“There is an epidemic failure within the game to understand what is really happening. And this leads people who run Major League Baseball teams to misjudge their players and mismanage their teams.”
—Peter Brand, Moneyball
H Street’s 1,000% revenue growth was because we finally had the humility to realize that our success as direct-response advertisers had limitations. Previously, we were under the assumption that any advertising campaign with the right strategies and tactics, well-executed, could drive new growth for any business with which we partnered. This assumption was naïve.
Despite experiencing wild success for several clients, we would struggle in the most painful ways to scale other clients. We applied the same honed strategies and tactics that drove powerful gains with one client, only to see them fizzle out for another. We would also scale clients to dizzying proportions, only to have them pause advertising due to issues with cash flow.
Over a longer timescale and with more experience, we began to understand that we were dealing with much bigger issues than the levers we could pull to optimize advertising campaigns. More importantly, there are several contexts in which our clients operated that were not ready for advertising or where advertising would negatively impact the growth of their business.
Through some long and painful reflection, we realized that there are three important questions to ask before partnering with a brand:
1. Is there product-market fit?
2. Are the business economics strong enough for direct-response advertising?
3. Has the company reached a point in the marketing learning curve where it can advertise at scale?
In the following sections, we’ll dive deep into each question. Why it’s important to ask the question, what the question is revealing, and how we answer the question as specifically as possible.
Q1: Is There Product/Market Fit?
Direct-response advertising does not scale at a pre-product market fit stage. Even the most sophisticated and powerful direct-response digital advertising campaigns are limited by a natural fact: they are an accelerant, like gasoline. While brand advertising might ignite an idea in consumer’s minds about a product or service, a direct-advertising campaign can only accelerate the growth of that idea. Strategics and tactics in this realm of advertising are more aligned with the injection and allocation of that gasoline, not to start the fire, or build the engine that will run from this combustion.
Our advice to founders who are pre-product market fit is to not advertise. Instead, go out and sell direct-to-customers (preferably at least 100) and try to understand who your target customer is, where their needs are underserved, your value proposition in that context, what MVP would test this conclusion, prototype your MVP, and test it. Digital advertising is an expensive way to manage this process, and it's unlikely it will provide the necessary learnings to improve P/M fit.
While it seems like it’s a turnkey, high-leverage, scalable channel to generate new customers, if you don’t know the audience and the required messaging to get them to convert, you shouldn’t run ads. You will be spending thousands of dollars (or for venture-backed and aggressive companies) hundreds of thousands of dollars for results that are not actionable. Performance will be bad. If you choose to go the brand awareness route, you will deliver hundreds of thousands of impressions (potentially millions) to tell people about your product or service that they won’t care about…yet.
We identify this stage of growth by asking a series of questions:
1. How many customers do they have?
2. What % of those customers are organic?
3. What % of their customers are repeat buyers?
4. How is their churn rate?
5. What are their website conversion rate metrics?
6. What surveys do they have to collect feedback from customers?
7. Do they have a defined customer persona?
Q2: Are the business economics strong enough for direct-response advertising?
Some businesses do not have strong enough margins for direct-response digital advertising. When deciding if to run digital advertising for new customer acquisition, the business needs to analyze its unit economics and determine if there is enough profit margin to successfully run ads on digital advertising channels.
We have had several discovery calls where prospects either arbitrarily defined their CAC (customer acquisition cost), based their CAC on competitors, asked us to define their CAC, or set their CAC at an unreasonably low number. What the company must do is determine its contribution margin and acceptable profit margin, and then define its CAC.
Additionally, digital advertising channels like Meta, TikTok, and Google ads have ad delivery limitations based on the cost of serving ads to a target audience. These limitations are based on CPMs (cost to deliver ads to 1,000 people). Even if the ads had the best CTRs possible and the best website conversion rates a business could possibly generate, the cost to deliver the ads could make the campaign unsustainable.
The target CAC also needs to align with how these advertising platforms dynamically optimize based on the algorithmic learning curve. Platforms like Meta and Google ads require a minimum of 50 conversions per week to “exit” the learning phase and start optimizing. If it’s unlikely to generate that number of conversions, the platform will simply remain “stuck” in the learning phase.
Ideally, the business is ready to spend an advertising budget in a timeframe that will contribute to this learning cycle. For example, if the target CAC is $50, you need to spend at least $2,500 per week to generate enough conversions at that CAC to exit the learning phase. If these conversion windows are not being hit, there will be limited learning from campaigns to understand whether tests are successful.
We analyze business economics by asking the following questions:
1. What is your contribution margin?
2. What’s your LTV: CAC ratio?
3. What is your monthly advertising budget?
4. What is your total addressable market?
5. What’s your AOV (average order value)?
6. Do you have a subscription model?
7. Does your business depend on repeat purchases?
We also run the business through our COGS and Target ROAS calculator:
Q3: Has the company reached a point in the marketing learning curve where it can advertise at scale?
It’s very common for a company to have P/M fit but not know how to effectively market to their customers. Service companies are a great example. A law firm provides a service for a painful need, but they often struggle to differentiate themselves and speak clearly enough to their target audience.
H Street is looking for companies that have developed some success acquiring new customers and generally know what marketing messages have deterministically attracted customers in the past. We’re also looking for advertising campaigns that have achieved some modicum of success but failed to apply the rigorous process we’ve developed for scaling. This typically occurs when the company has an overworked and overwhelmed digital marketing strategist who does not have time to stay disciplined with advertising management, or they have hired a full-service digital marketing agency that is a jack-of-all-trades, but a master of none.
What we’re looking for is a spark and an indication that the fire is burning, albeit the “gasoline management” is poor. We thrive by applying our Five-Step Test & Learn process in combination with our proprietary methodologies around campaign management, creative development, landing page optimization, and email and text marketing. When successfully executing our processes and staying disciplined in our approach, we have repeatable learnings that continue to reduce acquisition costs and increase advertising spend.
We ask a series of questions to determine if prospects are at a point in the marketing learning curve to scale digital advertising:
1. Do you have a defined customer persona?
2. What pain do you solve for your customers?
3. Can you list five competitors, and if so, what makes you unique?
4. What does your brand stand for?
5. What resources do you leverage for creative development?
6. Have you run digital advertising before, if so, what happened?
7. Have you worked with advertising agencies before?
We also project, based on their past growth, what would necessarily need to occur in terms of advertising KPIs for their campaigns to be successful:
Conclusion:
The direct-to-consumer digital advertising game is dealing with the same reckoning that happened in the early 2000’s in the MLB. Advertising has relied on qualitative aspects and gut instinct to assess whether a brand will be successful in digital advertising.
Most advertisers are thinking like Phil Pote from Money Ball: “He passes the eye candy test. He's got the looks. He's great at playing the part. He just needs to get some playing time.”
When companies see campaigns underperform and experience a decline in revenue, they don’t know how to separate the qualitative noise from the underlying data that will tell them if their advertising campaign is successful. Specifically, what area needs to be improved in the contribution margin equation, or what “performance levers” need to be optimized in the conversion funnel.
Brands and advertisers need to dig down into the unit economics of the business and the conversion funnel metrics of the campaigns. If the math does not signal that digital advertising will drive profitable revenue, they shouldn’t be running ads. They should be focused on what factors need to be improved for the math to work.
