Paying for ads could ruin your startup.
Paying people to download an app is easy. Building an amazing product that people want to pay for is a lot harder.
Cheating growth metrics is a habitual mistake that many inexperienced founders make in the early stages of their startup. This can manifest itself in a variety of different methods: paying users to download your app, buying google/facebook ads, etc. When prompted, founders will declare that they are paying for ads to “quickly drive users to their platform.” In reality, most founders pay for ads as a shortcut for having to build great product — this will usually come back to bite them in the long run. Using Sakichi Toyoda’s, Five Why’s technique, you can quickly find the ultimate reason behind this common founder mistake:
Q1: Why are you paying for ads?
A: Because I want to quickly drive users to my app.
Q2: Why don’t you drive users to your app through organic channels (word of mouth, virality, etc.)?
A: I’m trying and it’s not working that well.
Q3: Why is it not working that well?
A: Because i’m not growing fast enough. I need to reach a larger audience.
Q4: Why aren’t you growing fast enough?
A: People aren’t sharing the app with their friends / colleagues.
Q5: Why aren’t people sharing the app with their friends / colleagues?
A: It’s early and there’s still a ton of bugs. People aren’t that excited about the app
“In reality, most founders pay for ads as a shortcut for having to build great product — this will usually come back to bite them in the long run.”
What’s so bad about paying for ads early on?
Paying for ads = cheating growth. Imagine that you’re given a pile of clay and told to make a functioning bucket. The purpose of this bucket is to hold and retain as much water as possible. When building the first iterations, you’d likely pour water into the bucket to test if it can do its job effectively. If there were massive leaks at any point, you’d likely spend time identifying and fixing the leaks before adding more water. This all seems intuitive, right?
Now imagine that your startup is that pile of clay. The purpose of your startup is growth — attracting and retaining as many users as possible. While building the first few iterations of your startup, you’re likely to experience low retention rates and software bugs (massive leaks in your bucket). This is where many founders lose their sense of intuition. Instead of doing the grunt work to identify and assuage the leaks in their company, founders will pay for users to download their app. This results in vanity metrics: numbers that look good on paper but don’t actually indicate any real value. These metrics often hurt founders in the long run because they mask the underlying issues until it’s too late and funding dries up. The only real benefit that these metrics provide are making founders feel good about themselves while working on their startup. But can you guess what happens to water that’s poured into a leaking bucket?
Priority #1: Finding Product-Market Fit
As a founder, your primary concern should be to find product-market fit (PMF), the way in which your product satisfies a strong market demand. This concept was developed by Andy Rachleff, Co-Founder of Benchmark Capital:
“If you address a market that really wants your product — if the dogs are eating the dog food — then you can screw up almost everything in the company and you will succeed. Conversely, if you’re really good at execution but the dogs don’t want to eat the dog food, you have no chance of winning.” — Andy Rachleff
Finding product-market fit proves that you’re building something that (1) tons of people want and (2) has the capability of reaching and serving all those people. Unfortunately, very few founders will ever actually find PMF. The ones that do are typically the ones that we read about in TechCrunch. Although there is no formulaic approach, building with a user-centric focus and consistently iterating on feedback will place you in the best position possible. According to Marc Andreessen, a successful entrepreneur and investor, founders should know exactly where they stand in relation to Product-Market Fit.
“You can always feel when product/market fit isn’t happening. The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of ‘blah’…. And you can always feel product/market fit when it’s happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can. Reporters are calling because they’ve heard about your hot new thing and they want to talk to you about it.” — Marc Andreessen
What if there’s no other way for me to reach my target user than buying ads?
Founders often excuse cheating growth by saying that they don’t have organic contact with their target user. For example, a college male building an app to help middle aged women shop for clothes. While this may be a valid question, it elicits another major concern: Product-Founder Fit. This is the measure of how well-equipped a founder is to run his or her startup.
When product-founder fit is combined with product-market fit, you have founder-market fit. According to Forbes, this is the innate, unfair advantage that sets founders apart from their competitors. For example, Mark Zuckerberg had founder-market fit in building Facebook given that he was a college student at the time. If there is no organic way for you to communicate with your core users, you’re likely not the right person to be building that product. How do you build an effective solution without being able to empathize with your user’s pain points? Often times, the most successful founders are the ones that fit perfectly within their own target demographic.
“Paying people to download an app is easy. Building an amazing product that people want to pay for is a lot harder.”
Paying for ads is not always bad
Founders should invest in paid advertisement if (1) they’ve already found product-market fit, or (2) they have high switching costs and have clearly identified that the lifetime value (LTV) of a customer is worth far more than the customer acquisition cost (CAC).
(1) After finding PMF:
After you’ve found product-market fit, paying for ads can result in an extremely high return on investment. In the today’s advertisement world, you can optimize your marketing dollars efficiently by showcasing your product to your exact target user. Otherwise known as targeted ads — the crux behind the social media business model. This is the equivalent of building the perfect bucket and then filling it with a fire hose.
(2) LTV > CAC, with high switching costs:
As mentioned previously, LTV stands for the lifetime value of a customer. This can be calculated by the following formula:
(Rev. per customer — expense per customer) / (1 — customer retention rate)
If the average revenue of a customer is $100, the expense of having that customer is $80, and we retain 75% of our customers annually, then the lifetime value of that customer is (100 - 80) / (1 - 0.75) = $80.
The CAC, measures the cost of acquiring a new customer. This is measured by dividing the number of new customers by the amount of direct marketing dollars spent to acquire them. For example, if I spend $1,000 on a Google Ads campaign and get 100 new customers, the CAC will be $10. In other words, it costs me $10 to get a new customer.
In this scenario, the LTV/CAC ratio would be 8x. In order to create economic value, the LTV/CAC ratio of a business must be greater than one.
As an early startup, founders should pay for growth if the nature of their business induces high switching costs, and the lifetime value of users is much higher than the cost to acquire them. A great example of a company that fits within this mold is TurboTax, which boasts a 77% retention rate. Once users become comfortable with the software, they are very unlikely to switch platforms. Thus, they can justify spending a significant amount to acquire each new customer.
Stop paying for users and start getting scrappy
The art to being a successful founder is the ability to get scrappy — finding cheap and innovative solutions to get things done. In Lenny Rachitsky’s article, he wrote an amazing piece on how some of today’s greatest consumer apps acquired their first 1,000 users through seven main strategies. You’ll notice that none of these strategies include “Sat at home and paid for Google Ads.”