Acquisitions & Costs

Here we go

Friends,

I hope that everything is well with you and yours.

Things my end are, thankfully, a lot better than last week; the stomach bug has been well and duly squashed, and life has returned to normal (as normal as is currently possible).

So, without further ado, let us make up for lost time and jump straight into the basics of customer acquisition.

Questions of growth

There are, logically, two ways in which a company can grow; it can a) acquire new customers faster than it loses existing ones, and b) increase the overall revenue contribution per acquired customer, be it through purchase frequency, value per purchase or a combination thereof. This is, of course, entirely elementary.

Yet how to balance the two is not as obvious.

Most marketers up to speed on empirical research will know that the most common pattern, by some distance, is that revenue increases come from expansion of the customer base, but it is not without exceptions. Nor is all growth created equal; as numerous companies have demonstrated throughout the years (no, it is not a phenomenon unique to tech verticals), simultaneously increasing growth, revenue and losses is only too easy. There is no universal causal mechanism whereby penetration automatically translates to profit.

Consequently, there are three questions that any serious conversation about acquisition has to address:

1. What kind of customer should we acquire?

2. At what cost?

3. How?

The myth of the ideal customer

If traditional marketing wisdom could be summarized in one sentence, it would be to target the best (most likely, highest spending) customers. This line of thinking remains prevalent in most companies globally, and it is so easy to see why it does not warrant much further explanation.

The heavy buyers represent a small part of the baseline, yet provide a large part of the revenue and a larger part still of the profits. Getting them to spend even more – preaching to the converted (bad pun intended) – is also habitually claimed to be a viable path to growth. Yoon, Carlotti and Moore, for example, argued in Harvard Business Review that heavy buyers often discover a hidden appetite to increase their purchases, and that serving them can be done very efficiently.

Staplers are a prime example. Most people have just a single stapler—or maybe two, one at home and one in the office. But in our work with an office supply company, we identified stapler superconsumers, who own eight staplers each, on average. These consumers don’t do more stapling than other people. Their stapler buying is related to a need to be highly organized: They believe that the presentation of the papers they staple together matters as much as what is on the papers. So they want just the right stapler for each stapling occasion. They keep different sizes and shapes in various places—their offices, their kitchens, their purses, their cars. Absent these findings, common sense might suggest that there would be little ROI in trying to sell someone who owns eight staplers a ninth or a 10th one. But the analysis proves that selling those additional staplers to superconsumers is a smarter growth strategy than simply selling replacements for broken or lost staplers to “normal” consumers.

Admittedly, this is strictly speaking not a pure acquisition argument, but it nonetheless follows the relevant line of reasoning; acquire by targeting narrowly and increase purchase frequency. Both paths to growth are, it would appear, covered.

But it is a narrative based on assumptions and hypotheticals.

Large-scale empirical evidence paints a completely different picture. Though context matters, all brands have a long tail of infrequent, light buyers. We discussed Dove two weeks ago, for which 80% of sales came from buyers who purchased the brand at the rate of once a year or less, but the pattern has proven to hold up time and again across nations, markets and brands. 50% of Coca-Cola buyers buy one to two cans a year. 30% do not even manage that. For Pepsi, a smaller player (and thus affected by Double Jeopardy law, that is, they have fewer customers and those customers are slightly less loyal), 50% of its buyer base is made up of people who purchase less than one can annually; a heavy buyer is someone who buys three a year or more. Pick any brand and you will see a similar story. Target the heavy buyers and you invariably leave a sizable sack of potential revenue on the table.

Some will argue that it is a price worth paying. After all, revenue does not equal profit, and heavy buyers are significantly more likely to contribute to the latter. The problem, however, is that purchase behavior today is not indicative of purchase behavior tomorrow; it follows regression toward the mean.

A story from my own life illustrates the point.

I was 39 years old when I got married. For 38 and a half of them, in other words, I was a non-buyer of the wedding category. As my wife-to-be and I began to move toward the Big Day™, I became a light buyer.

Time ticked on. The closer I got, the more I bought. Eventually, I was the heaviest of heavy buyers – what Yoon et. al. would have labelled a ‘superconsumer’ – and subjected daily to an obscene barrage of carefully targeted digital ads.

But then, one beautiful morning, I woke up with what had become my wife beside me. And while I love her with all my heart, indeed more than life itself, the single best thing about being married is not having to plan a fucking wedding. I had once again become a non-buyer of the category yet, as you might expect, I continued to be retargeted with wedding ads for another four months or so. Not only was I not going to convert, it was the last thing I wanted to see.

