Marketing Companies Will Win In Scale

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Photo: Philo Nordlund via Flickr

In my post about my current thesis, I mentioned three types of IT companies that I believe are poised to lock up markets and scale. I have written about two of the company types, information companies and technology companies, before. I wanted to dive into my thinking about marketing companies here.To be clear, when I use the term ‘marketing companies’ I’m not referring to companies that provide marketing services. Rather, I’m describing a category of companies that are poised to scale largely based upon their profitable marketing equations.

For those who aren’t familiar with the marketing equation, it’s simple maths that quantifies the unit economics of a customer. The marketing equation is:

     customer lifetime value

–   cost of acquisition        

     customer contribution

Marketing companies differ from information and technology companies in the way they create barriers and sustain their market position. Unlike information companies rely on data synergy and technology companies rely on high capex or R&D advantages, marketing companies don’t benefit from barriers that build with scale. They fight for and win each customer independently as each new customer derives little benefit from using a service that other customers use. This stands in stark contrast to the dynamics surrounding 1) information companies that benefit from network effects (buyers ebay are better off being where all of the other sellers are) and 2) technology companies (a hosting service gets better when they have more customers and can spend more money on enhancing their technology). While information and technology companies often become more attractive to each new customer as they scale, marketing companies have to win each new customer in isolation.

Marketing companies, however, can own categories. They key to their ability to block the competition lies in a vague, yet powerful, barrier called customer captivity. Customer captivity is a concept that primarily encapsulates switching costs and brand loyalty. Customer captivity is an interesting beast as it can even be present even when switching costs are low. Take Kayak for example. The switching costs in this space are very low – one aggregator is arguably nearly as good as another. Kayak, however, has a dominant market share. From my perspective their position persists because their service is already free to consumers and works well, there isn’t a lot of incentive for consumers to use their competitors effectively giving the site customer captivity. Marketing companies, like Kayak, Groupon and Constant Contact, that can profitably acquire customers and retain them can own markets.

The key for these marketing companies is to acquire customers as rapidly as possible since once a customer is acquired switching cost may prevent them from changing services. They’re in a land grab situation. As a result, barring a fundamental differentiator in the company’s service, being the first well-funded mover is usually of paramount importance.

In sum, scalable marketing companies have a seemingly simple model, they rely on rapidly acquiring profitable customers that they hope will continue to use their service.

This article originally appeared at Get Venture and is republished here with permission.

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