The “flywheel of doom”: when brands use ROAS as their source of truth for media planning, it often becomes harder to sell at full price as time goes on.
This content was published in the No Best Practices newsletter on 3.13.2022.
Note: the “customer file” refers to all of the customers you have acquired, who you can market to. The most relevant slice of the customer file are buyers who shopped within the last 12 months.
ROAS stands for Return On Ad Spend, or the money generated by your advertising investment. You can learn more here.
I’ve received a few questions on Twitter along the lines of “how do I determine if my customer file is healthy?” My high level answer: a healthy customer file enables a business to succeed today, but it also sets a business up for success in the future.
That’s a bit abstract. To make it real, we’re going to use the next few newsletters to explore what not to do if you want to build a healthy customer file. A lot of these appear to pay off in the short term, but make it harder for the business to succeed in the long term.
First we’re going to cover what I call the “flywheel of doom”. When brands use ROAS as their source of truth for media planning, it often becomes harder to sell at full price as time goes on. The longer this goes on, the more expensive it becomes to break the cycle.
What Is The Flywheel Of Doom?
As a marketer, you’re probably aware that campaigns featuring promotions and sales typically drive more conversions per impression than full price campaigns. Discounts unlock untapped demand from consumers who are on the fence, as well as from consumers who love your brand but simply can’t afford it at full price.
But maybe you’ve been in a scenario where promotional campaigns are the only consistent performers. The average revenue from a full price campaign gradually declines over time, until these campaigns are barely meaningful to the business overall.
What makes this confusing: nothing changed in the business’ overall strategy. Marketing budgets and channel mix remain steady over time. The business isn’t trying to be more promotional. So why does this happen?
Many brands use ROAS as their north star–not just for day to day campaign management, but for financial planning and budget allocation. ROAS is higher when a brand is on sale or promotion. Brands that plan this way spend more of their marketing dollars during markdown periods. And for some reason, the customers acquired during these periods don’t usually shop the brand at full price.
This kicks off the flywheel of doom. If you’re tasked with growing topline sales 20% this year, are you going to plan that growth into periods when you struggle (full price) or periods when your sales are strong (markdown)?
The eCom team will plan more growth into markdown periods. The planning team will purchase more inventory to support the higher volume of transactions required. And the marketing team will allocate more budget to markdown months in order to ensure that the new, higher sales goals are achieved.
As time goes on, a greater percentage of annual sales is clumped into a few key selling periods–usually when the deepest discounts are offered. This is how Holiday becomes a make or break period for many brands. The business becomes more fragile overall; one wrong move during a limited time frame could jeopardize the year. This leads to more stress for everyone involved.
In the worst case scenarios, it becomes almost impossible to sell at full price and brand credibility erodes.
The Flywheel Of Doom & The Customer File
To understand what’s really going on here, we need three pieces of context:
- The standard digital media budgeting process is biased towards promotional periods. You need to consciously fight this (or build a new process) to grow full price sales.
- The majority of your returning customers on a given day last purchased within the prior 6-12 months.
- Customers are price sensitive; everyone has their own definition of a “reasonable” price to pay for something.
Let’s dig deeper into each of these:
Media Budgeting
A direct response marketer typically wants their media investment to pay off within one to seven days. That’s fair. The outcome of this goal is that months with higher planned sales receive a greater percent of the year’s marketing budget. That’s also fair…but it isn’t exactly wise.
This is how the budget allocation process usually goes down:
- Direct response marketing is 20% of overall revenue on this year’s P&L
- Therefore, finance sets an overall media efficiency target of 5x ROAS for the year
- Marketing is expected to hit that target each month. This is often measured via Google Analytics last click attribution because it’s what finance is used to and feels they can trust.
- Marketing creates the total monthly budget allocation by taking 20% of each month’s topline sales plan. The months with the highest sales receive the highest budget.
In this process, marketing spend for a given month is directly proportional to planned sales. This assumes that media efficiency is static throughout the year. But all of your marketing is more efficient when you’re running a sale because your addressable audience is larger and more impulsive.
So you really don’t need to budget 20% of total sales every month, but it feels risky to go into the month knowing that you have to perform even better than your baseline KPI.
