research – Adam Fillion

Fall 2024

During the initial phases of the covid pandemic, I once started up a small online shop that sold posters. We were very profitable selling on platforms like Etsy that seemed to have a lot of organic outreach to buyers that wanted our posters specifically, but of course, being the greedy capitalists that we were, we wanted to sell more to a bigger audience. Facebook has the largest of audiences, so we went there. Organic outreach on Facebook can be difficult unless you’ve carved out a niche with a loyal following, so Ads were the logical choice for us. When you’re selling a product with a cost of, let’s say, $100, you need to make sure that the total cost of selling this product is less than $100, and you pocket the difference. This includes your time, production, shipping, and finally advertising costs. For simplicity, let’s say time, production, and shipping cost $50 per item. It’s the last of these things which is the most variable. In our case, we were selling a very niche stock market related item. We could expect a very high conversion rate when targetting small, niche audiences that were interested in “stock market art”. If we could target this small niche, we would have a cost per customer of $10, leaving us with $40 dollars of profit (100 - 50 - 10). This is clearly a profitable arrangement for both us and Facebook. The only limitation is the nicheness of the targeted audience - not many people are interested in ‘stock market art’ according to Facebook’s algorithms. For the sake of argument, let’s say we can sell 100 posters a month with this single advertising target. That’s $4000 dollars of additional profit for us, and $1000 dollars of revenue for Facebook (of which nearly 100% is profit). Online entrepreneurs don’t stop here though, they want to scale. They branch out from the niche target audience that is making them $4000 dollars a month, and begin targeting much broader categories. Perhaps they notice that men in the 25-34 age group are the most likely to buy their posters, and so they target this group as well. Now, this is clearly a MUCH larger population than before, but also less likely per-capita to be converted into a customer. What would be the expectation here? Many more people will be exposed to your adds, costing you money and generating Facebook revenue, but a smaller % of them will be converted. If you are lucky and have a good product, even though a much smaller % of them are converted, you will still end up selling a much larger total volume of posters. But at what cost? The lower conversion rate costs you, and benefits Facebook. For the sake of argument, lets say your cost per customer has skyrocketed to $40, leaving you with a paltry $10 of profit. Luckily for you, your volume has also increased, and the 1000 posters a month you sell to this group pockets you $10000 dollars, and facebook $40000. You can see why the advertising giants are worth trillions. Now, this arrangement is profitable to both you and Facebook, and will continue as long as it is. You are profiting $14000 a month, and Facebook $41000. It’s important to remember that this revenue stream is essentially composite - there are 2 very different modes that comprise it (the first being smaller, but with a higher margin, than the second). I like to think of it as a group of concentric rings, where the innermost small ring is your core business directed at your niche-lovers, and the outer rings are attempts to reach a broader customer base. What happens if consumer behaviour changes, though? For example, a recession hits and customers are 25% less likely to buy your product. Let’s think about each ring. In the first tier, on your organic platform (Etsy in our case), you simply sell 25% less product. Nothing else changes. In the second tier, rather than having to pay $10 to acquire a customer, you now need to pay $12.50. Instead of profiting $40, you profit $37.50, and you sell less posters and make less profit (75 * 37.5 = 2812.5 a month). Facebook makes the same $1000 a month here, a big win for them. But on the last tier, the story is different. Instead of paying $40 to acquire a customer, the cost has balooned up to $50. We have reached the equilabrium point where it is not profitable to sell to this demographic, since after all costs are factored in, you do not turn a profit. A shrew business owner would thus shut off this advertising campaign, losing $10000 a month of profit but, more importantly, starving Facebook of the incredibly lucrative $40000 a month it was previously earning. When it’s all said and done, you have suffered a ~65% loss in profit, but facebook has suffered a 98% loss in profit, all due to a 10% change in customer spending habits. It’s clear to me that advertising giants are in an inherently volatile position - where they can capture absurd amounts of profit when times are good, but suffer fast and dramatic losses when times are bad. I expect that the business sentiment around these companies will be equally volatile in years to come. We have already seen these dramatic ebbs and lows with Facebook, although it’s hard to pinpoint the exact cause. If you are an expert on this sort of thing, is there a name for it? If there isn’t, don’t mind if I coin one: Adverse Advertising Amplification, or AAA for short.

