The hidden risks of growth models relying on paid marketing

The hidden risks of growth models that rely on paid advertising traffic

You’ve finally found a scalable growth channel through paid ads. The first tests show inspiring results: your CAC (Customer Acquisition Cost) payback time is eight months, and the predicted LTV (Lifetime Value) exceeds the CAC by a factor of two.

  • The marketing team now focuses on increasing the volume of the paid traffic by optimizing the acquisition funnel and searching for new advertising channels.
  • The product team focuses on growing LTV by optimizing key product flows and features.
  • The CEO focuses on raising a new round of funding to accelerate growth (CAC payback period is eight months, so additional funds are needed for an aggressive growth).
  • Paid marketing doesn’t scale with product growth.
  • Advertising channels tend to saturate over time.
  • Others can easily copy a growth model that relies on paid marketing (both at the marketing and product levels).
  • Your interests and those of advertising networks differ greatly.

Hidden Risk 1: Paid marketing does not scale with product growth

One of the characteristics of paid marketing is that scaling the traffic acquisition and growing your business are two very separate processes. This entails both an advantage and a disadvantage.

  • The team acquires new users through paid ads.
  • The cohort acquired within the launch month brings in $500,000 in the same month.
  • The mobile game has a phenomenal retention rate and great monetization, so the first cohort’s monthly dynamics looks like this: $500,000, $450,000 (90% of the previous month), $405,000 (90% of the month before that), and so on.
  • Both marketing and product teams perform well and manage to regularly improve the effectiveness of the key funnel. During the first year they steadily increase the volume of the purchased traffic, which ensures the 10% revenue growth of cohorts from subsequent months (the first cohort’s revenue was estimated at $500,000, the following cohort’s revenue $550,000 and so on).
  • A referral growth channel in Dropbox where users invite their friends to the product in exchange for additional storage space.
  • SurveyMonkey’s viral growth channel, where users not only receive poll results’ when sending out their surveys, but also promote the service itself (when a user finishes the survey she is offered a link that encourages her to create her own survey on the platform).
  • The content growth loop of Medium, where users create content that is later indexed by search engines, increasing the influx of the new users via search traffic, which leads to an increase in the number of users who eventually create more content. Medium has another similar growth loop, in which content creators promote their articles and bring new users to the platform.
  • As more people use Dropbox, more users participate in the referral program, inviting their friends to the service.
  • As more people use Surveymonkey, they send more polls, therefore more users learn about the service and sign up with it, and as a result the service’s audience increases.
  • As more people publish content on Medium, the platform receives more traffic, i.e., more users create blogs on the platform and start to use it to publish content and distribute it on their own channels, promoting the platform in the process.

Hidden Risk 2: Paid marketing channel saturation

The Golden Cohort is a group of early adopters of your product. The Golden Cohort is usually more engaged and has a better retention than those who come after.

  • There will be less and less relevant users from your target audience in the channel, which means it will become harder (i.e., more expensive) to find and acquire users there.
  • At some point, you will notice that the users you acquire through the paid channel are reacting worse to your ad messaging and are less engaged in the product.

Hidden risk 3: Advertising growth channels are easy to copy

As soon as the market notices the first signs of your new product’s success, clones will emerge out of nowhere.

  • At the beginning of 2019, Playrix was one of the leading companies in the casual mobile games market.
  • At the time, Firecraft Studios was a newbie in the mobile gaming market. A little over a year earlier, they had launched their first Matchington Mansion title, which was basically a clone of Playrix’s title (copied at the product level).
  • At the end of 2018, Firecraft Studios started to aggressively scale Matchington Mansion mostly through paid marketing. By February 2019, the game’s revenue was nearly matching Playrix’s leading games.
  • Playrix realized they were losing their market share and responded by pushing their installs to an all time high, starting a war for the same female player base (heating up an ad auction).
  • This paid-traffic war affected other market participants. The gaming company Glu Mobile referred to the aggressive UA campaigns from the two casual game publishers in their Q1 Earnings Call Transcript, which prevented the company from achieving their goals in respect to their female-centric titles (all market participants suffered from a heated ad auction in this case, while the advertising networks became the big winners).
  • During this fight, Firecraft Studios came up with a new interactive type of ad that didn’t not refer to gameplay. This allowed them to gain an advantage in terms of CAC (new marketing strategy).
  • In order to defend themselves, Playrix quickly copied this approach, neutralizing the advantage of the aggressive competitor (copying at the marketing level).
  • Feel free to read the full version with a detailed analysis here.

Hidden Risk 4: Your company and ad networks have conflicting interests

A more fundamental problem with being dependent on paid marketing channels is that your main partner, which is the advertising network, is not really your partner. It may seem that your interests are aligned at first, but in reality they are not.

The consequences of neglecting the risks of becoming dependent on paid marketing

Let’s look at a classic scenario in which the risks we’ve talked about in this essay can lead to negative consequences:

  • The company launches a new product.
  • After a while, the company finds advertising channels with a positive unit economy and starts scaling paid marketing. At the same time, both product and marketing teams devote most of their time to optimize the key funnel.
  • Everyone enjoys rapid growth for a year or so.
  • Against the backdrop of this rapid growth, the company attracts new funding at a high valuation because everyone expects them to keep accelerating their growth.
  • Gradually, the risks we described above start to show:
  • As the advertising channels scale up, they begin to produce smaller and smaller incremental growth.
  • Competitors copy your marketing strategy and new players make similar products and join the game.
  • Advertising channels start getting saturated and the unit economy starts to deteriorate.
  • The company increases its CAC payback period from the initial eight to 12 months, and then bumps it up to 16.
  • The product temporarily goes back to normal growth rates. Perhaps the company raises a new round of funding to solve the problem. But this will only relieve the symptoms without curing the main disease.
  • As the company burns through its funding, money starts running low. At this stage it’s impossible to repeat the trick with increasing CAC payback period.
  • The company can’t raise more funding based on its current valuation (the company’s growth has slowed down).
  • The company leaves the battlefield for the market or closes down (like the numerous group-buying services that did several years ago).
  • Facebook and Google publish reports with revenue growth of 40% year on year.

When does a growth model based on paid marketing look robust and secure?

In a number of situations, the advertising growth model will be less exposed to the risks we explored in this article.

Summing it up

Growing through paid marketing is a great tool to achieve your goals. It is important to have the right expectations, but keep in mind the limitations of this growth channel and be aware of the risks of becoming dependent on it. In this case, you will be the one to benefit from the advertising networks, not the other way around.

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Oleg Yakubnekov

Oleg Yakubnekov

I am a product and data guy with experience in building and growing things at scale. Forbes 30 under 30