Ads are a trap.
By: Franz Enzenhofer
Tags: Systems Thinking, Ads, Growth, Startup, Paid Advertising

In my piece “10 Things I learned as VP Growth at a hypergrowth Fintech in London.” I stipulated that Google/Facebook ads are a beautiful trap. I want to iterate on that point.

At the end of the article, this graph will make sense.

Sometimes ads are not a trap, just a cookie-cutter.

For some companies, digital ads are not a trap, but just another cookie cutter. A 3rd party that you “need” and that chips away on your profit. If you buy a product for 40$, sell it for 100$ and pay Google/Facebook 20$, then you have 100$-40$-20$=40$ left for all other costs, including yourself, internal company costs, and taxes. In that scenario, ads are not a trap; ads just an annoying cost factor.

Let’s look at other cases, where we don’t have a fixed costs buy&sell value chain, but calculate with more abstract value numbers.

The Fake Customer Lifetime Value

Say you are a startup. A growth-dependent startup. Your goal is to grow, to prove product-market-fit, to grow and secure your next financing round.

You have a calculation of how much your product is worth, based on an estimated, mostly guessed (but pitched) CLV Customer Lifetime Value. I call this the fCLV, the fake Customer Lifetime Value. With the fCLV, you can not do that simple calculation above, as the crucial part of the question is missing/fake.

?$-40$-20$=?$

Cause of this, for growth-oriented startups, the profit at the end does not matter. Yet. The goal is growth. And that’s an entirely valid proposition in the hypercapitalist society we live in.

Get market share, then make money!

If you are in this position: Never bet on ads as your dominant growth channel.

Growth/hypergrowth via paid ads as the dominant channel is a trap.

Let’s make a simple model. I left a lot of stuff out. All models are simplifications; therefore, all models are false. But some of them are useful.

Churn

Churn (C) ist the opposite of retention. Retention if how many users you can keep. Churn is how many users you lose over time. Let’s say you have 500 users but a 10% churn-rate.

C 10%

Let’s just say if your user graph looks like this, you are doing something very wrong.

Referral

Your referral (R) rate is the amount of how many users you get ’cause of the users you have.

Don’t think of referral just users sending around referral links or participate in more or less sophisticated referral scheme. These are only methods to encourage and measure referrals. Referral is the likelihood that a current user brings in a new user. I.e., a referral-rate of 10% means that on average, every 10th user refers 1 new user. Via word of mouth, recommendations, reviewed, via shares, or more or less sophisticated referral schemes…

Let’s combine churn and referral. You have a referral-rate of 12% (Every ˜8th user brings in another user.) and a churn rate of 10%. This means you have an “organic growth” of 2%.

C 10% R 12%

Looks good, exponential growth: the more users → the more users.

But a scenario with a 10% churn and an 8% referral-rate. -2% growth a.k.a. 2% negative growth.

C 10% R 8%

We are near the “very, very wrong” negative growth scenario again. So quite clearly, your churn rate must be lower than your referral rate. Sounds logical. Ok, let’s bring in the money.

Ad Spending

In the last 2% negative growth scenario, we start spending money on ads. We spend 1000$ each iteration (in this scenario, we did not define if it’s a day, week, month, or quarter, and it does not matter) and pay, on average 5$ per user (ACPU — average cost per user) to Google/Facebook. (200 users with each ad spend.)

C 10% R 8% ACPU 5$ 1000$/i

Yeah, growth! Paid growth. We just turned a negative growth curve into a positive one. Like magic🧚‍♂️. And this is your culminated ad costs.

C 10% R 8% ACPU 5$ 1000$/i

Maximum Ad Budget

And now reality kicks in. As long as you are operating on an fCLV and not real profit (after all(!) operational costs deducted), you will not have an unlimited refreshing budget. The glass 🥃 is half empty. There is a limit, latest when the money of your investors runs out.

Let’s se what happens in the 2% negative growth scenario (10% churn, 8% referral) when you cut of ad spending halfway through.

C 10% R 8% ACPU 5$ 1000$/i then 0$/i

Money is always about more, never about better.

Any growth activity that you can scale with money alone is never about doing things “better,” it’s just about doing something more. Money and the paid growth you buy will not fix your problems.

C 10% R 8% ACPU 5$ 1000$/i 🧚

⬆️ Even though the graph above looks “ok,” you are running a broken company. The paid growth, the money you throw into the black hole of Google and Facebook prevents you from seeing this. Like a good trap, it lures you in.

This is how your company growth would look like without a magic money fairy🧚‍♂️/investors. ⬇️

C 10% R 8%

I stand with my statement that “Ads are a trap.” Digital ads hide the real growth state of your company while depleting the resources of the company (money, brain share, time).

Are you in the “better” or “more” phase?

Ok, ads can also be an accelerator. If you have something that works, ads can be upgraded from trap to accelerator. It depends if you are in the “better” or “more” phase. Do you need to do better, or do you need to do more of what you are currently doing?

C > R: Better phase

If your churn rate is higher than your organic referral rate, you are in the “better” phase. You must do better.

Lower churn.

Increase referrals.

In that order.

C < R: More phase

If your churn rate is lower than your referral rate. (Or your referral rate higher than your churn rate) you are in the “more phase,” and here money can be a halfway decent accelerator. Scenario 10% churn, 12% referral, 2% organic growth, 1000$ and 5$ per user, stopped ad spending at some point.

Get out of the trap.

If you are already spending lots and lots of money on ads, it’s will be nearly impossible to see your organic growth. Turn them off, yes, turn off all ads.

Only then determine if you are in the “better” or “more” phase. Act accordingly. If you show negative growth without ads, the absolute wrong way to solve this issue is to spend more on ads. It would be entirely the wrong decision. Sadly that’s exactly what most people do.

About the Author

Franz Enzenhofer changes the internet since 1998. Over his career he worked with startups, market leaders, startups then market leaders, market leaders that reinvented themselves as startups, state-owned companies, freelancers, concert halls, cities, political parties, betting companies, NGOs, economic chambers, TV stations, family-owned small businesses, Fintechs, old school banks, national and international newspapers and news agencies, media houses, media conglomerates, sports teams and more. He worked with organizations in the US, UK, D.A.CH, Ireland, India, Thailand, Peru, Colombia, Spain, Portugal, Poland, Netherlands, Italy, Germany, Switzerland, Croatia, Hungary, Bulgaria, Gibraltar, Sweden, Cyprus and more. He cares about scaleable, systematic Growth. He is known for his No B*llshit SEO. He does Growth.

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