Are The Most Successful Media Companies Just Good at Arbitrage?
In financial markets, arbitrage is when a trader is able to buy and sell a specific asset on two different markets where there’s a price difference. When crypto was more immature, for example, arbitrage would occur where the price of bitcoin on a South Korean exchange was far higher than it was on a U.S. exchange. For traders with access to both, this presented a unique opportunity to buy on a U.S. exchange and then sell on the South Korean exchanges.
In media, there is a similar type of arbitrage. Surprisingly, though, it was only very recently that I’ve started to notice more companies start to take advantage of this. If we think about the publishers that get the most discussion—and the ones that are most successful—they tend to share the same thing: a deep understanding of that arbitrage opportunity.
I had two separate conversations this week where this exact topic came up and one thing we sort of concluded is that, by and large, it’s just a math game. For those operators that understand how the game works, it’s probably easier to win.
I’m talking about paid user acquisition and the ability to monetize that exact audience at a higher rate. For example, if I acquire a user for $1, but I can earn $1.50 on that user, there is a $0.50 arbitrage opportunity that exists. If I told any entrepreneur that, they would try to find as much money as possible to acquire users so long as the arbitrage opportunity was greater than the user cost.
When most hear about this type of arbitrage, they immediately think about media companies that cram as many ads onto a page as possible or rely on slideshows to increase the number of total ad impressions. Then they buy traffic from chum boxes and any other possible source with the hope of eeking out a few cents margin. At scale, it can add up.
That’s not what I’m talking about here. Instead, I am referring to a long time frame arbitrage where an operator feels comfortable enough spending money to acquire a user because they know they’ll earn their return over a longer period of time. If I spend $1 in January, maybe I don’t make the $1.50 until May. In my mind, that’s still an arbitrage opportunity.
Historically, these sorts of opportunities don’t exist for long. For example, Instagram was fantastic for user acquisition a few years ago. I’ve talked with operators who were getting newsletter sign-ups for like a nickel a pop. Now? It’s not as lucrative because everyone else has learned that it’s a good opportunity.
But most people are slow to recognize that a channel is not as efficient as it once was. Yesterday’s great arbitrage opportunity is today’s standard marketing practice. The best arbitragers have already moved onto the next area of focus.
All of this is to say that I believe the best media companies are those that are not only great at creating exceptional content but are also great at figuring out how to invest time and money in user acquisition that pays for itself through monetization.
I’ll break that down by first focusing on monetization. We can’t know how much to spend on user acquisition if we don’t understand how much we’re going to earn from them. That means we need to assess the entire monetization suite and understand roughly what the value of a user is.
To do that, you first need to understand how much revenue you generate per user. This is a simple formula:
Average Revenue Per User = Revenue in a Time Period / # of Users in Time Period
This means that if you have $1,000,000 in revenue and you have 100,000 users over a month, your average revenue per user (ARPU) is $10.
The next thing you want to understand is your churn rate. To calculate this, you first need to understand your retention rate. That looks like this:
Retention rate = Non New Users This Time Period / Total Users Last Period
If you had 100,000 total users last month and have 95,000 non-new users this time period, that would mean you have a 0.05 retention rate. With that, you can then calculate your churn rate:
Churn Rate = 1 – Retention Rate
Finally, you need to calculate your gross margin percentage. This formula is:
Gross Margin = (Revenue – Cost of Goods Sold) / Revenue
If you do $1,000,000 in revenue and your COGS is $500,000, then your gross margin percentage is 50%. With all of this, let’s now make a few assumptions for our final formula:
- ARPU: $10
- Churn: 2%
- Gross Margin Percentage: 59%
With these three numbers, we can now calculate our customer lifetime value (LTV). That looks like this:
LTV = (ARPU x Gross Margin %) / Customer Churn Rate
LTV = ($10 x 59%) / (4%) = $147.50
Now for those of you who are in finance or are just smarter than I am, there are more complicated and accurate ways of calculating LTV. As you start introducing trial periods for subscriptions, discounts, and other variables, the calculations can get quirky. However, the above gives you a decent idea of what your LTV is.
Now that we understand how we are monetizing and how much we earn per user, we can now figure out where to find users. This is where you have to get creative. The first thing people do is think about places like Facebook, Instagram, and Google. Those are fine. You’re going to find people. But that’s not enough.
Where else are your readers? What other publishers are they getting information from? Are there newsletters related to your topic? What about creators, either in newsletter, video, or audio form? Are there any secondary platforms that are not as popular as Facebook or Google? Are there any associations in your industry?
It’s important to take stock of all the possible places that your desired audience spends time and then start testing things out. What you’re looking to track is how many people are converting and then what their early engagement looks like. You can absolutely start small.
Like I said earlier, though, today’s arbitrage opportunity is tomorrow’s standard marketing practice. Once you find something that works, go for it. For example, if it costs you $75 to get a customer that will be worth $147.50, invest as much as you can. Be incredibly focused on the numbers and pay close attention to how your costs are relative to your LTV. If you’re finding the LTV decrease or the costs increase, it might be time to take your foot off the gas. Or, more importantly, just hit the brakes entirely.
This is obviously a simplified approach. It doesn’t take into consideration a few things that can change the math for you considerably. First, how long does it take to break even on a user? Second, how long does it take to hit the LTV? Since running a business is, ultimately, about managing cash, the longer it takes to break even and reach LTV, the more capital investment you’ll have made.
The other thing to think about is retention. In the above example, I have churn at 4%, which gives us an LTV of $147.50. What if we get really good at retention and reduce it to 2%? Now your LTV is $295. That increases the amount you can spend on user acquisition, allowing you to get bigger.
It goes without saying that good media companies start with great content. That content is how we are able to extend our relationship with the reader, reduce churn, and monetize appropriately. However, what I think many publishers forget is how important it is to take advantage of these opportunities. It’s really just a math problem. When all else is equal, if you can acquire a user for a lower price than you monetize, it seems like a no-brainer. The most successful media companies are doing this.