This Guide Will Change Your Business

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[00:00:18] Richard: Hey everyone. Welcome to the E-Commerce Playbook podcast. My name is Richard Gaffin. I'm the self-styled professor here at Common Thread Collective, and I'm joined today, as always by Mr. Taylor Holiday, CEO here at Common Thread Collective. Taylor, how you doing? we're podcasting in the early morning. It's 8:38 AM here on the West Coast. 

[00:00:37] Taylor: You know, it's funny, I'm uploading some clips right now from our last episode, and I have a beard, and now I'm very freshly shaven this morning. So I'm feeling a little vulnerable without my beard, 

[00:00:47] Richard: No, you look, five years younger or whatever.

I can only look on it with jealousy because I can't grow a beard at all. So I can only imagine what it would be like to be able to change yourself that much, you know, over a course of a couple days. 

[00:00:58] Taylor: I'm feeling good cuz we were talking earlier off camera about your Phillies hat, which hearken back to your Oh.

early nineties. Love of sports before you became a world class musician. But I also just noticed your blockbuster sweatshirt, so you're That's right. You've really thrown it back today. Yeah, 

[00:01:13] Richard: well, it's not early nineties. I'm not that old. This is more of an early two thousands things, but yeah.

Okay. Okay. Just celebrating two things that are very important to those of my generation. Yep. Which is the Phillies, well, I mean me specifically, I guess, but Yeah. going to the series. Very exciting stuff. First time since 2009. So today we're talking about, something you guys may have heard about out there.

The Enterprise Scaling Guide. We've been talking about it for two or three months now. and essentially what this is, it distills all of common thread's, philosophy on e-commerce growth, and how to scale a business into one document. Essentially, this is about a hundred, 120 pages, worth of information on How to grow, how to measure your business's growth, how to model future revenue, so on and so forth. it comes in about in four parts, but today we're gonna be talking about just kind of the introduction and then part one, and part one goes through what we kind of talk about as the three basic pillars of e-commerce growth.

And we're gonna be talking about part. Pillar one, which is the hierarchy of metrics, which is kind of the thing we've been alluding to it in over the last few episodes anyway, because we talk about this a lot. but I wanted to kick it off by talking about the introduction a little bit and introducing what this guide is.

And so I feel that I'm I'm able to speak on this a little bit because I wrote a lot of this, first part here along with, our good friend Aaron Orndorff, and. Essentially how this is built, It's built around the idea that once you hit around $50 million in annual sales, you reach a sort of plateau for a while.

You've been pursuing a strategy that works, generally speaking, that involves relatively cheap acquisition on Facebook. You've been able to push on that channel and really get your business to a place where you feel proud of. However, once you reach that kind of 50 million mark that starts to plateau, the things that you've been doing have stopped working, and yet inevitably there's still gonna be pressure on you to continue to grow the business at a profitable margin.

And so what do you do? we come across so many clients who come through CTC who have this exact same problem. So this is essentially our. Of, if not giving you a definite solution, giving you a framework to find the solution that will work for your specific business. so I guess if I could distill what the core principle is and then Taylor, I'll have you talk about it a little bit.

The idea here, And we frame it in the scaling guide as the solution to 50 million plus growth is so counterintuitive, it simply doesn't occur to most marketing directors. And that may be a little bit of an overstatement, just for the sake of getting you to continue to read. However, the idea or rather that thing that is counter counterintuitive is that you're going to have to, on the top, on your acquisition, lose ef.

You have take a higher cack and a worse row ass for the sake of growing in the long term, growing your ltv, so on and so forth. Taylor, frame that? How would you word that? 

[00:04:14] Taylor: Yeah, there's a couple of important things here. One is the $15 million numbers sort of arbitrary.

What it's intended to represent is a stage of maturity and we're gonna focus this conversation specifically around, Let's call it digitally native brands. Brands that grew up on the internet as their primary point of distribution reach, where they are beginning to see this primary growth driver that they've had most of their lives as a business exist on, which is hyper efficient, new customer acquisition, deteriorate in some capacity.

And they are businesses that have run very e. For many years, and when I talk about efficiency, what I mean is that they're used to running in the eight to 10 MER range, which for us is marketing efficiency ratio, which is just total revenue over total ad spend, such that their marketing is a percentage of their total revenue would be somewhere around 10%, somewhere in the 10 to 15% range.

And that's how they've been able to exist for most of the life cycle of the. So their business begins to build the infrastructure around that premise. So we have this other framework we call four Quarter Accounting, which is just sort of looking at the division of a brand's revenue across four categories, cac, cost of delivery, opex, and Profit.

And what happens oftentimes is businesses get ingrained into a structural composition. That requires their marketing to remain at this specific level this hyper efficient 10 to one. And so what happens is as a brand's customer file becomes large enough as that new customer acquisition becomes less efficient.

