Causal Loop Diagramming (Part 2)
This post continues our introduction to causal loop diagramming – in particular we will take a look at how to incorporate the effect of market saturation in our prototype of the customer acquisition process.
In our last post we started to build a causal loop diagram that explains the dynamics of customer acquisition.
Remember that we played with our first interactive prototype and quickly realized that whatever settings we chose, the number of customers increased indefinitely in a linear fashion.
Of course we know that in reality, the number of customers cannot grow forever, simply because the number of people on the planet is finite: eventually, every market must saturate.
Therefore in this post, we will take a look at how to include market saturation in our causal loop diagram.
Any Market Must Saturate Eventually
I’ve sketched a little diagram that will help us to think about advertising and define some key terms:
- the population is the set of people we could possibly reach (through all of our marketing activities).
- the target market is the subset of all people who we are trying to sell our product to.
- the potential customers form the subset of the target market that haven’t bought our product yet.
- the customers form the subset of the total market that have bought our product
Given this diagram, we can easily quantify market saturation – it is simply the ratio of the number of our customers to the size of our target market.
Once all potential customers have turned into customers, we reach 100% market saturation.
A Lot of Marketing Effort Is Wasted
Now let’s think about what happens when we do some advertising to spread the message about our products and services.
Our adverts will reach a subset of the total population, as illustrated in the sketch. There are really only three cases we need to consider:
- Our advert reaches a person, but the person we reach is not in our target market. In this case our marketing effort is wasted.
- The person we reach is in our target market, but he or she is already a customer. Again our marketing effort is wasted in this case. The more saturated our market becomes, the more marketing effort we waste.
- The person we reach is a potential customer and there is a chance that he or she decides to buy our product or service.
This diagram reminds me of the old saying in marketing that 50% of any marketing effort is wasted, but unfortunately we never know which 50% that is!
Including Market Saturation in Our Causal Loop Diagram
How can we incorporate these aspects into our causal loop diagram?
Let’s start with the causal loop diagram we built in our last post.
First of all, let’s include market saturation. As discussed, this depends on the size of our target market and on the number of customers we already have.
If the number of our customers goes up, then so will market saturation. That’s why I have added a plus sign next to the arrow connecting customers and market saturation.
If the size of our target market goes up, then the market saturation will decrease. That’s why I have added a minus sign next to the arrow connecting the target market and market saturation.
The Effect of Market Saturation
As we learned from my little sketch drawing, market saturation is going to have an effect on the potential customers we reach through advertising: the more saturated the market is, the fewer potential customers we will reach for the same advertising effort.
Our First Closed Loop
Well, this creates our first closed loop because the more customers we have, the more highly saturated our market is going to be.
This actually creates a loop in our diagram … I’ve redrawn the diagram below to make the loop more explicit.
Obviously, the higher the market saturation is, the fewer potential customers we are going to reach for advertising because a lot of the people we reach with our adverts are already going to be your customers. And if your market is 100% saturated, then it does not matter how much advertising we do, the number of potential customers we reach is always going to be zero simply because there are no potential customers left.
This is kind of loop is referred to as a balancing loop: a balancing loop ensures that the factor it is controlling doesn’t exceed a target value.
In our case, the factor being balanced is the number of customers and the target value is the number of people in our target market – the balancing loop ensures we can never have more customers than exist in the target market.
It is easy to identify balancing loops: you just need to travel around the loop counting the minus signs. If there is an odd number of minus signs, then you have a balancing loop; if you have an even number of minus signs, you have a so-called reinforcing loop; we will learn more about reinforcing loops in our next video.
Experimenting With The Improved Prototype
Let’s take a look at the effect of market saturation using our prototype.
I have assumed that our advertising success rate is at 0.1% and the number of people we reach per month through our adverts is 800,000. Then we will acquire around 800 new customers per month so even after one year, we would only have around about 10,000 customers.
Given that we are assuming our target market has 6 Mio. potential customers, then our market saturation will only be minimal, around 0,17%. So with these assumptions, our customer acquisition graph still looks like a straight line.
Now let’s assume we have 100% marketing success. In this case we will acquire customers at a rate of around 800.000 per month. This would add up to around 9.6 Mio. customers if we neglect the effect of market saturation. This is a lot higher then the 6. Mio in our target market, so we would expect to the market saturation effect.
Test it for yourself, you can see that the graph is no longer straight – it is interesting to see that we only end up with around 4.8 Mio. customers and not with 9.6 Mio – this is because the market saturation effect set is and our advertising becomes less and less effective.
To reach full market saturation we also have to increase the number of customers we reach each month – the market becomes fully saturated at the end of the year if we assume that we reach 3.3 Mio. people per month. if we assume that we test this for yourself, but
Of course I’m not claiming that these figures are realistic, I’m just illustrating how our prototype works.
Experimenting with The Improved Prototype: Scenarios
As always, I’ve provided you with some predefined scenarios – make sure you can recreate them using the interactive prototype:
- Low Advertising Success. In this scenario, I assume that our marketing success is at 0.1% and our advertising reaches 800.000 persons per month.
- Medium Advertising Success. Advertising success is at 10%, our advertising reaches 800.000 persons per month
- High Advertising Success. Advertising success is at 100%, our advertising reaches 800.000 persons per month.
Make sure you are able to recreate these scenarios using the prototype.
Great, we have definitely moved our understanding of advertising a step forward and our prototype has become a lot more realistic.
Still, we cannot be completely satisfied with our prototype at the moment: Currently, the only way of building a large customer base is by assuming either that our advertising success rate is going to be really high or that we reach a really large number of people through.
Of course we may be lucky and our product will sell really well – but experience shows that not more than 10% of people react to adverts and of those probably only 1% will actually buy.
So when setting up a marketing model, I would not assume that more than 0.1% of the people we reach via advertising actually will buy our product.
The number of people we reach through advertising will be directly proportional to our advertising budget, and let’s not forget that advertising is expensive – on average it will cost us around EUR 100 to reach a thousand people, so the cost per acquisition through advertising is going to be at least around EUR 100.
Of course the exact figures will vary according to your product – but if we play this through in our simple example, we would need around 600 Mio. in advertising budget to reach saturation in our 6 Mio. target market.
Surely there must be a better way, no company can afford to spend that much money on advertising?!
In practice, what we hope for is the word-of-effect: to sell a product not just via advertising but also through satisfied customers that recommend our product to colleagues, friends and relatives, at costs that are more or less zero or at least don’t scale in proportion to the number of customers we reach.
I will explore the word-of-mouth effect in my next blog post.
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