Using Ads to Create a Reproducible Business Model

Let’s say that you have a company, you want to sell more of your thing, but you do not want to pay for advertising. How are you going to increase sales? It can be done:

  1. If your company has a very resonant idea, then your idea will spread on its own by word-of-mouth. This is utterly fantastic when it happens, and this is why, given a choice, you would like for your idea to be extremely resonant. Facebook was highly resonant and spread quickly by word-of-mouth. So was Google.  So was Dropbox. So were fidget spinners and Silly Bandz (for a brief period of time). When this happens, your company grows all by itself through word-of-mouth (and it is glorious).
  2. If you can get your web site to rank in Google, then you receive free “organic traffic” from Google when people search for topics around your idea. If you increase the number and diversity of pages in your web site, you can increase the free organic traffic you receive.
  3. If your idea has an absolutely no-brainer value proposition and great ROI, a sales person can make sales calls and get just about every contact to sign up. For example, when cable TV was first developed and deployed, a sales person could walk through a suburban neighborhood and sign up half of the households. We talked about the Terravion value proposition on this page and it is similar – if you are a farmer in the target audience, and you hear this pitch, it would be silly not to sign up because the ROI is huge and nearly guaranteed.

So it can happen – you can create a company that does not need to pay for advertising. But if your thing does not fall into any of these buckets (and most don’t), what are you going to do? You are going to turn to paid advertising, and you are going to build a Reproducible Business Model around paid ads.

Building a Reproducible Business Model

At the simplest level, there are just five things you have to keep track of in order to create a Reproducible Business Model:

  1. FCOGS – your Full Cost of Goods Sold. There are a couple of different ways to determine COGS. If you are selling a product, COGS is traditionally the cost of the components to make the product (also known as the Bill of Materials, or BOM), plus the cost of labor/equipment to assemble the product. On this page we are going to go one step further, and call it Full COGS, which is COGS plus the operating costs (things like administrative staff salaries, insurance, rent for office space, etc.). If you would like to see a a detailed breakdown of what Full COGS looks like, try this article:
  2. CAC – the Cost of Acquiring a Customer. If you have to run $100 in ads on average get one sale, and it costs $1 per click, your CAC is $100.
  3. LTV – the average Life Time Value of a customer.  If you sell a monthly subscription for your service and it is $5 per month, and the average customer is a subscriber for 18 months, then the average LTV per customer is $5 * 18 = $90.  If you sell a printer for $80, and the cartridge for it costs $30, and the average customer buys three cartridges, then the LTV is $170. On the other hand, if you sell a product like a fancy can opener or a cast iron skillet, which a customer buys once in a lifetime, then the wholesale price is the LTV per customer – it’s a one-time thing when you make the sale.
  4. Profit – you have to make a profit. A good starting number to aim for is 20%. 10% should be the lower bound for profit. If your LTV is $170, you want 20% of that to be profit.
  5. Price – this is the price you charge for your product or service. It’s either the one time price paid, or the price per month of the subscription, or some freemium model, or whatever.

If you know these five things, you can calculate whether you have a reproducible business model using paid advertising. You can do the calculation either forwards or backwards. Let’s imagine that you want to sell a widget.

  • Forward calculation. You do some tests using Facebook ads, and you find that you can make a sale with an average CAC of $18. Your Full COGS is $25 per sale. There is no LTV beyond the single sale. You want to make $5 profit. Therefore your price needs to be $48.
  • Backward calculation. You do some tests and you find that your optimal price is $50. That is, when you price it at $30, you sell X widgets; when you price it at $50, you sell Y widgets; when you sell it at $70. you sell Z widgets; and  Y * $50 yields the highest return. Since COGS + profit is $30, you have $20 available to spend on ads.

In both cases, you can see that the CAC and the price interact with one another. You may have to push the price up above the optimal point if your CAC does not fit inside the optimal price.

Here is your goal: if you can make a 20% profit at a price that fully covers FCOGS and CAC, you have created a reproducible business model. You can spend money for ads, and you know you will make that money back plus a profit. Just about every product or service that you see being advertised today has achieved this goal. This is Nirvana. It can be much easier to find investors once you find this Nirvana. If you can say that CAC*3=LTV, or even better if CAC*4=LTV, it can become a complete no-brainer for an investor in some cases.

