Rising CACs

“The Facebook magic machine is dead”

Ecommerce has seen astronomical growth over the last decade. But no one saw what the pandemic would do to the world of DTC. For the first time, US ecommerce sales will surpass $1 Trillion…that’s right —? $1,000,000,000,000.?

Experts didn’t expect sales to cross $1 Trillion until 2024.

But that growth isn’t coming without difficulties: inventory, supply chain, and shipping issues have all been highly disruptive to D2C brands, but there is a glaring issue that has arisen in 2021 that we’ve consistently heard from our portfolio companies – it’s gotten exponentially more expensive to acquire new customers this past year. Anecdotes across our portfolio of customer acquisition costs (CACs) rising by 2x is not uncommon.

When talking to an ecomm-focused founder recently, he summarized the acquisition challenge bluntly, “the Facebook magic machine is dead.”?

So what’s going on?

To boil it down, there seem to be two major trends that are driving the recent increase in CACs:

1. Consumer demand for online goods has never been higher and channels are limited. Demand for ad inventory on major digital acquisition channels like Meta (fka Facebook) is growing faster than FB’s user acquisition.
2. On April 26, 2021, Apple released iOS 14.5 that gave users more transparency and control over apps that want to track them for advertising. This has greatly reduced the effectiveness of targeted ads from platforms like Facebook, as 96% of iOS users have opted out of app tracking.?

Online acquisition channels are crowded

Since the beginning of the pandemic, the Federal Reserve printed more money and increased the money supply by 40% over the past two years, the largest two-year increase in history.? Below is a chart with the annual changes in M2 money supply since 1959:

In addition, the Federal Government has committed $4.5 trillion in Covid relief, a majority of that going directly to the American people through stimulus checks, unemployment programs, paycheck protection programs, etc.

So what effect did all this new money have on the economy during the pandemic? It drastically increased consumer demand for physical goods while the bottom fell out for demand for services (like travel). The charts below show real personal consumption expenditures (PCE) for physical goods versus services.

So as a result, 2021 was a record breaking year for ecommerce, with US consumers forecasted to spend $933 billion on ecommerce in 2021, up 17.9% YoY.? While brands (especially large brands) stayed on the sidelines and pulled back on budgets in 2020 due to the uncertainty with Covid, in 2021 they started investing heavily in digital advertising channels when they realized we were all staying at home buying things.

And while nearly 10 million online stores across the world were scraping and clawing for every inch of digital attention to capture this demand, Facebook’s user base has been growing anemically in the US and across the globe. With 2.9 billion users globally, they’ve basically run out of humans with internet access.? And this quarter for the first time in its history, Facebook reported a decline in daily active user numbers.? FB lost roughly 1 million daily active users between Q3 and Q4 of 2021. Below is the number Facebook DAUs worldwide over time:

So in a nutshell, demand for digital advertising channels reached an all-time high in 2021, but growth in the number of eyeballs on Facebook, a critical ad platform for D2C brands, was stagnant.? A classic supply and demand problem.??

iOS 14.5 privacy change rocks the system?

Facebook’s stock had a really rough week after announcing Q4’21 earnings, immediately dropping 21% and wiping out over $200B in enterprise value:

Several issues contributed, but on Twitter former Facebook exec Nikita Bier summed up FB’s current issues well:

Lots we could unpack here, but I wanted to focus on #4 – IDFA is referring to “Identifier for Advertisers”. Due to the iOS 14 change, Facebook is no longer able to rely on IDFA to target users with ads, a crucial and lucrative feature that digital marketers have relied on for years. In the recent earnings call, Facebook’s CFO said that the iOS 14 change could cost FB $10 billion in 2022.?

This poor earnings report likely surprised exactly zero digital marketers because they have been feeling the pain of increased CACs in digital channels over the summer and fall after the iOS 14 change was implemented. In several conversations with founders over the past few months, it is not uncommon to hear that CACs from digital channels have risen by 2x. This has severely hampered growth and increased cash burn for several D2C brands.

Opportunities for new tools and platforms to emerge?

So what can digital marketers do?? For starters, across our portfolio we are hearing lots of brands have success with TikTok (see #1 from Nikita above).??

But there are some more nuanced tactics, and for a VC firm like Peterson Ventures, we are interested in emerging technologies that will help digital marketers and DTC brands lower CACs. Below are some examples of categories that we are especially interested in:

Zero-party and first-party data

Due to the challenges of tracking users after the iOS 14 changes, marketers are challenged to know where their users and customers are coming from and how to measure the success of different marketing campaigns and channels.? As a result, marketers are starting to rely on tools that collect zero-party and first-party data:

• Zero-party data is data that customers intentionally share with a company; this can be obtained using polls, quizzes, sweepstakes questionnaires, or interactive social media stories.
• First-party data is data that a company collects directly from its audience; this can be collected from website and app analytics, CRM platforms, etc.

