How much VC money should you spend on marketing?

Introduction – Why this is necessary

So after speaking with a bunch of people, from fellow entrepreneurs to people working at venture capital funds, I came to the realization that very few people have a deep understanding about how to look at marketing spend, or even how to calculate the key metrics to track marketing efficiency.

Why is this important? Because if you want to build a huge B2C business in a short span of time, marketing spend will likely be the way to scale your spaceship to glory –if it works, it can launch your business into the realms of profitability. If it doesn’t, marketing spend might be an amazing roller coaster with bankruptcy waiting at the end.

I have gathered this knowledge both with experience and interactions over the years and, of course, numerous iterations: From my time working building Westwing in India (Heavenandhome.com) for Rocket Internet, my classmates from undergrad who are now dominating the European startup scene, to some of my expert investors who have built multiple large online B2C businesses. I have reprocessed this knowledge, tried to connect the dots and built a semi-theoretical framework around it. Hope you guys like it!

As you may already know, consumer internet companies are always evaluated the same way on the marketing/ scaling side: Customer Acquisition Costs (CAC) versus Customer Lifetime Value (CLV). So what does this mean for your business and category?

Well firstly, let’s get an intuition for CACs, as many of your investors or team members would love to look at CACs and benchmark them with CACs of other companies. In order to avoid surface-level analysis, it is always important to remind people who evaluate your metrics that CACs have no meaning without the corresponding CLV: How much money do I pay to acquire versus how much money do I get back over time from the customer.

Everybody loves CACs, but CACs only tell 30 percent of the story

In a perfectly competitive world (assuming ceteris paribus) and all players selling homogenous products and having the exact same marketing skills and strategy, CACs should ideally behave like a perfectly competitive pricing mechanism with a supply and a demand.

As the demand for the customers from companies (=industry marketing spend) in that specific segment rises, CACs go higher and as the supply of customers in the market for companies increases, CACs reduce (=market grows). The chart below (Chart 1) should give you one out of many perspectives on how to think about CACs from a market perspective.

Also note that with every customer acquired, the pool of potential new customers in a non-growth market logically has to shrink – in a steady state market and in an ideal hypothetical world therefore every subsequent acquisition has to be more expensive.

In the real world, however, you can differentiate your product through building brands or design innovations that allow you to reduce competitive pressures and reduce CACs even if you have an extremely intense supply side.

In other words, there are external factors like competition and market growth affecting your CACs (Cost per Visit; see below) but you can also influence CACs through internal factors (Conversion Rate; see below). Hypothetical example: If you build something completely new with high barriers to entry, no competition and a lot of demand for it, naturally you will have extremely low CACs.

For your day-to-day marketing operations; I found that breaking down CACs into its core elements helps a lot with daily ad-hoc optimisations of campaigns. These elements are Conversion Rate and Cost per Click. Technically, if you look at overall conversion rates you are calculating Cost per Transaction/ Order and not Cost per Acquisition, because you are taking into account repeat purchases.

Customer Lifetime Value (the 70 percent) and Customer ROI (the complete 100 percent)

Bringing all together – How fast is fast enough?

For general amusement – here are some standard answers to use in your next pitch to look smart