acquire users at $40 — they make $60 / user! That’s a pretty good margin.
After successful campaigns are achieved — the agency can scale down experiments and let the campaigns run on autopilot for a bit without having to assign too many internal resources for ad operations and creative production.
Note: in practice, it’s not all sunshine here of course — if the performance is harder to achieve, then the upsides are harder to reach.
Conclusion
Although advertisers may find comfort in acquiring users for a fixed CPA, they’re likely missing out on higher quality users or gains on cost efficiencies that the agency is discovering. CPA-based pricing will reduce the focus put on the long-term value of a user, and focuses the teams to only meet short-term goals.
We almost always recommend other pricing models. Either a flat monthly retainer (for smaller budgets), or a fair ad-spend percentage that can be set in stone based on the current budget and cost of acquiring customers.
It’s paramount to align the agency and the advertiser’s incentives, and CPA pricing fails to deliver on that in the long-term.
If you’re looking for advice, or are thinking about working with agencies — we’re happy to help. Just give us a shout!
What is CPA Pricing?
For clarity’s sake let’s define Cost Per Acquisition pricing, how it’s defined and calculated.
CPA pricing is when a marketing firm or advertising channel commits to a flat cost per acquisition cost for the advertiser. They either guarantee it (very rare) or structure the contract so that the advertiser doesn’t pay the agency if the average CPA is higher than the set limit — this is usually called an arbitrage model.
For example, let’s say the brand and marketing firm agree to acquire iOS app installs at a $10 CPA pricing with an arbitrage model for the firm: this means the firm will do whatever they can to keep the CPA below $10, and the difference between the actual CPA and the flat CPA will go to the marketing firm.
To put it in numbers, if the firm acquires 1000 app installs at $8, then they are paid $2,000. If they acquire 1000 app installs at $11, then they’re not entitled to any payment.
Why I have an opinion
For the past 7 years, I’ve been deploying ad budgets on digital platforms in some shape or form. Be it Facebook, Google Ads, Bing, Pinterest, Snap, or smaller networks.
I started my career running growth at various startups, and eventually a company called Checkout 51, where I spent millions of dollars on ads and hired agencies to help us achieve our aggressive user acquisition goals. I left when the company was sold a few years later, to start a unique performance agency called Pearmill.
At Pearmill — we help brands grow through advertising. We’ve spent millions of dollars in the past couple of years for brands like Frank & Oak, Cover, and many more — using our own technology for reporting and ad operations.
I’ve been on both sides of the table: hiring agencies as an advertiser, protecting my budget tightly in a competitive market, as well as working with our clients as an agency attempting to achieve high growth goals!