And I don't mean running at a loss here. I wanna be really clear. We're not suggesting you go light money on fire in the name of ltv, but we are saying that there's going to be some degradation in. What we see happen a lot is that as that occurs, what brands begin to do is they do what we call squeeze the sponge.

They move to depending less on new customer acquisition, and they depend more on squeezing revenue out of their existing customer base, cuz it's large enough to sustain that actually for a little while. They probably have hundreds of thousands of customers at this point, and so they begin to set off a cycle.

That is very dangerous, which is short term profitability extracted from their existing customers and negating the constant influx and demand creation around net new customers that sustains long term healthy growth. And so that's what we're beginning to set up as the problem that the scaling guide is predicated on helping you solve.

[00:06:59] Richard: Right. yeah, no, it's a good point around, well, two things. One, the 50 million being sort of an arbitrary number. I would say, the way I framed it also is that, You've been growing, you've been growing, and now it's plateau. Like if you're in that situation, you've been growing in a way that's, that you have, I always frame it as like, felt proud of or has felt sustainable, or you felt like you're really doing something, you're really growing and then you hit a plateau.

The scaling guys for you there? But then I think like, this is a really good segue. We can get right into the hierarchy metrics because it's so fundamental to this problem, which is you mentioned that eight to 10 mer, right? You have set that up as your success metric, let's say. Yeah. And more likely you've set up sort of single channel ROI targets, right?

Which are sort of similar, right? And you hit this plateau, and your only way to judge success is whether or not you were continuing to hit the eight to. You're continuing to maintain that efficiency. You're still in that MER range when in actual fact you have to be able to accept a lower MER, and actually you'll find that the long-term success and long-term profitability of your business will be positively affected by affecting or by accepting that lower mer.

So that's right. Anyway, the point being like that one metric, you kind of following that single goal is the thing that's causing the problem to some. 

[00:08:16] Taylor: That's right. And so, so often people build these constraints around percentages. they build the constraint of growth around not total dollars in, say, contribution margin, which we would suggest, or even operating income or net profit.

They build it around a percentage. So marketing has to remain a percentage of total revenue or the operating profit has to remain a total percentage. And the danger there is that not. every season, you know, has the total potential to generate that kind of efficiency.

I think about it a lot like going to run a marathon. there are days when you go to run the marathon and the wind is at your back, and so a great time in that marathon would be a faster expectation than if you went out and there was a 15 mile an hour wind in your face. . So you would not hold yourself to the same performance standard in those environments.

And so sometimes I think it's really critical though that in those moments of headwinds, and let's even say the era that we're in right now is that you don't sacrifice continuing to drive new customer acquisition so that when the wind becomes at your back again, what you are able to realize in terms of the available profit is so much.

now you have to avoid the opposite scenario too, which is that you don't get hooked into building an infrastructure around this level of efficiency that actually could be greater too. And you always drive to the red line. And so you have to understand in each moment what you're attempting to accomplish.

And the scaling guide is really about a model to think through sort of 

[00:09:48] Richard: Exactly this, Right? Exactly. Yeah. We're not saying. MER or measuring MER ROI is in and of itself bad. That's not, that's of course not true, but it is only meaningful in the context of the other metrics surrounding it. That's right.

And so I think what happens if you're not thinking about the context in terms of seasonality and then sort of the other metrics in the hierarchy, which we will discuss, you get into a situation where, The only acceptable scenario is to be going at that eight to 10 mer pace, let's say, to use the marathon metaphor.

And you have to be going at that pace all the time. And in order to go at that pace all the time, you have to start, stop acquiring new customers essentially, and start pouring all your money into current customer acquisition or that's retention rather. so with that being said, let's get into the hierarchy itself.

So obviously we've been talking a lot. single channel roaz or, mer or rather, we've been talking about these single metrics or these single efficiency metrics that you should not be going after. However, we do start off the hierarchy of metrics with a kind of one metric to rule them all. so maybe actually let's first kind of set up, so you kind of call it the e-commerce Pyramid of Success, right, Taylor?

So, maybe gimme some of the background behind the hierarchy and how you came 

[00:11:04] Taylor: up. . Yeah, so There's two people that have sort of informed my thinking of this, and either of them are business people specifically, but first is John Wooden. Obviously the pyramid success and the Pyramid of success is predicated on the idea that if what you want at the top is competitive greatness, which is just another clever way of saying winning, right?

Competitive greatness, then that output is a function of a whole series of. . Right? And so when we think about the hierarchy of metrics, the point is that the pinnacle of the pyramid is the scoreboard. That's the primary thing that you're ultimately going to try and measure yourself against. But it's not actually the mechanism, it's the output.

It's not the input. Right? And so that's what the pyramid is successful is all about. It's about the. Competitive greatness is at the top. And for us, if what we want is contribution margin, which as a marketer, we would say is the closest proxy to profit. Cause we don't control the Outbacks. That's sort of my witty little marketing phrase that I'll say

But that's the first thing that I thought about was like, okay, if the output that I want is contribution margin, what are the inputs that I need? The second person that informed my thinking aloud on this is a statistician by the name of George E P Box. Okay. Real math nerd here. and he talks about building data models and he says this phrase that, all models are wrong, but some models are useful.