Returning Customers
The focus of many digital marketers–and therefore, many agencies–is achieving their return on investment target by any means necessary. Customer acquisition and retention are rarely factored into the equation. If they are, those metrics are a distant second to financial returns.
But the new vs returning customer mix for a given month or event matters a lot, because it’s less expensive to convert a returning customer than acquire a new customer. Markdown events–especially sales that only take place once or twice a year–are a great opportunity to convert existing customers again. This is another reason that baseline media efficiency will be higher during promotional periods.
Price Sensitivity
Some marketers claim that running promos is a valid customer acquisition strategy. In most cases that isn’t true. And that’s because your customers are price sensitive. Think about it: would you pay $20 for a cup of coffee? Probably not.
Similarly, everyone has a price they think is “reasonable” to pay for a given item being sold by a given brand. The price point of a customer’s first purchase is a good indicator of what they’re willing to pay. So if someone enters your business paying $80 for a pair of shoes on sale, do you think they’ll be willing to pay $250 for a very similar pair in a month when you’re selling at full price?
Higher prices and deeper promotions magnify this risk, because the “out the door” price becomes further and further from the original price. A customer who enters your business paying $20 for a $100 item is less likely to pay full price than a customer who paid $40 for a $50 item.
The Gnarly Outcome
The standard media budgeting process has brands spending more when they’re on markdown. And that spend is more effective at acquiring new customers, because markdowns and promos result in more efficient spend.
But because all customers are price sensitive, the customers you acquire during sale periods are highly unlikely to purchase at full price.
You wind up with two parallel businesses that rarely interact: your full price business and your markdown business. The full price business is slowly starved of resources, unless the brand is spending on full price customer acquisition outside of digital. And even if it is, those customers quickly encounter promo-centric digital messages and their perception of the brand is diluted along with their lifetime value.
Assessing Your Risk
Here are some analyses you can run, and questions you can ask, to determine if this is a problem for your business. I also included some thought starters on alternative approaches to budgeting, because that’s the root of this problem.
Determining If You Have A “Flywheel Of Doom” Problem
First, ask yourself if your media budgeting process resembles what was outlined in the last section. If the answer is “yes” and you run any kind of promotion or sale, you probably have this problem to some degree.
Next, calculate each of your customers’ preferred promo behavior by creating promotional bands that range 1,000 basis points from 0 to 100 (ex. 1-10%, 11-20%, etc.). Determine how many dollars each customer spent in each band over the last two years. Tag each customer with the band where they spent the most–that’s their preference.
Then analyze the following:
- What percent of your L12M customers fall into each promo band?
- What % of L12M customers spend outside of their band?
- When they do spend outside of their band, is it at a higher or lower band?
- What % of L12M revenue happens at each band?
- What % of new customers were acquired at each band?
These analyses will give you an idea of where your business sits from a customer perspective. If you want 70% of this year’s sales to be full price, but 50% of your L12M customers prefer to shop at 50% off, you’re going to have a bad time (or you’ll need a solid customer acquisition strategy).
Alternative Approaches To Budgeting
First thing’s first: you need to factor customer acquisition and retention into your budgeting process. I covered that topic in one of my first newsletters of 2022. I’m not sharing prior editions via email anymore, but I am working on getting the archive online, so sit tight.
If you want to escape the flywheel of doom, you need to spend less to hit your goals for markdown sales and reinvest that spend during full price periods.
Two pieces of good news:
- You can probably cut a lot of your paid media spending during markdown without impacting sales. Run incrementality tests in your largest digital channels during your next sale period to discover where you can cut some fat.
- Promo-hungry customers absolutely love channels like email and SMS. Make a dedicated effort to make anyone with a promo preference of 50% or more opt into one of these channels.
“Full Price Customer Acquisition” is its own very large topic, and this newsletter is quickly closing in on 2k words. Everyone has customer acquisition ideas, but you also need a framework to make sure your efforts are profitable–a framework that your finance team/budget owner will accept.
If you’re interested in hearing more on this topic, reply to this email and let me know. If I get enough interest I will cover it in an upcoming mailing.