High Costs of Social Media Advertising

In the good old days of marketing mass media was the main vehicle through which companies reached out to potential customers. The marketing process was standardized. You would target a specific segment of the market, analyze what mass media consumers in this segment followed, and advertise the targeted message in these media. People’s attention was easier to grab because there was not as much competition for it. Thus, a well-designed message delivered through appropriate channels would most likely be successful.

Today rapid changes in media consumption habits forces marketers to reinvent the marketing process. Mass media still have a very significant impact but lost influence on market segments consisting of younger buyers. Cord cutting is rampant and 25% of millennials without children do not have cable television at home [1]. Streaming services such as Netflix that charge a small monthly fee for ad-free content are becoming more popular than regular television channels. Furthermore, marketers are struggling each day to adapt to new social media platforms trying to make the best out of each.

Social media advertising that can replace conventional advertising has its own challenges. When it first became available, social media advertising was touted for its low costs. However, prices went up significantly in recent years. Analyzing the Facebook advertising platform today shows that with general targeting the average cost for one person to click on an ad is approximately $2.20 US (see table below). Narrow targeting can increase or decrease costs depending on how much competition there is for the targeted narrow segment. For example, targeting Canadian men in general costs $2.10 US per click whereas targeting men in Toronto aged between 18 to 24 and interested in Spotify costs 33% more at $2.78 US.

Screen Shot Showing Suggested Bid for One Link Click

Considering how low conversion rates are the advertising costs shown above are very high. The conversion rate is lower when a lower percentage of people that click on an ad take the desired action. For example, if you are advertising an online store, what percentage of customers who come to your website by clicking on an ad actually end up buying a product from you? The median conversion rate is around 2.5% while the conversion ratio is less than 1% for about a quarter of all ads [2]. Given the average costs explained above, the table below shows how much it costs on average to sell one product through social media advertising.

Social Media Advertising Expenditures Required to Induce One Purchase (Average CPC $2.20 US)

When the conversion ratio is 1%, to sell one product 100 people must click on your ad. At current prices 100 clicks would cost you about $220. As the table above shows, the cost to sell one product is extremely high. At 1% conversion rate, if the gross profit margin on your product is 40%, your product’s price must be at least $550 to break even. This analysis clearly shows that social media advertising costs are beyond reach for most businesses and social media advertising is useful to sell only a limited number of all products.

If social media advertising is beyond reach for many, how do social media companies continue to sell advertising? Many argue that there is a private investment bubble [3]. Startups with free money from investors throw it on advertising without much concern for the return on advertising costs. They do so hoping that one day they will gain widespread recognition that will enable them with sufficient leverage (e.g., word of mouth, publicity) to recuperate those expenses. While such a positive outcome materializes only for a small number of startups, the investors continue to take risks as the returns are huge once they materialize.

References

  1. https://www.nytimes.com/interactive/2015/10/03/business/media/changing-media-consumption-millenials-cord-cutters.html?_r=0
  2. http://www.wordstream.com/blog/ws/2014/03/17/what-is-a-good-conversion-rate
  3. http://www.latimes.com/business/hiltzik/la-fi-mh-the-silicon-valley-investment-bubble-starts-to-deflate-20151019-column.html