Okay? So all models are wrong. And he goes through and talks about like, you know, physics formulas for predicting the gas of certain particles and blah, blah, blah, and how they give you sort of this relative. But if the goal was to be a hundred percent objectively true, that it's useless, but that's not actually the point.

It's to be directional. And then the other thing he would say is that the purpose of a great model is not just about attempting to be right, it's about understanding where you are importantly wrong, so that you can adjust and take action. And I really have come to believe that forecasting, which is really the exercise we're talking about, how do you build a model to predict the future in a way that gives you a framework to operate?

Is as much an exercise in execution as it is in model building, right? . . And so we wanted to think about building a hierarchy of metrics that could create the foundation for what would actually be a day to day operating model of how to run your e-commerce business and execute against the premise.

Because any operator knows that. You don't just write a spreadsheet and go, Well, let's see what happens in 30 days. We'll check back in and hope, we were right. You are actualizing against that idea every day. The model is useful if it can very quickly help you to illuminate where you are wrong and make adjustments, and so the hierarchy of metrics sets up the output, and then all of the critical inputs in hierarchy of importance from top to bottom that we think that you should be measuring or forecasting, measuring and improving every single.

Yeah. 

[00:13:49] Richard: it's a set of metrics that I think creates a certain set of behaviors, maybe, which is another way to think about like, that's right. When you have that single metric that you're shooting at. Without any context around it. Oftentimes you can treat it as sort of like it's guiding you somehow.

like you can't really affect it per se. You've made the model. You just need to hope that it kind of ends up that way. That's right. Whereas with when you have a series of metrics, you are not beholden to the metrics per se. There's something that you can control, that you can sort of measure and look at, and then adjust your behavior to a, to hopefully affect those metrics.

[00:14:22] Taylor: That's. The key, of the hierarchy, premise, Lost thing, is that they're subservient to one another. What do I mean by that is that you're allowed to change the second layer to improve the first layer. You're allowed to change the third layer, to affect the second layer so metrics that hold supremacy in your behavior move in that order. And so oftentimes what we see is as we go through these, you'll see that marketers often flip them. They definitely move in the opposite direction. where Is then the bottom for us, which are channel specific performance like ROAS or cpa, end up becoming the governing principle to rule everything.

And that's when things get really screwed up. And so it's really important just like a hierarchy of effects model like ada, where things have to move in order attention, interest, desire, action. our hierarchy of metrics. It's important that each layer is subservient to the one above it, in terms of how you guide your decision making.

Right. 

[00:15:14] Richard: Okay. So with that in mind then, let's start at the very top, the most important. I guess we've called it in here the financial metric. Yeah. But it is sort of the one metric that pushing for, which is, or the one goal you're pushing towards, which is contribution margin.

so explain how this isn't a one metric to rule them all. 

[00:15:33] Taylor: So I think about. The scoreboard is still the end output that I want. But here's what I would say. You are allowed to trade this out. Yeah. If you have a business objective that demands it. So as an example, if you were to say to me, Taylor, I'm a small business item, not quite at 50 million.

I actually wanna measure all the way down to operating income cuz I do control Op X and I'm the founder and. The reason we say contribution margin financial metric is because we believe that a business exists to produce a financial result. in some cases, maybe that's revenue growth and you are like, you know, predicated that your entire business is about market taking in this moment, and that's what drafter, I'm okay with that.

But for us, we are saying in the event that we get to choose, or when we run our own businesses in Bamboo Earth and four by 400, this is the governing that we would give to ahead of. Cmo, a marketing leader is to produce contribution margin, which takes into account both revenue and cost. It creates alignment between demand planning and demand creation between product costs and marketing costs and revenue.

Between returns, right? So, and quickly we'll define contribution margin cuz there is some debate about what should be included in that definition. It's not a pure gap term, so we would call it as net sales. So order revenue after returns, minus cost of delivery, which is a phrase we've made up to describe every variable dollar.

That goes up as orders go up. So this is cost of goods. These are transaction fees, these are shipping fees. Pick pack fees, your merchant processing fees. Every cost that goes up as orders go up is your cost of delivery. And then third is ad spend. We would take it ad spend. So net sales minus cost of delivery, minus ad spend.

ad spend is the one that people will debate, whether it should be included in contribution margining, cause it's not perfectly linear with orders. I understand that. But for the sake of what we're trying to evaluate as a marketing. Whereas a group responsible for growth, that's a critical component of that generative value of dollars.

So for us, net sales minus cost delivery, minus ad spend equals contribution margin. And that's the driving goal that we're gonna set. The whole organization's gonna have a KPI or objective. 

