There’s three layers of revenue for any business: New customers, owned audiences, and existing customers. Maintaining the correct balance between these three tiers is crucial to sustainable growth. This week, Taylor and Richard explain how the “layer cake” metaphor helps ecommerce businesses focus on building a foundation of predictable revenue first.
Watch on YouTube
[00:00:00] Intro Ad: This episode of the E-Commerce Playbook is brought to you by Insense. We all know UGC video converts higher than most creative, but most of us don't have the time to find and manage collaborations with creators, that's why the creator marketplace from Insense doesn't offer you, and they're offering a $200 credit to all of our listeners, just go to Insense.pro or tap the link in the show notes to learn more.
[00:00:23] Richard: Hey everyone, welcome to the E-Commerce Playbook podcast, I'm your host, Richard Gaffin. I'm joined as always by the CEO of Common Thread Collective, Mr. Taylor Holiday. Taylor, how you doing?
[00:00:33] Taylor: A little tired, Richard. My daughter was not well last night was up and providing minimal sleep opportunities to US parents, but I'm gonna bring the energy anyways, I'm gonna champion through it.
[00:00:43] Richard: Well, incredible. And as somebody who just bought a new puppy, I feel like I can relate in the slightest way.
[00:00:50] Taylor: Very similarly illogical.
[00:00:52] Richard: Right, they do a lot of things that don't make a lot of sense. But I was bemoaning this to somebody who actually has kids the other day and they said, hey, dogs don't have opposable thumbs, so you're fine. They can't throw anything at you.
[00:01:02] Taylor: That's fair. Yeah.
[00:01:03] Richard: Anyway, so today what we're gonna be talking about, we're gonna be revisiting our occasional series on the e-commerce enterprise Scaling Guide. And for the first two iterations of this, we talked about the first two principles out of the three core principles that formed the basis of the entire guide.
So just to recap, principle number one was never judge performance by a single metric as expressed in the hierarchy of metrics. Principle number two was about not shrinking the sponge, or not squeezing the sponge too much, which is to say making sure that your net active customer profile or file rather, is kept full.
And then we're gonna tie it all together with principle number three, which is how we phrased it, is grow predictable revenue first. And the way we think about that, we'll get into it a little bit later, the core metaphor, but the idea is that there are three layers of revenue, for any business, there's new customers, owned audiences, and then existing customers.
And the way you think about the relationship between those three tiers is extremely important to sustainable growth. So Taylor, let's get into our core metaphor is the layer cake. Why do we talk about this in terms of the layer cake?
[00:02:16] Taylor: The reason I like to think about, and there may be a wrong baking term here to draw distinction between a layer cake, which is like three even equal layers and a tiered cake. And so the visual in the PDF, and we should throw that right here for the sake of our video edit. Is really a tiered cake, and the reason for that is that we're always trying to take ideas like revenue and decompose them into parts that are easier to predict and understand.
Revenue in total, very difficult to predict. It's composed of a bunch of inputs that generate that output, but as you begin to deconstruct it into layers, in this case, the bottom layer being your existing customer base, and then the middle layer being your organic new customer acquisition and the top layer being paid, new customer acquisition.
What I want to illustrate is one, that revenue is composed of those parts. So that's the first thing we're trying to illustrate, is to take one idea, break it down into its component pieces, to then be able to approach how to solve for it. The second thing though, is to illustrate how your revenue should be comprised and variably sized layers.
And the healthiest business, the ones that are the most profitable, move from the widest foundation being your existing customers, making up most of your revenue to organic new customer acquisition. Being the next size layer to paid acquisition being the smallest, and when you look at a, like a giant retailer or a long-standing legacy business, like if you looked at Nike's e-commerce revenue for the month of December, I promise you that's what their revenue stack looks like.
It's probably 90% from existing customers, cause most people are already Nike customers. And then it's a bunch of organic demand and then it's paid demand because that's what brand does for you. Most e-commerce businesses are what we call the upside down layer cake, where their largest. Section is actually paid new customer acquisition, then organic, then new customers, and that's early stage businesses.
And so we're trying to help them think about inverting that idea. So that's like why the metaphor helps is like, if the layer cakes two topsy-turvy, it tips over, it doesn't work, it breaks it follow apart. And so a healthy sturdy layer cake is one that moves in that direction. And also for the sake of forecasting is important to understand that the predictability.
