Efficiency and arbitrage: two strategies to own performance marketing
In an increasingly efficient world, what works today won't work tomorrow. So what should marketers do? Columnist David Rodnitzky discusses some key tactics.
“Facebook ads don’t work anymore,” according to an investor friend of mine, who had witnessed one of his portfolio companies reduce their Facebook spend by more than 50 percent in the past few months. “Companies can’t get the ROI they used to get on the network.”
The complaint was reminiscent of a Yogi Berra quote about a popular restaurant: “Nobody goes there anymore. It’s too crowded.”
The truth about Facebook — and almost every other online marketing channel — is that it is becoming an efficient market: As more advertisers enter the market, and as Facebook improves its tools and user interface, the price of an ad on Facebook edges closer and closer to its “true value.”
As a result, advertisers who have been using the system for a while will notice their ROI decline (assuming that the advertiser does not make improvements to their campaigns that outpace the increase in competition).
So what’s an advertiser to do? There are two ways to combat efficient markets: improving your own performance and arbitrage.
Improving faster than market efficiency
As noted, as new advertisers join a marketing channel, prices rise. Prices also increase when existing advertisers improve their performance — enabling them to bid more for inventory. And prices rise when publishers (e.g., Facebook, Google) make it easier for advertisers to spend money on their networks.
Put another way, in a dynamic, ever-more-competitive market, standing still is definitely moving backwards. To maintain historical ROI, an advertiser has to improve their own metrics at the same rate of growth as the channel’s own efficiency growth.
Both Google and Facebook are essentially cost-per-thousand (CPM) networks where click-through rate (CTR) multiplied by cost-per-click (CPC) multiplied by 1,000 determines the rank of advertisers. So an advertiser who is striving for a return on ad spend (ROAS) goal (which is revenue divided by cost) would need to increase their revenue-per-thousand impressions (RPM) (Revenue multiplied by CTR multiplied by 1,000) at the same rate as the increase in CPM.
Improving RPM can be driven by numerous factors: conversion rate optimization, pricing/offer optimization, CTR improvement, improvement in lifetime value (LTV) and so on. And to be clear, to grow ROAS, improvement needs to exceed the CPM growth of the channel.
So simply improving performance year over year does not guarantee better results — indeed, improving at a slower rate than the market will guarantee worse results. That’s right — improvement can lead to worse results year over year!
Arbitrage: getting in early
Tactic number two is to attempt to find inefficient marketing channels. This is known as “arbitrage.” Marketers who launched campaigns on Facebook as soon as the advertising network went live were able to buy ads at a deeply discounted price, simply because fewer advertisers were competing at that time.
Every new marketing channel follows a similar arc to Facebook (which I call “the arc of Internet marketing channel adoption”). There are three stages to this arc: 1) no one cares, no one spends any money; 2) everyone cares, no one spends any money; 3) no one cares, everyone spends money.
Advertising on a channel before the majority of advertisers have allocated budget to that channel is a great way to get ad inventory at below its “efficient market” value.
Of course, arbitrage is not without its risks. For starters, new advertising channels typically have limited reporting and tools and immature user interfaces, all of which means that advertisers have to put in a lot of sweat equity to get results.
Second, not all new channels will drive great results, so advertisers looking for arbitrage are going to have to accept a certain number of unprofitable failed tests.
Lastly, arbitrage — by its nature — is a short-term strategy. Highly profitable channels do not stay secret for very long; once other advertisers discover the channel, the arbitrage strategy must be replaced by a performance improvement strategy that outpaces the increasing efficiency of the channel.
Efficiency neutralizes your secrets
My wife always complains that I “give away my secrets” when I write tactical how-to guides to online marketing, like my explanations of The Lin-Rodnitzky Ratio and the Alpha Beta Account Structure. But here’s the thing about tactical secrets: They have a half-life of usefulness.
Secret strategies either get discovered by the masses or simply become outdated; these are both consequences of market efficiency.
Online marketing is a moving target, so discovering a new technique, or a new arbitrage channel, will help today but not tomorrow. This fact, by the way, is why it’s often a huge mistake to replace online marketing experts with cheaper junior staff; the junior staff is generally able to maintain the current performance, but they fail to keep up with change, and eventually, performance declines.
So the next time someone tells you that online marketing no longer works, put the comment in the proper perspective. The truth is that there are companies that continue to improve and evolve their online marketing, and thus maintain consistent profitability from their efforts.
Many other companies, however, believe that what worked yesterday will work tomorrow. In an ever-more-efficient world, that is a strategy doomed to failure.