Digital marketing has helped to propel a brand to market leadership many times in the past decade and will continue to shape the startup scene. However, the effectiveness of digital marketing channels is declining and it is becoming increasingly more expensive on a per user metric. Enter the “buy-and-build” approach, a strategy which gives companies access to new customers via profitable growth and accounts for more than 50% of all private equity deals globally.
Digital marketing declines
Nothing can last forever, especially in a rapidly evolving environment like marketing. New marketing opportunities are discovered and then become saturated and ineffective. Take for example email campaigns: in 2003, emails had an 88% open rate and a 68% click-through rate compared to a 25% open and 3% click-through rate today. It has become less effective and more expensive.
Ad space has shrunk, and the use of ad blockers has increased. Internet browsing patterns have shifted from discoverable to actionable (short burst of activity), effectively reducing the total opportunities for firms to reach consumers. Bot traffic is increasingly fraudulent – around $12.5 billion (22% of total spend on digital advertising) was globally lost to ad fraud in 2015. Fiercer competition on the demand side gives more power to the supply side to inflate prices. Indeed, US advertisers spent 42 percent more on search in 2017, but the number of visits to the advertisers’ websites only increased by 11 percent.
It is envisaged that companies no longer benefit from marketing economies of scale which once saw their CPAs decreasing as their online marketing spend and user base increased.
Buy and build
This is where buy-and-build comes into play as a customer acquisition strategy. Buy-and-build refers to the process of buying a platform company with a well-developed management team and infrastructure, then scaling the business via horizontal and vertical M&A.
This concept can well be adopted to the start-up world. Throughout a wide range of traditionally very offline focused industries that are disrupted by digital challengers at significantly higher relative valuation levels, the opportunity for multiple arbitrage has emerged.
Buy and build can lead to lower customer acquisition costs. For example, a new online insurance brokerage recently gifted with large amounts of Venture Capital funding wants to drive its customer growth. Rather than spending money on largely unprofitable digital marketing initiatives, it could acquire profitable but stagnating offline based competitors (often regional and heavily fragmented) and integrate their customer bases into its own tech infrastructure. Rather than spending €500 per customer on online user acquisition, it could purchase an entire offline brokerage firm for €1,000,000 that most likely would have a customer base well above 2000 clients, thus a lower CPA.
The ideal industry for buy-and-build usually shows a fragmented market with low concentration, small average business size often correlating with business continuation problems, and high potential to realize economies of scale.
Another benefit of customer growth via buy-and-build is the availably of additional forms of financing for such transactions and the resulting growth. While traditionally startups have been heavily reliant on continuous VC funding given the unprofitable nature of their business, buy-and-build acquisitions can be financed with debt. Most targets are profitable stand-alone businesses and therefore banks are willing to finance an acquisition with the company as security. This can be attractive to mid-to-late-stage companies from a pure dilution perspective.
As growth via pure digital marketing becomes more and more challenging and certain B2C markets become saturated and ready for consolidation through digital incumbents, we do expect to see buy-and-build happening more frequently and eventually displacing digital marketing. It will be increasingly important for startups, Venture Capital firms and other intermediaries to develop the required expertise within their management and investment teams so that they don’t fall behind.