In other words, how accurately can you forecast each of the layers? They become less predictable the more you move up the cake. So your existing customers are the most predictable set of revenue you have. Next month, the customers that you have already acquired are going to purchase some amount of revenue or some amount of product to generate some amount of revenue at a pretty predictable.
And that's gonna form the foundation of all of our revenue forecasting is the thing that is most likely to happen that we can predict with the most accuracy. Then as we move up the change, or your organic demand and your paid demand become far less predictable. In the top of the layer cake, the paid acquisition is where the most variability happens. So there's a few different ideas that we're using this metaphor to help people understand and illustrate.
[00:05:20] Richard: And at its core is stability and reliability.
[00:05:23] Taylor: There you go.
[00:05:23] Richard: That's the big layer is more stable, more reliable. Yeah, so here's a question then, as you had pointed out, we often see businesses that have this cake built upside down. And part of the reason I think that the upside down cake is such a good metaphor for this is because it just doesn't make sense, obviously. If you were to see your, an upside down cake or really this is like a wedding cake. If they were to bring your a cake into the wedding and the littlest layer was on the bottom, you know, you were about to have a problem, right?
And yet we see people bringing in upside down cakes all the time. So what I think is an important thing to address here is like, why does this happen? Why do so many people end up over leveraged on, and not adequately leverage on the other layers?
[00:06:04] Taylor: So two reasons, one is because every new business starts with zero existing customers. So in the beginning, the layer one doesn't exist, and that's fair, and that's just a reality of a startup. But that's not really what we're talking about here, the Enterprise Scaling Guide is built to 50 million businesses. So why does it happen at that level? It's because brands try to move too fast.
They outpace, the existing customer growth with their new customer demand creation. So in other words, if I know next month, okay, I was gonna get 1000 orders out of my existing customer base, if I want to maintain what we would call the healthy or the strong foundation or appropriately layered revenue cake, I cant acquire more than 1000 new customers, or I start to build an upside down revenue cake.
Now that may be okay. And there's some relationship where, hey, a pretty equally distributed cake 50/50 is a pretty healthy thing in most cases. And part of this has to do with how efficient is your new customer acquisition, right?
There's lots of variables here, but as you begin to accelerate, you will deteriorate margin. So let me try and illustrate this cause it's conceptually hard to understand. Let's imagine that like we do at Bamboo Earth, we're striving for basically a small amount of first order profitability on our new customer acquisition.
Okay? If all of our revenue in a month came from new customer acquisition, how much profit would we have? Like none, right, because every order is producing just the slightest or maybe even break even on first order. And some businesses are actually negative on first order. So every new order they generate actually deteriorates short term profitability.
So for bamboo Earth, what we've gotta think about is we knowing that every new customer that we spend is gonna produce present neutral revenue. No profit margin, in order for us to think about ensuring we reach the profit percentage or MER target that we want, we have to be careful with how much new customer acquisition that we do, because every time we add another dollar that we paid $1 for where the profit zero, the profit margin is a percentage goes down.
So we don't actually improve the short term profitability of the business at all, and that's fine because your profit in total dollars is gonna basically be whatever your existing customer base produces. And net neutral is still gonna be pretty good. Where it becomes really dangerous is when brands are willing to take a first order slight loss.
Then they have to be really careful because they can be really destructive to both cash and profitability, if every month they're going out and generating more and more negative contributing orders, you'll actually never catch up. Even though you're modeling this LTV to CAC that works, you'll destroy cash in the short term and potentially go out of business.
[00:09:01] Richard: One other thing I wanted to point out, and we can maybe have the editing put a graph up here as well, but this is included in the scaling guide as well. One reason that this tends to become a real issue and in some senses this is like at the core of this problem that we've been talking about in the scaling guide, which is that we used to do these things at work, now those things at work don't work anymore, what do we have to do?
And part of that is that when you reach this size or this annual revenue. You've already tapped out the majority of people who are early adopters of your product. So you hit this hump where the people who are gonna buy have already buyed and all of a sudden getting more people to buy and expanding the market becomes more expensive.
And so CPA is going to always increase over time, no matter what, so that's why you hit this point where all of a sudden building the layer cake properly becomes absolutely critical.
[00:09:50] Taylor: Yeah, that's a great point. And the graph that we have in the scaling guide shows this like perfectly linear up into the right CPA against spend and audience, and it doesn't of course work like that.