Fall 2024 During the initial phases of the covid pandemic, I once started up a small online shop that sold posters. We were very profitable selling on platforms like Etsy that seemed to have a lot of organic outreach to buyers that wanted our posters specifically, but of course, being the greedy capitalists that we were, we wanted to sell more to a bigger audience. Facebook has the largest of audiences, so we went there. Organic outreach on Facebook can be difficult unless you've carved out a niche with a loyal following, so Ads were the logical choice for us. When you're selling a product with a cost of, let's say, $100, you need to make sure that the total cost of selling this product is less than $100, and you pocket the difference. This includes your time, production, shipping, and finally advertising costs. For simplicity, let's say time, production, and shipping cost $50 per item. It's the last of these things which is the most variable. In our case, we were selling a very niche stock market related item. We could expect a very high conversion rate when targetting small, niche audiences that were interested in "stock market art". If we could target this small niche, we would have a cost per customer of $10, leaving us with $40 dollars of profit (100 - 50 - 10). This is clearly a profitable arrangement for both us and Facebook. The only limitation is the nicheness of the targeted audience - not many people are interested in 'stock market art' according to Facebook's algorithms. For the sake of argument, let's say we can sell 100 posters a month with this single advertising target. That's $4000 dollars of additional profit for us, and $1000 dollars of revenue for Facebook (of which nearly 100% is profit). Online entrepreneurs don't stop here though, they want to scale. They branch out from the niche target audience that is making them $4000 dollars a month, and begin targeting much broader categories. Perhaps they notice that men in the 25-34 age group are the most likely to buy their posters, and so they target this group as well. Now, this is clearly a MUCH larger population than before, but also less likely per-capita to be converted into a customer. What would be the expectation here? Many more people will be exposed to your adds, costing you money and generating Facebook revenue, but a smaller % of them will be converted. If you are lucky and have a good product, even though a much smaller % of them are converted, you will still end up selling a much larger total volume of posters. But at what cost? The lower conversion rate costs you, and benefits Facebook. For the sake of argument, lets say your cost per customer has skyrocketed to $40, leaving you with a paltry $10 of profit. Luckily for you, your volume has also increased, and the 1000 posters a month you sell to this group pockets you $10000 dollars, and facebook $40000. You can see why the advertising giants are worth trillions. Now, this arrangement is profitable to both you and Facebook, and will continue as long as it is. You are profiting $14000 a month, and Facebook $41000. It's important to remember that this revenue stream is essentially composite - there are 2 very different modes that comprise it (the first being smaller, but with a higher margin, than the second). I like to think of it as a group of concentric rings, where the innermost small ring is your core business directed at your niche-lovers, and the outer rings are attempts to reach a broader customer base. What happens if consumer behaviour changes, though? For example, a recession hits and customers are 25% less likely to buy your product. Let's think about each ring. In the first tier, on your organic platform (Etsy in our case), you simply sell 25% less product. Nothing else changes. In the second tier, rather than having to pay $10 to acquire a customer, you now need to pay $12.50. Instead of profiting $40, you profit $37.50, and you sell less posters and make less profit (75 * 37.5 = 2812.5 a month). Facebook makes the same $1000 a month here, a big win for them. But on the last tier, the story is different. Instead of paying $40 to acquire a customer, the cost has balooned up to $50. We have reached the equilabrium point where it is not profitable to sell to this demographic, since after all costs are factored in, you do not turn a profit. A shrew business owner would thus shut off this advertising campaign, losing $10000 a month of profit but, more importantly, starving Facebook of the incredibly lucrative $40000 a month it was previously earning. When it's all said and done, you have suffered a ~65% loss in profit, but facebook has suffered a 98% loss in profit, all due to a 10% change in customer spending habits. It's clear to me that advertising giants are in an inherently volatile position - where they can capture absurd amounts of profit when times are good, but suffer fast and dramatic losses when times are bad. I expect that the business sentiment around these companies will be equally volatile in years to come. We have already seen these dramatic ebbs and lows with Facebook, although it's hard to pinpoint the exact cause. If you are an expert on this sort of thing, is there a name for it? If there isn't, don't mind if I coin one: Adverse Advertising Amplification, or AAA for short.

About Me

Links