[00:17:44] Richard: yeah it's any cost that could be affected by you kind of pouring on the gas, on your marketing efforts too.

Right. I think that's one thing the contribution with margin really helps with is that it kind of bridges the gap between ops and marketing. so that there's some understanding of if we kind. Turn on the gas in terms of our, how we're pushing our marketing that's going to have an effect on the amount of product that goes out the door and the amount of cost against that product and so on and so forth.

So normally marketers aren't thinking about that stuff at all, but if that can kind of be in your head as well, then you're sort of more united in your effort, I think. 

[00:18:20] Taylor: totally. This is actually really, is that the introduction of cost consideration at the product level.

Probably one of the more novel advancements for a marketing department to begin to take on. Yeah, right. I think it's very common for them to be responsible for revenue or to be responsible for a roaz on their ad dollars, but as a consideration of the marginal value creation from their sales, it forces them to think about what's the margin of the pro?

What am I selling and why? What is the discount rate and how does that affect my overall income? It just adds a layer of financial depth to the consideration of the marketing efforts. 

[00:19:01] Richard: Right. Totally. Yeah. This may be a good topic for another podcast actually, because it is interesting to think about like if your marketing team is pushing towards just like generating top line revenue, they could be pushing a product that ultimately loses you money at the end of the day.

Right. 

[00:19:16] Taylor: Especially ahead of Black Friday, Cyber Monday. Right? Like that's a big potential. 

[00:19:20] Richard: Yeah, exactly. okay, so if that's at the top, contribution margin or whatever other metrics you sort of use to judge the financial success of your entire business, the next layer, we've called in the scaling go, we've called the business metrics, and this is order revenue, ad spend, MER and aov.

So to some extent those are kind of like the metrics that make up contribution margin from the marketing end, but. let's get into those a little bit. So talk to me about those four metrics, what they mean and how you should be tracking them. 

[00:19:48] Taylor: Yeah, so order revenue, this is an important distinction because a lot of businesses track various forms of revenue, is what I mean by various forms.

There's gross revenue, there's net revenue, there's order revenue, there's Shopify's default is something called total sales, which is order revenue after returns, right? Like, so why do I prefer order revenue? At the business metric level, I'm interested in the total generative value of my marketing efforts.

Generative value, meaning for dollars spent, What is the dollars returned in terms of what the customer is paying me? So order revenue is every dollar that is processed by the customer. Now at this point, if returns become an issue, that's a problem to solve in a different way. But my marketing still sold the.

right now. there's all sorts of little caveats here that somebody's like, Well, what if they're doing a try before you buy a program? And they're not cons like, Yes, okay. There's edge cases. There's al always will be. The point is I prefer order revenue. And my favorite example to use of this is one of the things that we run into all the time in January is that we'll have a business that's reporting MER on a net sales basis.

Well, December is usually your largest revenue month and your highest return rate month. But because those returns show up in January, so you have more customers than you do in January. December's usually more revenue than January in a lot of cases, and you have a higher return rate. If you use net sales to determine your MER.

In January, it's going to appear. That your marketing is way less efficient, but that's not actually what's happening. What's happening is that you're dealing with an influx of returns off of the December cohort of customers, and I use that point to illustrate why a net sales against MER number can distract you from what you're actually doing now, what like value creation that you actually have now on your revenue.

And so we would prefer to use an implied return. That we actualize very regularly to ensure and track against, instead of the actual netted out returns from the previous month. So hopefully that makes sense. And the January example sort of illustrates why order revenue. and then spend is obvious, and I would include this as all marketing spend, meaning all advertising, marketing spend.

I wouldn't, some people will include, and this is again, there's personal preference here. Some people include influencer spend. They'll include their content creation budget. In this number, this is where you're just getting into accounting premises. The point is that you're consistent and everybody's clear on your team about how you measure it and what the goal is for the production of it.

But that total spend, then you have mer, which is just those two numbers divided against each other or often referred to in larger organization as a cost average. Cost of sale or ad spend is a percentage of revenue. Those are all ways that you'll hear the same metric referred to each. That's just to give you a sense of how much of my revenue is being given to that part, how much my revenue is deteriorated in me media spend.

And then the fourth is aov. And again, a O v, which is a metric I've often criticized, but it's important to think about cuz it gives me a glimpse quickly of what I'm selling because it shows me the composition of the products and the value generated according. . And as I think about an important metric we're gonna talk about in a second, which is my weight to new customer cac, I probably have to break AOV even more specifically up into first time AOV and returning customer aov.

And if I do that, I'll get an even more specific glance of what kind of value I'm creating.

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[00:24:30] Richard: would it be fair to kind of characterize these four metrics as. The metrics that marketing is most responsible for, perhaps particularly in terms of order revenue. It's like your marketing team doesn't really affect whether or not people hate the product.