Also note that it is easily possible to have products where you cannot create a reproducible business model – it simply is not possible. If your CAC or your COGS (or both) are too high, you cannot create a price that your customers will pay. This is what happened with the Segway. When it came out, the price was ~$5,000. Not many people were willing to pay the price. The same thing happened with the Iridium satellite phone system, as described on this page. The price for service was too expensive for most people, when normal cell phone service was “good enough” at a much lower price.

How to Experiment with Paid Advertising

Let’s say that you start your company, and this is your big question/goal right now: how do you get your first 100 customers? How can you do this?

The easiest, most mechanical  way to do sales with ads is to create a “reproducible business model” using paid advertising. There are many places to buy the advertising, but the four easiest are:

  • Google ads
  • Facebook ads
  • LinkedIn ads
  • Reddit ads

The advantage of platforms like these is that you create an ad in a few minutes, you can easily change ads to find ads that work, you can turn the flow on and off quickly and easily,  you can use very small amounts of money to do testing, and you can do fine targeting. Many companies that are just starting out do not have a lot of money, so these advantages sound fantastic! In theory, once you make one profitable sale, you can recycle the money to make the second sale, and so on.

So let’s say that you try Google, and you set up some ads on related topics. Think of keywords that your customers would use when searching for products like yours.

To use these platforms you generally build a purpose-built landing page on your site. The landing page needs two core features:

  • A compelling value proposition
  • A compelling offer

The landing page may also have:

  • A solid list of the benefits to the customer for your product.
  • A video sales pitch, usually in the form of a 1-minute or 2-minute explainer video.
  • A demo area where people can try it out for free, or a demo video (could be embedded in the explainer video, or can be separate).
  • Examples of success, testimonials, case studies and/or white papers
You can find guides to value proposition creation all over Google. Here are two I have shared with my class:
The offer is as simple as: for $X (the price), the consumer will receive A, B and C:
You then run some tests in which you vary/adjust the ad, the value proposition and the offer to optimize results. Important in these experiments are two things:
  • What is the cost of acquiring a customer? If it cost 75 cents per click and 1% of arrivals actually make a purchase, then the CAC is $75.
  • Does the math work out? Can your price accommodate the CAC?

You can also do some pure pricing experiments. Vary the price and see how it affects sales. This will let you find the optimal price as described in the previous section.

The thing is, this might or might not work. I have no idea. You have no idea. So you have to experiment to find out. What is the right value prop that resonates with your customers? What is the right price? This is a multi-variable optimization problem, and experimentation is the only way to get data. There are lots of ways to improve the probabilities however, as indicated in these links:

Making your ads more successful

Getting into a platform like Facebook or Google to run ads is not trivial if you have never done it before. Here are several links to help:

Types of Ads

In the previous section we focused on Web advertising through places like Facebook and Google. But keep in mind that there are many other different ways to advertise. Here are some examples:

  1. Television ads. I worked with one company where the CAC was $50 with Facebook ads, and a CAC this high was impossible (made the price too high). But by advertising on Monday Night Football, the CAC was $20, and this CAC completely worked.
  2. Infomercials. Lots of products have achieved blockbuster sales through infomercials. P90 comes to mind. It is even possible to test products before producing them with infomercials. If you run an informercial and no one orders the product, you know that either you have a bad product or a bad ad.
  3. Radio ads. Many companies rise to prominence through radio ads. Simplisafe used ads on talk radio stations quite effectively.
  4. YouTube ads. The Purple mattress company used this YouTube ad to drive sales. Here is a typical landing page for the campaign:
  5. Outdoor advertising, like billboards.
  6. Transit advertising on buses, subways, etc.
  7. Goodyear blimp ads.
  8. Superbowl ads. Both GoDaddy and SquareSpace used Super Bowl ads to effectively reach national audiences.
  9. End caps in stores. Nest used end caps very effectively to sell themostrats.
  10. Podcast ads.
  11. Banner ads and sidebar ads through places like DoubleClick.
  12. Influencer ads. Pay an Instagram influencer to say nice things about your product.
  13. Product placement ads.
  14. Newspaper and magazine ads. Can still sometimes be effective with older audiences.
  15. Direct mail.
  16. Email.
  17. Amazon ads.
  18. And so on…

The point is: you can try different advertising mediums and your CACs can be different for each one. Certain mediums will work well for certain types of products.

As mentioned in #1 above, it is quite possible that ads in one medium will work for your product, and in another medium they will not work. The only way to find out is to experiment in the different mediums and pay close attention to the real CAC they yield.

Now let’s look at sales with a sales force > > >