If you are in Facebook Ad Buyers Groups, ecommerce forums, or any other place where 9 out of 10 people have read The 4 Hour Workweek eventually you'll hear someone talk about "scaling up". The scenario is usually "I'm making 3:1 ROAS ($3 in sales for every $1 spent). Now I'm trying to scale up my spend.".
I'm going to let out a little secret I discovered in 2008. It's incredibly stupid to think that way unless you are building something like Amazon where the "flywheel" feeds itself. An example would be you are somehow able to build a marketplace despite the chicken/egg problem of needing customers to attract sellers and sellers to attract customers. In this case if you can somehow attract tons of new customers then you'll get new vendors which will allow you to gain new customers and the flywheel perpetuates until you've reach the maximum addressable audience.
But let's face it, that's not you. That's Jeff Bezos, and he's not reading the ramblings of a guy who schleps a couple million dollars worth of t-shirts per year.
Let's say you've invented a novelty product or even a product with some minor utility, and it's got some unique hook to it that allows you to get some momentum with Facebook ads. Heck maybe you've even achieved some PR. Life feels good. You can spend $1,000 a day and get $5000 in sales, or you can spend $3,000 a day and get $10,000 in sales, or you can spend $5,000 a day and get $12,000 in sales. What do you do?
Fast forward for you TLDR's out there: The smart answer is almost always spend the $1,000 to get $5,000 in sales.
But but but but.... you're arguing with me already. At $5,000 a day that's not even a $2 million dollar per year business. At $12,000 a day I'm up over $4 million and then next year we'll scale it to $7 million and on and on. And then the magical private equity guy who only buys businesses with $10 million in revenue will finally talk to me and I'll get investors and really scale this thing or I'll sell it for an 3X multiple of revenue because once you get over $10 million in sales the PE guys become idiots and pay out way more (this might actually have been true based on the amount of money dumped into former high fliers like NastyGal and ModCloth but these companies did not grow on FB ads).
So let's play this out. How do you get from $4 million to your magical $10 million? Here are some things to consider:
Product Lifecycle: Once someone buys one do they want more or are they good to go for a while? Apple can reliably sell an iPhone to the same customer every 2 to 3 years. If I have your product today when will I next want one? If your product is at all faddish and especially if your product has hit major retailers assume that you'll never sell to the same person. If your product has utility and wears out figure that out too.
This is why we add so many t-shirts to the site. It's a constant cycle of newness where we are trying to convince people that this new shirt is worth buying.
Marketing Channel: Everyone eventually hits an upper limit on paid marketing channels. On Facebook if you don't have a ton of different products you'll eventually run out of the most qualified leads and your ROAS will suffer. If you have a ton of different products that hard part about scaling will be the effort required to creatively advertise all your products.
If you are on adwords either you'll get competition which will drive bids higher or you'll be at the maximum capacity for your search terms. You can raise awareness of your product to drive search, but that's not really search marketing. That's paying google after you've already paid some other channel to drive awareness.
If you are on Amazon assume if you are too popular there will be a ton of "me too" products from third party sellers and probably even Amazon. If you are building a brand on Amazon maybe that's more sustainable, but my gut says no. Even if I search for your brand Amazon controls the search results, and Jeff Bezos has no moral problem getting his Space Company to Mars by shoving some things up Uranus (gotta admit I love good and bad Uranus jokes).
So let's get back to our spend $1,000 a day at 5 ROAS versus $5,000 at 1.4. I'm going to give you the benefit of the doubt and assume you've got a really good gross margin. Like fantastically good. Something like supplements or makeup may have even better margins and if you are in a business with higher than 80% gross margins maybe you should scale to a lower ROAS if you have a large addressable market and you've got marketing channel momentum. Let's say your gross margin percentage is 75%. So your cost of goods is $0.25 for every $1 in revenue.
At $5,000 in sales your cost of goods is $1,250. You spent $1,000 on advertising. Shipping $5,000 worth of goods a day is relatively easy, and you can easily keep up with inventory in terms of making sure stockouts aren't an issue and you even have some money left over to pay for all the bad decisions you'll make as an entrepreneur. Your gross profit is $2,750. You're probably making $500 to $1,000 a day after paying for employees and rent. That's a home run baby.
At $12,000 in sales your cost of goods is $3,000. You spent $5,000 on advertising. Shipping $12,000 worth of goods a day is a little more than twice as hard because you are a small company and your systems aren't that great. Your inventory is harder to keep up with so now you've gotta hire a part timer to help write POs and you need that same person to help in receiving because you are getting more goods. And oh shit the new lady ordering the POs keyed the wrong thing in on an order and you just paid $200 in shipping for a 1000 widgets you don't need, and now you've got to convince your supplier to take back the goods or you owe them $10,000 for inventory you never wanted in the first place. Your expenses have doubled. But your gross profit hasn't doubled. Your gross profit is $4.000. That's only $1.250 more than the previous scenario. Payroll weeks make you nervous. Now you're taking those weird loans from Shopify or Paypal or Amazon where the percentage looks good but it’s actually the monthly percentage. (In reality most credit cards charge similar rates to these offers.) But it's an investment in your business, right?
Next month you notice that your software bills are more expensive. Oh shit, you hit the next threshold for order volume or advertising dollars spent for your order management or Ads management platform. And you were so busy putting out fires because you're just making things up as you go that you forgot to turn off that Facebook ad for the coupon code that expired over the weekend. Your ROAS went negative.
People are starting to notice you since you are so big. You just got a patent troll letter. Do you ignore it or do you have to get a lawyer? You don't have enough money to pay a lawyer because you are stretched trying to scale your business. Your spouse or girlfriend is starting to feel like they never see you, and when they do see you your mind is on your business. She’s starting to notice the attention from that guy who makes $80,000 per year but only works 40 hours per week.
Everyone is getting crammed at the office and there's no more room in receiving. You pray that it doesn't rain on a day when you get a big shipment because everything has to be stored outside while you move things around to make room. Now you are paying your employees just to move stuff around in the warehouse.
Sales are a bit slower than you expected and payday is coming up, so you discount your products. Your sales go up, ROAS looks good, but your gross profit is worse. Don't worry you won't pay for that until you need to restock those products.
Ok, you get it now, right? I'm not saying don't scale, I'm just saying that you need to think through your numbers to determine what makes sense for you. And remember that you can't assume the sales growth lines only goes up at 45 degree angle.