You know what I mean? And so pulling that out of it is important to judge whether or not you're actually doing your job or you're actually doing marketing properly, 

[00:24:50] Taylor: essentially. That's right. It's funny, me and Nate, Pauline, were going back and forth about building the modern.

Marketing org chart, and this could be a fun episode here soon. . But if I were to do it, basically I would have a growth department and a head of growth would, basically be over a mar head of marketing because I would have a product in marketing sit next to each other and growth sit over the top of them, and growth would be responsible for contribution.

Marketing would be responsible for these business level metrics, and then product would be responsible for things like return rate and Ultimate they would have a shared metric around, you know, marginal sale value, like different things like that. But the point is, yet you're exactly right, marketing.

I'm not gonna dismiss their entire responsibility for the experience of the product, because I think the promise that they make in the ad sure is what sets up the expectation for the user, of the product ultimately. But yeah they can't on their own. Create margin in marketing. Right? That's gotta happen at the product level at some point, So, but yes.

That's why I think the marketing department's ability though, to spend dollars to generate revenue at a specific efficiency with a specific average order value is a clear set of responsibilities that you can assign to that portion of your org. . . Yeah. 

[00:26:00] Richard: And actually even then, breaking out order revenue from returns would be important because if you were able to look at those two metrics separate from each other and see that there was a huge return rate on this specific set of products that was being advertised, then you could begin solving that problem.

Maybe people hate product, but maybe the ads are bad. Whatever. it just gives you more clarity. So, okay. Then roll down to the third, tier of the pyramid here. and this is where we get kind of the new customer metrics. And a lot of these might be kind of novel to some of our listeners.

I don't know. but, so basically they're new customers, which would be total number of first time orders, new customer acquisition cost, or n which is first time orders divided by new customer ad. acquisition marketing efficiency ratio. So a so new customer, mer, essentially. And then finally, repeat purchase rate, which is total transactions divided by returning customers.

So break these down. Why should we be measuring these? What's the point? How do they ladder up to everything else? 

[00:26:51] Taylor: Okay, so this is the layer most often neglected inside of organizations in terms of monthly goals and expectations, and it's the one that's the most destructive for the problem that we set up in the beginning, which is this idea of the shrinking sponge, which is, if you skip this layer and your only goals are revenue ad spend, and then you jump all the way to the channel level ROAS for your Facebook ads, There is a very good chance the larger you get, that you will watch your spend begin to move more and more to towards the bottom of the funnel, into existing customers, to the detriment of the growth of the better end in the long term. , this layer is critical to your success every single month.

And so if we go through them again, you mentioned, I'm gonna try and repeat them in the same order that you gave me them. , total new customers. every month. You want to think about the composition of all of your transactions into first simply two categories.

How many purchases am I gonna get from existing customers and how am I gonna get from new, And I want that. We call that the revenue layer cake, right? And then you could break new into organic and paid, but just for simplicity. Two layers, existing customers new. You wanna have a numerical expectation of each of those layers in terms of the total number of purchases every month.

And you wanna have an eye on that and those new customers, because remember, today's new customers are tomorrow's existing, They're next month's revenue and the subsequent months revenue. Cause they produce revenue from this day forward forever. And so getting new customers is always going to have the largest incremental value on your future revenue.

So you gotta have an expectation there. Then you want to have an expectation of the efficiency at which you acquire those new customers. this goes into, A video I talk about, around Roy, return on invested capital, where you have an idea of what is the expected efficiency at which you're willing to pay or what is the expected.

In which you're comfortable continuing to spend against new customer acquisition. Now that we would use a calculation like first order value, big V value, like net value over C as setting an expectation here. Some people, it's break even on first order. Some people want 20% profit. Some people would be willing to lose 5%, whatever it is.

That first order value, meaning first order revenue minus cost of goods over. That's your target. That CAC becomes the target, n C weighted cac, whatever you wanna call it. That becomes a really important number to keep an eye on and really important to keep an eye on in relationship to first new customer average order value, Those two in relation to, right?

So that's the second thing. Then a EER is just an efficiency measure of new customer revenue over total ad spend. So if you're used to looking at things in a row ass basis, Or a MER basis that you may be more comfortable with that number versus N cac. The reason I like them both is because the, a mer at glance gives me a sense of, if I increase my spend against this a mer, what am I gonna do to my total mer?

 And this goes back to our earlier point. If my MER goal is a 10 to. And I have an a MER of five to one. If I increase my spend on the five to one, my MER is gonna go down. But at a five to one, my contribution's likely going up, right? . So in that case, that's a trade I'll make all day long, but just helping people walk through that relationship between those two metrics to say, I can profitably go acquire new customers and drive my mer down.

And it could be a good thing for the business that's all possible, right? And so that's like sort of an easy number to set next to each other. and then repeat rate. Again, it's all about this relationship. What percentage of my revenue is supposed to come from new customers versus existing customers?