There are moments where you can make, your CAC go backwards even as you mature as a business, you run a great campaign, you launch a new product, you have a promotion. There's all sorts of things, but in trend it's up and to the right. So what happens is, even if you desire to maintain, the same amount of new customer acquisition, even if you aren't trying to scale aggressively, you're trying to spend a hundred thousand dollars every month, the amount of new customers that you're gonna acquire decreases over time, right as your CPA rises.
And so what can happen is if you say, hey, we want to get 5,000 new customers every month. The cost to do that is just gonna keep going up and up and up and up, and so your profit in the short term is gonna go down and down and down. Especially when you outpace like a simple bit of math is if you produce 10% LTV increase within 30 days. In other words, you acquire a hundred dollars worth of revenue, you would generate an incremental 10% within the next month.
If you increase your new customer acquisition beyond that rate, you will outpace the marginal expansion, okay? Because your existing customer file can only grow at the rate of that time value of the customers You aquire. That's a little hard to do it, and if we had a whiteboard, I could draw this idea.
But if I go from spending $100 to $120, but the customers I acquire went from $100 to 110. Do you see? I'm like reducing the margin, I'm increasing the cost, right? So you have to think about how quickly do I realize LTV, is gonna determine how fast I can scale my customers? And the more LTV you have, the faster you can scale your new customer acquisition.
But a lot of brands, that's not really the case, and they have slower LTV and they probably need to spend more time building a slower business and think about, letting the organic demand and existing customer demand build over time before they try and ramp up the paid demand.
[00:12:00] Richard: Yeah, that makes sense. And speaking of which, one lever that is frankly underutilized to build that foundation is the middle layer, right? Which is new customers acquired via organic channels. And our retention team bemoans us all the time, which is that email is, very underserved or is thought of rather as this is a technology from the nineties, we're not gonna spend too much time thinking about this. We've got our templates, we've got our one or two automations, we'll you know, hit and go and that'll be it. But there's real benefit here, right? To subsidize that CPA, even if your existing customer base or your LTV incremental growth isn't large enough to support that CPA.
[00:12:41] Mid Roll Ad: We talk a lot on this podcast about scaling your brand, but one key ingredient we don't mention much is funding. Adequate funding enables you to place larger inventory orders, invest more in marketing, and ultimately grow your business. And Q4 is one of the best times to secure funding because you can unlock the best rates.
Wayflyer's revenue based financing is faster and more flexible than traditional funding options, allowing you to get approved within hours and have cash in your account within days. No interest rates, no personal guarantees, no equity needed, just one simple fee. That's why thousands of e-commerce brands worldwide use Wayflyer as their go-to funding source.
To learn more about how funding from Wayflyer, you can unlock growth for your business and to turn the main event of Q4 into a record year in 2023, go to wayflyer.com or click the link in the show notes.
[00:13:28] Taylor: Yeah, that's exactly right. And when we say organic, I think it's important to define, we're speaking in sort of a google Analytic channel terms. So Google Analytics will break channels down into paid search, paid social, organic search, direct referral email. And so when we think about what are the organic versus paid channels, the organic channels are the traffic sources that you're not paying for on a pay click basis.
So again, organic search, organic social referral, direct and email. Those would be the five organic channels. Now, of course, somebody's like, you're paying for some of those somewhere. But in terms of a direct relationship between a click cost and that visit, they don't have a relationship. And so email like a simple way to illustrate this is, let's imagine you have an email capture popup for non-customers on your website and you're driving paid traffic to it. And right now you're capturing 3% of those emails. Okay? And those emails have a value, call it a dollar, whatever, to your business over time, if you improve that email capture from 3% to 5%.
40% increase in the total number of emails that you acquire, the amount of revenue that you will get out of that organic email channel for not yet customers, we're talking about new customer acquisition here still will go up dramatically over time in a way that will increase that middle layer for you.
And so that's like a little illustration of a channel that makes a big difference on how much future value you're gonna capture, and in ways that you can improve it. And in addition, brands that have the most leverage in their ability to produce profit, produce revenue in this channel or in this way, organic new customer acquisition. It's a reflection of brand awareness. It's a reflection of usually an owned audience, whether a large social follow, or maybe you have a TV show or a large YouTube channel, like you have some mechanism for driving attention.
But the brands, like right now, there's this Twitter conversation I'm having about the idea of brand. And I think one of the best measures of brand or brand awareness is how much direct plus organic search traffic you drive. The trendline of that is a measure of your organic brand awareness.
And so there are ways in which that middle layer, those brands they outperform all the other brands in the other layers too, usually. And so the middle layer is really this underrated signal of the overall health and potential of the business to produce highly leveraged revenue or profit, really.
