Online Marketing inflation will eat your business

As more companies move their advertising budget online, the cost of reaching new customers is increasing for everyone. This is the inflationary reality in which we build businesses today. Acquiring customers through performance marketing is more expensive today than last year, and it will be more expensive in the future.

More and more advertising spend is pursuing a finite supply of attention and spending power, driving prices up across the board. I like to think about this as supply (= consumers that can be targeted online) and demand (= advertisers) converging towards an equilibrium, due to an increasing amount of companies that are capable, sufficiently financed and willing to advertise online. Some business models will be priced out of the market, and most will reach their growth ceilings faster than they had anticipated.

Depending on incremental improvements in targeting, this effect will not be gradual and slow, but exponential. The reason is simple: Advertiser spend on Facebook is growing at a faster rate than user growth, but more importantly, the advertising spend per active user is increasing.

Note: Facebook does not break out revenue by platform in their quarterly reports, so we adjusted revenue down by 20%, based on current estimates for Instagram’s share of group revenue (source: Jefferies and KeyBank).

Of course, these numbers only show a top line trend, rather than the effective inflation for advertisers (which has likely been lower on average). Facebook has been improving their ad products and placements continuously over the past years with their push for mobile ads, deep-learning powered “Lookalike Audience” targeting and now “Stories”, as a new way to reach customers. This has been somewhat effective in keeping CPAs in check while they were doing an impressive job of increasing revenues. But as you can see below, even the numbers Facebook reports highlight that a growth in ad spending can’t be cushioned through more and improved ad products (while potentially being also affected by declining activity on their core platform).

Facebook attributes the recent microscopic dip in YoY growth to user growth in “cheaper” countries and the introduction of a new ad format for Stories, which implies that for certain ad products the prices may have increased further. Based on the underlying trends in online marketing spending I believe that we’ll see further price inflation over the coming quarters and years. Instagram will escape the diminishing return conundrum to some extent by becoming a marketplace. WhatsApp’s trying to become the “WeChat” outside of China might be able to move the group’s revenues away from advertising and “closer” to the actual transaction.

Inflation is not exclusive to Facebook. We see this trend on other platforms as well. The patterns on Twitter and Snapchat, where public numbers are available, are surprisingly similar (Twitter flattened out recently due to issues with attracting new advertisers).

This is Moore’s law, but in reverse. Back when Google launched Gmail with 1GB of inbox capacity, the average mail client at that time maxed out at 5 MB or 99 emails. Google knew that the cost of cloud storage would drop significantly by the time their customers would hit the limit and built this into their business model. The reverse effect is happening in online advertising, as more money is pouring into performance channels from VC-backed companies and incumbent brands alike. For founders and investors this is something to anticipate and price into their forecasts. While the marketing inflation seems to be common knowledge amongst marketers, I hear little discussions about business implications, which worries me and it should worry you as well. Will you still be in business when CACs have doubled or tripled?

There are a number of implications for entrepreneurs in all of this:

· If you have a business with low AOV and low repeat you will be priced out of the market.

· Invest to diversify acquisition channels and don’t rely on paid only. Proprietary acquisition channels are going to be an even bigger asset in the future. Companies that acquire customers mainly through paid will have a harder time to raise funding

· If Google and FB are the primary acquisition channels, growth is unlikely to become more efficient as time goes on. Forecasts need to reflect this reality.

· Retention is king. Invest in product, brand and CRM to engage and retain your customers after the first purchase