Skillz (NYSE: SKLZ) is an intriguing mobile gaming company. It allows users to wager on the games they play against one another, making the activity inherently more engaging. Skillz benefited at the onset of the pandemic as millions of people, stuck at home, looked for new entertainment options. However, as economies started reopening in 2021, Skillz hit a rough patch and its stock crashed as a result.

In some much-needed good news for shareholders, ad prices have started to moderate -- and since marketing is the company's highest expense, that could reduce costs or deliver more bang for the buck. Let's look deeper at how that could help Skillz.

Image source: Getty Images.

Ad price growth is slowing down

According to GroupM, a market research firm, digital advertising made up 64.4% of overall ad spending in 2021. Considering that Meta Platforms (NASDAQ: FB) and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) are the two overwhelming digital advertising giants, we'll use their reports on ad prices for insight on Skillz's key cost.

In its third quarter ended Sept. 30, Meta Platforms (parent to Facebook) reported a 22% increase in ad prices from a year earlier. That's much smaller than the 47% year-over-year increase it reported in its second quarter.

Similarly, in its third quarter ended Sept. 30, Alphabet reported an 18% increase in the cost per click (which is how much advertisers pay each time a person clicks on their ad) from a year earlier, and the cost per impression (the cost for each instance their ad is shown) increased by 39%. Again, that was far smaller than the increases of 31% and 63%, respectively, it reported in the second quarter.

Why does that matter for Skillz?

In the nine months ended Sept. 30, Skillz earned $275 million in revenue. At the same time, it spent $310 million on sales and marketing. Management is habitually spending over 100% of revenue on sales and marketing expenses. Skillz says that sales and marketing primarily consist of user-engagement spending (getting existing users to spend more money) and user acquisition spending (signing up new users). Much of that spending takes place on digital ad networks like the ones Meta Platforms and Google run.

Therein lies one of the rising challenges for the company as the economy starts to reopen. Skillz has spent aggressively on user acquisition with little results. It ended the fourth quarter of 2020 with 391,000 paying monthly active users (MAUs). As of Sept. 30, 2021, Skillz had 509,000 paying MAUs. That roughly translates to $310 million on marketing spending to gain 118,000 customers or $2,627 per paying MAU.

Management must consider the lifetime value of each customer greater than what it is spending to acquire one; otherwise, it would not spend so aggressively on marketing. However, the market does not appear to agree with management. The stock is down 77% in the past year. The good news is that ad price growth is slowing down, and that could allow Skillz to get more results from its spending. We shall soon see.

10 stocks we like better than Skillz Inc.
When our award-winning analyst team has a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now... and Skillz Inc. wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of January 10, 2022

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Parkev Tatevosian owns Alphabet (C shares). The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Meta Platforms, Inc., and Skillz Inc. The Motley Fool has a disclosure policy.