[00:16:10] Richard: Do you have any quick tips for how to improve that sort of middle layer? Because I can imagine somebody coming into this, maybe their brand's, organic search position isn't that great. They're not a household name yet, but maybe they will be someday. Is it just more email sends?
[00:16:28] Taylor: If I was running e-com for a brand, I would have channel, traffic and revenue expectations every month, and strategies deployed accordingly. So if I think about organic search organic search is the strategy, there is SEO. SEO can come in a lot of forms that can be like specific keywords related to your product. You sell lawnmowers and you wanna win terms of people searching for the best lawnmower, and you're gonna write a blog and try and capture the SEO, and CTC, that's trying to win, best e-commerce agency and trying to drive traffic to our website with articles.
That's content marketing, that's a strategy that's important. There's also like really clever ways that there's a long tail game here. Like one of the best stories about this is masterclass. Masterclass, if you look up like how to cook some random recipe, like you'll find articles for masterclass chef courses with their top chefs.
They basically went into all of these really niche long tail searches that weren't directly related to masterclass. How much pepper to put in a soup, and they just grabbed up, they took this volume of content production and grabbed up this ton of long tail keywords to build a mountain of organic traffic to their website.
It's a brilliant strategy, so that organic search is a whole game that you can play for opportunity. This is where influencer marketing is a strategy on the organic social side. How do you drive demand for your business on the organic social side? You get people to post on social about your brand all the time, and they are, making content and driving awareness and doing all of those things.
So there's every person I follow on TikTok is suddenly trying to hawk a ridge wallet to me. I'm like, it's the run gum guy, and then all of a sudden he pulls out a ridge wallet and it's this arm wrestling guy, and then all of a sudden he pulls out a ridge, it's literally everywhere.
And they're not ads, it's just this repeated brand awareness that eventually drives intent when someone goes to buy a wallet. And so, that's organic social and that referral source. And then there's referral, which is like getting your link onto a bunch of website. It's back links. That's a big part of our business, right?
How many places in the world can people click on commonthreadcode.com or your brand.com? The more places it has the potential to be clicked, the more times it gets clicked generally. So building back links and referral sources, that's PR is another example of that. That's a whole strategy.
Generating PR drives, back links and referral, to your website helps reinforce SEO drives brand awareness, like it does all of those things together. And so there's a whole subset and genre of marketing efforts that go into driving those channels. And that's why you get to this old idea that there's no such thing as organic anything.
Everything is paid for. It's just a distinction and meaning, pure PPC versus more top of funnel marketing efforts,
[00:19:16] Richard: Right, there's no spend, there's no cost that scales with volume or whatever.
[00:19:19] Taylor: That's right, there's not a perfect linear relationship.
[00:19:21] Richard: Okay, so one thing I did wanna mention or talk about is that, and let me just play this out cause I don't know if this is actually a contradiction or not, and I don't think ultimately it is, but we spent a lot of time on the last iteration of this or talking about the scaling guide, rather talking about not squeezing the sponge. And then we pivot immediately into part three, which is do build up your existing customer base. So I guess there's not necessarily a contradiction there, but it, there is a certain amount of care that needs to be taken, to grow or take advantage of the existing customer base without overleveraging.
So there's a version of this where if that three layer cake doesn't have a top on it, that's also a problem. This is where maybe the metaphor kind breaks down a little bit because like there's no trickle down effect on a cake, but so yeah speak to that like thinking about, taking advantage of your existing customer base without underserving the top layer of the cake.
[00:20:22] Taylor: So I think this is where we get into this idea of why the net active customer thing helps build a visual data relationship between this idea. So the reality is you're always squeezing the sponge, right? Like you are always squeezing it lightly and you're squeezing it, as hard as the water is coming in. As fast as the new customers are coming in, the harder I can squeeze and realize the value now because I have more, my sponge never dries, that's the key here is that there's a flow in both directions, like in the acquisition of customers and the realization of their value.
The acquisition of customers, which generally isn't a value capturing activity to the actual value capture of those customers, like acquire customers that basically break even realize their value. Acquire customers at a small profit realize most of their profit, and the key is to just do that in proportion to each other, right?
Is to have this healthy, steady state of one or the other. It's funny I was just on a SATs Jam for the admission community and one of the brands was, we beat our revenue expectation the month of November by a hundred percent. And of course everybody's like, oh, awesome, way to go.
