(2021-03-23) Chen How Startups Die From Their Addiction To Paid Marketing

Andrew Chen: How startups die from their addiction to paid marketing. Many of the biggest implosions in recent history – especially ecommerce – have been due to startups getting addicted to paid marketing while fooling themselves on Customer Acqusition Costs. As spend scales, it always gets more expensive and harder to track – never less.

Suddenly top line hits a ceiling. Payback period goes from 9 months to 12, then more. Unit economic profitable, but not with staff + HQ

This happens enough that y’all should be nodding your heads now – it’s tough, but there’s a pattern. This is the Paid Marketing Local Max.

The first mistake is to start by thinking of everything as Blended CAC – dividing all your acquisition against dollars – as opposed to understanding CAC of each channel (Facebook, Google display, Google AdWords, etc.). The former is misleading.

Scale effects mostly work against you in paid marketing. The longer your campaigns run, the less effective they become – people start seeing your ads too often. The messaging becomes stale, and novelty effects are real. Market performance has a reversion to the mean.

Saturation is also a thing. As you buy up your core demographic, the extra volume comes from non-core, who are less responsive. The first US-based ad impression on a property is the most responsive, but you eventually run out of those.

Contrast that to viral channels, folder sharing in Dropbox or team channel creation for Slack – these are highly situational and only a few folks can copy. Whereas in ads you’re competing with everyone going after your same demographic.

Addiction to paid marketing can get you into a local maximum. It’s much harder to fix the underlying issues – creating real moats, product differentiation, doing deeper adtech integrations. Easier to just spend more and push the LTV window from 9 months to 12 to 18.

The new generation of ad platforms makes it possible to scale revenue to new heights, but without profitability. Make sure you don’t get addicted. Build out new channels. Fix churn and frequency. Don’t congratulate yourself too early. And calculate LTV/CAC correctly :)

One of the best case studies of this is from @drewhouston’s Dropbox presentation from the early days. Lots of great stuff in this deck and it’s worth paging through, now nearly 10 years later

On slide 18, Drew talks about early experiments they did on paid search. They executed the industry best practices at the time – go to trial-based pricing, hide the free option, optimize landing pages

What they learned was that, in the mature market for cloud storage, there was already a lot of competition. All the paid marketing channels were unprofitable. Hiding the free option wasn’t user aligned. Etc etc.

grew virally instead – via folder sharing, the give/get disk space program, etc. It seems obvious now, remember that back in the day, “cloud storage” was the space, and it’s not clear that you can go viral there.

The point is, knowing that Paid Marketing is highly addictive and hard to scale down, all of us in the industry should always be thinking about the 2nd or 3rd channel, in addition to organic/WOM, to give us a way to wean off an ever-increasing ad budget.

To do that, you’ll need empower your creative team to attack the problem from all angles- new viral product features, really investing in your referral program, building out your content/SEO strategy even though it’ll take years. It’s worth the investment!