And if you set expectations around all of these things, what you're going to be able to very quickly do is any given day in the month, identify which part of my revenue stack is missing purchase. , and that's a doorway to go. Then strategically action against it. Ooh, struggling to get revenue from my existing customers?

Or am I struggling on new customer acquisition? Which one is it? that's like another step to go solving the problem. And so it's a critical layer. One simple metric. One of my favorite ways to illustrate this in the simplest form is what we, have in list called our net active customer. And so this just illustrates in any given month how many new plus returning, plus reactivated, meaning customers that had lapsed, but we brought back to life.

Did I have over how many lapsed and a lapse period is just the average time window. Usually it's about 78th percentile time window. if the normal customer purchases within a hundred days and 70% of customers who purchase, again, do it within 140 days, then your lapse period would be 140 days. And so in any given month, did you add more customers to your active file or did more of them lapsed? And was that net action positive or negative? And that would be the illustration for growing or shrinking the sponge. If you have positive net active. Your customer file is growing and you can expect consistently more revenue each month outta your existing customer base. And that's how you get sustained healthy growth.

[00:31:37] Richard: Right. we'll probably do another pod on the shrinking sponge itself because it's so central to everything that we do. But I did want to kind of point out again, we were making previously around why breakout returns from order revenue. Well, it gives you more clarity into where something is going wrong. I think, again, breaking out all of these new customer metrics from your broader efficiency metrics gives you a window, so when MER drops usually you're like, Something's going on. What might it be when you have this kind of clarity? On where things are going wrong, you have a better sense of like exactly what you need to do to fix it.

Or you might see a drop in MER like you were pointing out, but A MER is at a good place, or it's even going up. Then all of a sudden it's like the lower MER doesn't matter and you have something to point to explain why that might be the case. 

[00:32:23] Taylor: 

That's right. one thing I want to illustrate here too, because I want to go back to this idea that each layer is subservient to the one above it.

Okay? Because new customer aware is a thing that people can get hung up on. And what I would say, Especially if you are, bootstrapped, okay, and you are cash flowing your own business. And I'll give you an example of what we do at Baby Worth. Okay? Now we're not at 50 million, we're closer to, in the million dollar a month range here.

But what we do is when we launch a plan at the beginning of the month, we set a goal that we are going to go out and drive X number of new customers and y from our existing. Okay. But what we do amidst that plan is we plan for the end of the month, what we call a safety sale. And this safety sale is intended to say, if our new customer acquisition struggles and we cannot get the efficiency that we want, we will not press into non-profitable customer acquisition.

In other words, there are words we won't go make up the gap with inefficient new customer acquisition that deteriorates long-term profit. What we will do is try and squeeze a little bit more out of our existing customers if we have to make sure we hit the contribution margin goal. Okay. So there.

We don't want to have to do it, I'm not talking 20% offsite wide. It's like, we'll take everybody who's bought a cactus concentrate and we'll offer them 20% off of an alternative skew. Try and like add in the, you know, a positive behavior. And we understand that's going to be a sacrifice that we're pulling, you know, future revenue forward a little bit to hit this month's goal, but we don't miss.

So we absolutely have to hit this month's goal. And we know next month we've gotta go make that up with even better new customer acquisition. And so we're gonna have that in our heads and we're gonna know the task in front of us, but we are never gonna sacrifice the top layer and the name of a lower layer.

So in other words, total new customers doesn't have priority over contribution margin. Contribution margin has priority over total new customers. So if you have to squeeze the sponge a little in one month, you're gonna do that because the goal is contribution. Just like if new customer is popping off, like you might sacrifice a little bit of the MER in order to get more contribution margin, right?

Like the same principle applies, but the idea here is that. You may have to make those decisions to squeeze, to flex, to go back and forth, a little bit in some given months. It's the same reason I would say there can be months where you have too much profit, where you're actually, you're exceeding the profit and you're not filling the sponge enough to guarantee later months success.

And you should have actually been more aggressive in new customer acquisitions. So there's times when you should be more aggressive or less aggressive in your new customer acquisition, depending on the rest of the.

[00:34:49] Richard: Right. one thing that we talk about intro is this idea of, we framed the whole thing around sacrificing efficiency for the sake of long term benefit, But that's not necessarily true all the time, right?

Like, right To your point about running the marathon, it's like if you have that, tip of the pyramid, the contribution margin metric, the metric that makes sense for the total health and like the ultimate outcome of the business that you want. Then you can sacrifice efficiency elsewhere responsibly.

And that responsibly doing a lot of work there because the most important thing. It's like it's not, in and of itself, sacrificing efficiency isn't necessarily good. It's if you are doing it in service of the ultimate goal, which is contribution margin, and you have a system for understanding how you're affecting.

Ultimate goal, then you can, that responsibility piece comes into play. I think that's 

[00:35:36] Taylor: right. And a great example of this in practice is like if you were in healthcare or skincare, there's a very good chance that January is your best new customer acquisition month of the whole year. CPMs are just lower, there's less competition your conversion rate is strong because that's when people are considering that behavioral change to sort of health and wellness.