And then he's like, yeah, I don't know. I think it might be bad. I'm in the warehouse, I'm exhausted. Our customer service team is back loaded. We haven't been able to fulfill orders. We're not and it was basically like Facebook worked way better than we thought. And it's why is that a problem? It's a problem because you broke the expectation of the thing, and so you deteriorated the experience potentially and, now you went over dependent on the flow, like the sponge couldn't absorb the water basically in some ways.
And so the system isn't actually built. And so what I like about this sort of a sponge is this beautiful ecosystem that if there's too much water, it just all spills over, and if there's too much squeezing, then it dries out.
And so what you want is this saturation, and that's like the perfect growth rate for the business. Is this healthy, sustain, marginal value that has both new customer acquisition expectation and existing customer revenue expectation. And so every month you can't just have a revenue goal, you have to have customer level goals as well. And that's what this is really intended to help you illustrate, to avoid creating excess in either direction.
[00:22:36] Richard: Right, and actually, I was gonna say like maybe we can un unpack that a little bit because yes, there is such a thing as winning too hard and part of what you're pointing out what this helps.
Is showing you what revenue is reliable and what revenue is less reliable and where you should. Not only is the bottom of layer of the cake, a foundation for revenue, it's also a foundation for your forecasting and for making sure you don't get into those situations. So maybe you can, talk through that a little bit.
[00:23:01] Taylor: When I go to, I'll use our business and I'll come back as an illustration of another business. Every month we have an expectation of a certain number of new customers that start at CDC.. We use that model to plan the service side of our business. How many employees do we need in order to service that number of new customers?
If suddenly the sales team came to me and said, great news, we have 10 new customers this month. That may sound awesome, but I have no employees, and so the only way to get there is to overextend people, to make them do that, which would deteriorate the quality of the work, which would lead to dissatisfied customers and cause an increased reduction of the customer return.
When you plan a business, you plan, not just the amount of revenue you're gonna make, but the capacity to service that revenue. Whether you're a service business or an e-commerce business, how many e customer service reps do you need? How many people do you need to staff the warehouse?
How much inventory do you have available? And when will I need to purchase again? How is my cashflow planned relative to that? When can I hire new employees based on that cashflow? The dynamics of all of that. When you move wildly in any direct, up or down? Yeah, up might be less of a problem because now you've got privileged problem and money can help solve that a little bit, but it still creates indigestion in the system.
In a way that we would recommend that in the instance that you're more efficient than you thought. What we would encourage people to do is bank future revenue. What does that mean? Well, if you, let's say you spent the first half of your ad budget in the month and it was twice as efficient as you thought?
What I wouldn't recommend doing is not spend the second half of the money, but spend the second half of the budget acquiring owned audiences for the future rather than drive the revenue way up, don't do that cause it indigestion. By emails and audience that later can represent free new customer acquisition in the month when things aren't as efficient.
And so I think that's actually the trade off that when you're trying to build sustainability, you're trying to build anti-fragility, there is risk to going too fast, even if it's cause the getting is good and there's risk to going too slow. And so I think planning and thoughtfulness is how you execute business consistently.
And going too fast can be dangerous in the same way that going too slow is or squeezing the sponges is
[00:25:19] Richard: Okay, so practically speaking, walk us through how to use this model. How would you use the revenue layer cake?
[00:25:25] Taylor: Yeah, so the simple thing that I would ask yourself is, do I have an expectation next month of how much revenue is gonna come from new customers?
How much is gonna come from existing customers? Am I able to break that new customer segment into organic and paid, and how am I performing relative to that? And I'm, I become conscious of the composition of your revenue, and then you'll begin to understand how it affects profitability. So step one, become conscious of it.
Track those numbers, plot them over time. Think about what that relationship does to your profitability, and begin to develop ideas about what you want in the future and how you can use that to plan and forecast your revenue.
[00:26:01] Richard: Thanks again for joining us for the E-Commerce Playbook podcast. Please remember to rate and review if you're watching on YouTube, like and subscribe. If you wanna learn more about the Enterprise Scaling Guide, read up on the layer cake, the hierarchy of metrics. Check out the link in the episode description.
And on top of that, our expert strategy team is still putting together audit packages for 2023, if that's something you wanna get in on. If you wanna kick off January with a clear roadmap to growth, even through tough times, there's no better way to kick off your journey. If you wanna know more, go ahead and drop us a line at commentarycode.com, we'd love to chat. Have a good one, folks, and happy scalling.