From 2011 to 2021, Facebook’s average revenue per user (ARPU) shot up at a nearly exponential rate. Companies across every sector were paying more per “eyeball” than ever as CACs rose at an unsustainable rate. I shared this observation a couple years ago, predicting that startups would start to better scrutinize and reel back their spend.
My timing was only off by three years 😀, but we’re finally seeing this play out. For the first time on record, Meta’s average revenue per user actually declined year over year in the U.S. and Canada.
(Source: Meta public filings)
I spent most of the last decade as a startup operator, working through these challenges first hand leading growth at my own startup, then at TaskRabbit and Eventbrite as VP of Growth, and as a growth advisor to dozens of other startups. Now as an early-stage investor at defy.vc, I spend much of my time helping Defy companies navigate and chart their own growth paths.
With advertising costs rising for nearly my entire startup operating career, I biased heavily toward developing scalable organic channels and building in-product growth loops. But as the founder of my own startup during the Global Financial Crisis and its subsequent recession, I did learn how a broad market pullback in online ad spending can create opportunity for startups willing to double down on this area when many others are running for the exit. At my prior startup, we not only worked to build a core growth engine of unique user-generated content that fueled organic SEO growth, but also experimented across Google, Facebook, and other paid online marketing channels. In doing so we found channels and tactics that drove compelling CACs, and we used this spending through a downturn to ramp up our early user base more quickly, including learning faster by having more people using our product, than we otherwise would have.
Fast forward to today. Against a backdrop of inflation with the Fed tightening fiscal policy, the stock market in 2022 had its worst drop since 2008, and companies are enacting layoffs while broadly tightening their purse strings. Ad spend is one of the first areas to cut, hence the first pullback in Meta’s ARPU in more than a decade. It sounds gloomy because it is, but for opportunistic companies there’s a silver lining. Now is great time to go on offense from an acquisition perspective.
To share an example using one of the companies we work with at Defy.vc, in a recent board meeting the founders shared their growth metrics — our eyes widened as we noticed their paid CAC had dropped to single-digit dollars. Their payback became immediate on each new customer that they acquired — as a benchmark, immediate payback is “exceptional.” A good portion of the ensuing board conversation centered on the CEO’s question: “should we invest more aggressively in this acquisition opportunity despite the broader market challenges?”
I’ve since had similar conversations with other companies, and while each situation is unique I wanted to share my high-level advice below.
Five Recommendations To Guide Your Paid Marketing In a Downturn
- Ask yourself “Is paid marketing really the place to invest our precious cash when we factor in the new reality of our cost of capital?” Capital is more expensive now than it’s been in years. Where else can you invest to drive higher returns and to build a more durable competitive advantage? It’s important to recognize that paid advertising is arbitrage: you pay to acquire a customer for less than their value. While the current downturn is driving lower ad costs, thus presenting a near-term opportunity, this spread is shrinking over the medium term as competition increases and as the dominant platforms (Meta, Google, etc) squeeze more money out. Hence, over the long-run arbitrage tends to trend toward zero, and is another reason why a solid organic distribution advantage is a MUST.
- Organic growth > paid growth. If your company doesn’t have the resources to invest in both organic and paid channels, while it’s often much faster to drive results via paid marketing, taking a long-term mindset it’s usually best to prioritize investments in organic channels (content/SEO, product-led growth, etc). I can’t think of many recent examples of category-leading companies that built their leadership position on the back of paid marketing without one or more strong organic channels as well. Doing what your competition is doing, just better or harder, rarely leads to winning a market. You have to find ways to do things differently. Given that most of your competition will be using paid marketing, the chances of you outdoing them in these same channels is low — you need to find and invest in organic channels where you have some advantage as well.
- Focus on payback period over LTV:CAC. If you are going to ramp up paid marketing, you need to recognize that cash cycles matter. And they matter even more today when funding is tighter as even the best companies face more dilution for less money raised. My friend Dan Hockenmaier at Faire summarizes this well: “This is why payback period is a better measure of customer acquisition efficiency than LTV/CAC: LTV is blind to speed, but speed is half the battle.” Another commenter on this thread also shared a great perspective: “A shorter CAC payback period lowers working capital requirements and can produce positive outcomes like faster growth and lower dilution. A long CAC payback period is potentially deadly since it consumes what is like oxygen for a business: cash.” Payback is a better measure of efficiency given that it is also more grounded in fact as compared to LTV which is just a guess for most early startups.
- Closely monitor marginal CAC, not just average CAC. If you do ramp up your paid marketing spend, be aware that acquiring your next 100 customers via paid marketing will likely cost you more, and they will likely be worth less, than the last 100 customers you acquired. Why? Using an extreme example, it’s generally cheapest to find your first paying customer, and odds are if they found you so early they really need your product so they’re probably worth a lot more (ie: they’re willing to pay more, and/or they’re likely to keep using your product for longer). But as you scale further and further into your potential customer base — to customer 1,000, then customer 100,000, and customer 1,000,000 — each subsequent customer generally becomes more expensive to reach. Channels become saturated, your targeting has already found the low-hanging fruit with the lowest CPAs, etc. So finding your next marginal customer almost always costs more. And does your one-millionth customer who found you via a paid ad really need your product as much as your one-hundredth customer who heard about you via a raving referral from a friend? Not likely, so they are more likely to have a lower LTV and be worth less. Given this dynamic, if you do ramp up your paid marketing spend, it’s critical that you closely monitor your marginal CAC, not just your average CAC. Averages can be misleading, and if you get into a situtation where you have a significantly higher marginal CAC, with a lower-value customer, your payback period may end up being much longer than anticipated. Or worse, you could even find your marketing spend to be entirely upside down and unprofitable.
- Spending up to where marginal CAC = first month payback is usually a pretty safe place to be. My advice to most startups is that if they can recoup their paid marketing CAC in the first month, they should do that all day. Beyond that it’s largely dependant on the type of business, and the unique situation that each company is in regarding to cash balance, access to additional capital, other areas of investment opportunity, and more. My friend Lenny Rachitsky wrote a great post on “What’s a good payback period?” that can be a very helpful guide as you consider how much you should spend on customer acquisition relative to payback period.
You might be wondering, how did I answer the company’s questions above? My advice was to invest more aggressively in paid marketing up to at least where marginal CAC is equal to first month payback, and for them as a consumer business we were okay investing up to a three month payback period which is still considered to be great. I advised them to closely and continuously measure not just average CAC, but marginal CAC as they ramp up spend, as it will change over time. The company also had the resources and runway to continue to invest in their owned organic channels, which even despite lower costs on paid channels, we told them to continue prioritizing organic over paid marketing.
As you examine your 2023 growth goals, sit down with your leadership team and board to ask, “how can we go on offense for this once in a decade opportunity?” The principles outlined above can be used as a framework for how to leverage this once in a decade moment of lower paid marketing costs to accelerate past your competition. And if you want to get my take on your growth goals as an early stage company, I would love to chat!
Follow and/or message me at @bmrothenberg