And so in many cases, that's your tailwind, right? and so you're gonna take that lower MER that month because you're gonna load up on efficient new customer acquisition, right? And so the environment dictates the composition of these metrics at any given period of.

you have to be clear on that and know that you're making that decision such that you're gonna guarantee the best 12 month profit that you possibly can, the best 12 month mer that you can. But in January, that's not gonna be the governing 

[00:36:24] Richard: yeah, it'd be interesting to do a. Sort of a seasonality and the hierarchy of metrics pod as well, or, I mean, I guess that kind of the four quarter accounting piece maybe comes into well, 

[00:36:33] Taylor: and four piece theory is really where Yeah.

Right. Where that comes in, which is, Sorry, four peak. That's what it meant. Yeah. Yeah. How do you create moments of outsized efficiency of new customer acquisition, and how do you create periods of outsized existing customer revenue creation? Right? There's strategies and plans that you can design into your marketing.

Cal. To do both things in the period where maybe they don't normally happen naturally.

[00:36:55] Richard: Right. let's get into the fourth and final layer, the bottom of the pyramid. and this is just platform metrics, essentially. These are your roas, your cpm, cpc, CPAs on Facebook, on Google, on whatever.

So what role should these metrics. When you think about this hierarchy 

[00:37:14] Taylor: me, the goal of these metrics is to affect the ones above them. So in most cases, we're trying to improve our weighted average C, our A M E R. And so what we're always doing is we're looking at the relationship between these metrics and those.

So what do I mean by that? Well, in Facebook, let's just use a very specific example. I have three choices for optimization. I can use one day. Seven day click, seven day click, one day view. And the question I'm asking to make that choice is, which one of these optimization choices, which ultimately leads to an attribution measure, has the strongest relationship to a e r?

Because that's actually what I'm trying to do. I'm trying to actually change my ameer, which is trying to change, improve my revenue and mer, which is trying to improve my contribution margin. And so what I'm trying to do is think about the relat. And I would use, you know, a correlation analysis, both on a predictive, and linear basis to dry and see which of those I will use.

And then I try and set a goal for that metric to reach the a mer target that I want. now in most cases, we could literally run the business cutting this layer entirely out. But as you get large enough, you have multiple channels. You've got media mix in different places. You have to have creative data to give creative feedback.

And so it is important to think about these metrics and there are things to consider, like if I have the same level of efficiency, but half the cpc, I'll take double the traffic at the same return. And so there are moments where the channel specific data matters in your decision making and allocation of budget and those sorts of things.

but they only matter in so much that they relate. New customer efficiency metrics that you care about overall. 

[00:38:58] Richard: . so there's also an element of, the ongoing conversation that we've been having around attribution as well, right? Yeah. Which is the idea that the platform specific metrics, especially on Facebook, are the only things that the platform itself can optimize against.

And therefore Facebook Row has to be taken into consideration because that's what Facebook thinks is working. So how do you incorporate that into the rest of the 

[00:39:21] Taylor: hierarchy? Yeah. it's sort of that same thing, right? Any time I introduce a fifth layer I call it, into this, which is what attribution solution technically becomes, it's only useful if it's predictive of the layer above it.

So anytime someone gives me an MTA or a triple whale or whatever, the first thing I'm gonna do and say, Is there a correlation between this MTM MTA measure and new customer? Or new customer revenue or new customer ROEs like, and if not, it's actually a really distracting proxy that can move me away from the thing that I actually need.

And in often cases, the relationship between like something like a seven day click could either be none, in which case I don't want to use it. Or it could be so tight that it's actually duplicitous and unnecessary. . And so I don't want to introduce complexity. Unless it's absolutely necessary. Now, if there were a scenario where the MTA was perfectly correlated to my new customer revenue or really tightly correlated to my new customer revenue, but my Facebook spend or Facebook ROAS measures were not, then I'd say, Okay, well maybe let's use this, but I've got a bigger problem because now I don't know how to allocate the dollars within the channel on Facebook.

Yeah, and so what I believe an MTA can be useful for is helping you decide between the allocation of dollars, between channels, should I spend more on Facebook, Google, Snapchat, et cetera. and if there is a relationship between that MTA measure and new customer revenue, that can be a useful tool to do that.

But it doesn't really help you make decisions within the platform. And I think that's the mistake people are making is that they're jumping all the way into like making ad level decisions on the basis. , a tool that doesn't inform the optimization or delivery. And so, you know, we've beat this, we've beat this your ground here. 

[00:41:01] Richard: Well, I was gonna say that you have to. , consider Facebook ROEs because that is the metric by which you'll be making decisions in the account. 