In Ehrenberg-Bass lingo, this is called the law of buyer moderation. Over time, buying behaviors change. Light buyers become heavy buyers, heavy buyers become light buyers. Non-buyers of the category start buying while previous buyers of the category stop altogether. Successful marketing for most is thus that which increases the overall level of sales (or at least the purchase propensity) of every kind of buyer. And yes, that means we have to reach all of them. And yes, that includes current non-buyers. And yes, ergodicity may play a part.

Obviously, there will always be exceptions. Some business models, particularly in B2B, hinge on the scale provided by heavy buyers that will always be heavy due to their size (such as a large manufacturer) in order to make their light buyers profitable. Similarly, startups will have a disproportionate number of heavy buyers early on. I will cover such nuances and more in two weeks’ time for paying subscribers, but for now, let us stay with the main rule.

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The law of buyer moderation means that the likelihood that the heaviest buyers continue to increase their purchase frequency, as suggested by Yoon et. al., is significantly lower than claimed. That is not to say that it would be impossible in the short run but, over time, even the most dedicated of those in the stapler fandom inevitably reach a point where they have as many stapling machines as their housings, finances, consciences, or significant others allow.

The cost of doing business

The most common counterargument to, so to speak, targeting the whole market (all category buyers) is one of cost. After all, marketing managers only have so much money at their disposal, and sooner or later, someone higher up the corporate ladder might ask to see a return.

But focusing on ROI is fraught with danger. Many, if not most, marketing efforts accumulate over years precisely because of how buyer distributions are made up. Comparing a year’s investment with a year’s revenue consequently ignores the fact that said revenue was largely created by previous years’ investments – and that the investments just made will lead to additional sales down the line.

Some organizations therefore opt to instead focus on net present value (NPV) and discounted cash flows (DCF). However, while undoubtedly superior to ROI, they too carry the risk of skewing targeting towards heavy buyers; the total company value will likely be considered to decrease as the NPV that each customer contributes to the bottom-line within the measured window does. Given that this could have a negative impact on the stock price of a publicly traded firm, the incentives to look for NPV-maximizing, high CLV ‘best customers’ are obvious (more on this next week).

Customer acquisition cost (CAC) vs payback (spend recovery) time is a crude but often useful rule of thumb alternative. The faster a customer covers the cost of acquisition, the faster a company can grow. In a perfect world, the product or service should be priced such that it is covered upon first purchase, but this may for various reasons obviously not be the case. With the wrong approach, attempting to get closer to that point may lead to short-termism.

So, what do do?

Well, from a business strategic standpoint, marketing is a cost of doing business and costs need to be covered if a firm is to survive, let alone thrive. How to best do that will ultimately have to come down to the relevant context, but ignoring empirical evidence of market behavior is unlikely to ever be of much use; as I have written elsewhere, if a strategy fails to match reality it is much wiser to change the strategy than to attempt to change reality. A hallmark of a good marketer will always be their ability to accurately estimate levels of expenditure needed to achieve goals set in the marketing strategy – and there is no excuse for not taking both cost structures and observed customer distributions into account while setting them. Of course, this assumes that such a strategy exists.

The modus operandi

And so, lastly, we come to the ways in which one acquires customers, yet again a massive topic on its own. Although I am certain that I will cover them in detail at some point in the future, the various merits of marketing vs sales, brand-building vs so-called activation, online vs offline channels and so on will not be discussed here and now. The points just made pertaining to cost structures are, I hope, sufficient for the overall strategic argument; in broad terms, it is less interesting how one achieves set goals as long as one actually does it – at an acceptable cost.

What is, perhaps, worth digging slightly deeper into is the ways in which certain companies currently acquire customers at what appears to be an unacceptable cost. Particularly in digitally native vertical brands (DNVBs) such as platform businesses, direct-to-consumer (DTC) companies and e-commerce sites, there is a tendency to attract buyers using promotional offers and discounts.

Although there are conversations to be had about the role of intangible assets such as collected data in the overall company valuation, and the potential need for speed as a result, promotions carry substantial strategic risks often unconsidered. Customers acquired through them are in general no more likely to purchase the brand again; especially for larger brands, there is little evidence of any ‘try it, like it, buy it again later’ effects. While a discount on a subsequent purchase (e.g., in the form of a gift card or credit obtained after a full-price first purchase) may have a better effect, acquisition discount depth has proven to be negatively related to repeat-buying rates and customer asset value alike.

In verticals that already suffer from near-negative margins, such as any that feature a one-to-many model, promotions thereby effectively ensure that profitability is impossible. For every extra sale, companies give away margin on another two times as much sales volume (or much more if margins are narrow). Given the prevalence of the approach, it is no wonder losses mount.

Nor is it that the companies in question attempt to build loyalty as a means of counteraction. Next week, we will look at whether they should.

Hold on to your hats – and have a lovely weekend.

Onwards and upwards,
JP