Some examples in this space are Jebbit that collects data via quizzes pre-purchase and EnquireLabs, that collects data via surveys post-purchase. For instance, a tool like EnquireLabs can efficiently obtain attribution data for word-of-mouth advertising and out-of-home (OOH) advertising.??

Customer Data Platforms

A customer data platform (CDP) creates a persistent, unified customer database by aggregating data across systems. Data is pulled from multiple sources, cleaned and combined to create a single customer profile. Essentially, customer-data platforms centralize zero- and first-party data, enabling companies to use that data for personalized experiences, manage customer profiles, and build targetable audience segments.

The estimated market size for CDPs is expected to explode between 2021 and 2028, growing from $1.1B in 2021 to $5.5B in 2028 at a CAGR of 25%.??

The CDP competitive landscape mostly consists of big-name brands that have launched a customer data platform as an add-on product, like Microsoft, SAP, Oracle and Salesforce.? But emerging leaders include Segment, Bloomreach and Tealium.?

With the ‘cookie-less future’, we believe there is room for other CDPs to emerge to assist brands with aggregating data to understand their customers.? A CTO of the one the brands in our portfolio recently shared that one of his major priorities is rebuilding the “customer graph” with proprietary tools after much of their data was wiped out after the iOS 14 change.??

Experiential Marketing

Experiential marketing immerses customers within a product or deeply engages them and the pandemic fueled new digital platforms that enable new shopping experiences.? For instance, one area within experiential marketing that emerged as a prominent trend is Livestream Shopping.? An example of this is a platform like Popshop Live that is a combination of QVC/HSN, social chat, live stream and commerce.??

This livestream shopping trend has been popular in China before the pandemic. For example, Singles Day 2019, Taobao’s sales event featured an eight-hour livestream with popular influencer Viya that attracted more than 43 million customers. In 2020, livestream shopping was projected to generate about $136 billion in revenue in China.?

Some questions remain about the viability of these platforms for retailers – if they can attract loyal customers and repeat purchasers – or if consumers are more persuaded by the celebrity or influencer.? But these platforms have the potential of providing exposure for brands without having to go through traditional digital channels.

Word-of-mouth and referrals

Word-of-mouth advertising has long been the holy grail of advertising. One of Peterson’s portfolio companies, Allbirds, exemplified this – people would naturally ask, “where did you get those shoes?”? Their word-of-mouth marketing was so good that in the early days their LTV to CAC ratio was 10:1.

Tools that help harness the power of word-of-mouth by enabling customers to be a brand's best salespeople are especially interesting to us. One of our portfolio companies, Wooly, enables brands to build community among their customers and drive referral sales.?

Out-of-home, Over-the-top TV & Offline media

With brands looking to alternatives due to the ineffectiveness of digital channels, out-of-home (OOH), Over-the-top TV & Offline media (e.g. podcasts, terrestrial and satellite radio) continue to grow and attract more and more ad dollars.?

Especially interesting for us are products that enable brands to measure the effectiveness of these campaigns and solve the age-old question of attribution.? AdQuick is an example of a company that assists brands with measuring attribution of OOH campaigns.

Creators and community

With the rise of the creator economy, creators are building niche communities and loyal followers around their content and products.? By accessing these followers, brands can target communities that tightly align with their core customer base.??

Pearpop is an interesting example – the promise is that it will enable a brand to access a creator’s followers as easily as buying a digital ad.??????

Contextual advertising

I was recently reading an article on TechCrunch about venture capital and I noticed an ad for Pipe, the revenue financing alternative to traditional VC funding:

This is a perfect example of contextual advertising – there is a high likelihood that readers of this article are entrepreneurs that are considering ways to fund their business.

Retailer websites are also getting more mature in their contextual advertising inventory. Amazon just publicly disclosed its Ad business is at an eye-popping $31 billion annual run rate and Walmart’s US digital advertising revenues are on pace for $1.55 billion in 2021, up 53.5% for the year.? And on Instacart’s platform, for example, the growth marketing consultancy Right Side Up recently stated in their newsletter that they went from managing $0 in Instacart ad spend in 2020 to $2.9M in the past six months.

The contextual marketing market is expected to grow from $157 billion in 2020 to $335 billion by 2026. The future of contextual advertising includes greater technology advancements in AI, algorithms, and customer mapping, including distinguishing not only context but also who would be looking at that text.??

Increase average order value and lifetime value of existing customers

Given the rising costs of acquiring new customers, it is more important than ever for brands to retain their existing customers and drive repeat purchases.? As it is commonly known, acquiring a new customer is anywhere from five to 25 times more expensive than retaining an existing one.

One of our portfolio companies, Rebuy, increases a brand’s average order value by 5-20% on average by offering personalized cross-sells and upsells throughout the customer journey.? Another example, Recharge enables brands to turn transactions into long-term subscriptions.????

The portfolio companies identified and described herein do not represent all of the portfolio companies purchased, sold or recommended for funds advised by Peterson Partners.?The reader should not assume that an investment in the portfolio companies identified was or will be profitable.?A full listing of investments can be provided upon request.