[00:41:08] Taylor: right? Like that's or right in sense that Facebook. Yeah, exactly if you have a CBO campaign with five ads in it, it doesn't matter what the tool says is happening. So anytime I see somebody using one of these tools, I'm like, you have credibility to. If you have it set up where you have one ad, one campaign, one ad set, and that's it, and you're making manual decisions across the whole thing.

Cool. Right. Credibility. Like you have decided to go manual hero game. I can respect the hustle, right? Like you believe in this and you're gonna allocate all the dollars yourself. But the second you go campaign with multiple ad or multiple ads, I'm like, Now you're just running in a complete circle because Facebook's making a decision that's completely different than the one that you want, and now you're gonna interject yourself.

It's just a zoo. 

[00:41:51] Richard: Yeah. brings me to mind of like, you know what, like when the waiter takes your order, but they don't write it down cuz they can memorize it. It's like, it's really cool if you can memorize it, but you're still making me feel uncomfortable. You know what I mean?

Exactly. why even do it? but anyway point being is that you do have to take platform specific metrics into consideration despite the amount, or despite how much we kind of, crap on them, I guess. The point is that they're on the bottom of this pyramid. Often for marketing teams, they're treated as the top, and that is the ultimate problems now.

Exactly. 

[00:42:22] Taylor: The hierarchy gets flipped where the whole organization makes a decision around Ross. But the problem is, again, the Ross has no relationship to the financial measure. And I've literally seen this in organizations where I've come in and done an analysis and said, like, at the, like CFO and board level, they're mad because their profit is deteriorat.

The marketing team is like thinking they're winning because their third party, you know, measure of success that they've defined is going up. And so they keep reporting back to the finance team, We're winning. And the finance team is like, No, you're failing. And they cut their ad spent, they cut their budget because it's like this proxy metric is disassociated from the financial metric.

And ultimately this is our job as marketers. We can use proxy metrics, we can use them, We should never report on them up the. , but what we should understand is our ultimate job, those metrics are only useful to us in so much to their ability to drive value up the hierarchy, get more new customers, drive more revenue, drive more profit.

That's your job not to make. Google roas. Go up Facebook roas, go up last click roas, go up rocker box roas, go up. Triple RO A, it doesn't matter. None of that matters unless it's moving things up. The hierarchy, it's getting you more new customers at an efficient level. It's driving more total revenue at the MER you want, and it's putting more money in your pocket.

If that's your job, that's what you have to hold yourself accountable 

[00:43:41] Richard: to. Exactly. I think this is a great illustration of, David Ogilvy has this incredible point, like very well phrased where he says too many businessmen, use research the way that a drunkard uses a lamp post for support, not for illumination.

And I think the point of the hierarchy of metrics is to force you to use data for illumination to give you information of what real thing is happening, how people are behaving, as opposed to what tends to happend And I know this from personal experience where you get the success metric, you make the number go up, you feel good.

And that's it. That's right. You have no thought about what does it really mean about the way people are behaving When ROEs goes up and down? You don't think about that at all. You think about it, if it. My boss will be happy if it's down, my boss will be mad. And that's it. Right. And that's a very human thing to think, but you have to find a way to, for your organization, create a structure to make people not think that way anymore.

and it's all about providing context, right? 

[00:44:35] Taylor: I talk about this all the time. As an entrepreneur, you, it's so easy to try and grab onto whatever signal reinforces your good feeling about your work. Yeah, right.

employees growth, I have more employees than I used to or whatever. But business has a thing that you're trying to do, which is drive shareholder value, which is generally measured as a multiple of profit. And if you increase that, you're doing your job. And I watched one of our media buyers tell a client whose revenue, and ultimately their contribution was, That good news, your cts are going up and what it was missing was exactly this, which is that, and our head of customer success came in and coached them through like, Hey, you need to understand that CTR going up is only useful if and only if it's a direct impact on the money in their.

Otherwise they're gonna tell you, I don't give a shit. Pardon in my language, , your CTR could be 7000%. you could get one person and seven of their friends to click on every ad that you served. If it didn't lead to any revenue, it's not effective. And so I think we can get into the habit of trying to grab onto and absolving ourself of the responsibility to actually do the thing that we set out to.

by using some of these like, you know, measures that we can grab onto as marketers to impression share or engagement rate or whatever it is, as a mechanism to try and, feel successful because it's really actually hard to drive profitable road. 

[00:45:58] Richard: Yeah. The hierarchy of metrics is your freedom from bs.

It is the way I like to think about it. Thanks again for joining us for the E-Commerce Playbook podcast. Please remember to rate and review, and if you're watching on YouTube, remember to like, and subscribe again, it really helps us out.

if you wanna learn more about the Enterprise Scaling Guide go ahead and check out the link. that's gonna be in the episode description or in the video description. And if you're interested in starting a conversation with us about working together, How to apply the hierarchy of metrics to your specific business because every business is unique.

go ahead and drop us a line@commentsredco.com. We would love to chat and once again, have a good one everybody, and happy scale.