Spend to Grow

Rule of thumb: A catalog company can’t break even on the initial orders generated from prospects. Catalogers must be willing to invest to acquire new buyers to grow, or at least maintain, their 12-month buyer count.

This month, I’ll cover the cost to acquire a new buyer, why it’s important to invest in prospecting and why you shouldn’t expect to break even on the initial order.

Catalogers tell me they don’t want to prospect below the incremental break-even point. That’s a nice goal, but it’s not realistic. Today’s economics, such as postage costs, paper prices, etc., combined with lower response (an ongoing trend that results mostly from list fatigue), are the main reasons catalog companies can’t break even on the initial order mailing to outside rented lists — and that includes the co-op databases.

Typically, a few lists or database segments will break even or better. But the universe size from these top-performing lists won’t be large enough to generate the desired number of new buyers required to grow or maintain file sizes. Therefore, to grow your 12-month buyer file other lists and/or database segments that perform below breakeven will need to be part of your circulation plan. It’s simply a fact of life and a part of the cost of doing business today.

Invest in Growth
Not investing in growing your housefile can negatively affect your business and future growth. At the same time, overspending to acquire new buyers and trying to grow too fast can lead to financial ruin. It’s the balance of mailings to your housefile vs. prospects that’s important to long-term success. The size and financial performance of your housefile really is what determines how much prospecting you can afford to do.

There always are customers who elect not to purchase again. They may not be pleased with your service, or they purchased based on a one-time need, or a specific promotion caused them to buy once, and so forth. At a minimum, replace those customers who elect not to buy again with fresh buyers so your 12-month file doesn’t decline.

Replace Inactive Buyers
If you want to grow, the amount of prospecting you do needs to exceed your normal housefile attrition rate. For example, let’s assume that 50 percent of a typical customer file will purchase again next year. This means that, at a minimum, you need to replace the 50 percent who don’t purchase so the active housefile doesn’t decline. This includes a combination of adding new buyers and bringing “older” buyers on your housefile into the 12-month category. If you want to grow the percentage of new-to-file buyers, you must do so at an even higher attrition rate than normal.

Rule: The percentage of revenue growth will approximate the percentage increase in your 12-month buyer file.

In the first chart (on pg. 39), I look at how much you can afford to spend for a new buyer based on what you expect in return. Consider a payback of one year (or less) a reasonable investment payback period. Some catalogers might say you want to base the cost to acquire a new buyer on expected lifetime value. This isn’t an unreasonable approach, but most prefer to take a shorter term view.

It’s not unrealistic to expect to prospect in total (on a cumulative basis) at or above the break-even point, but it’s reasonable to attempt to pay back that investment within one year. How much you can afford to spend for a new buyer, assuming a one-year payback, is calculated in the first chart.

Be Ready to Lose
You want to break even (or better) within one year. Accept the fact that you’ll lose money on the initial order. In the example, based on a mailing to 100,000 prospects, the company in the first chart lost $18,214. It cost $12.14 to acquire a new buyer. At a 1.5 percent response, 1,500 new buyers were acquired. If these 1,500 buyers are mailed 10 times during the next 12 months, they’ll generate an estimated contribution to profit and overhead equal to the contribution loss from their initial purchase.

Therefore, if your goal is to break even after one year on the investment you initially make to acquire a new buyer, you can afford to invest up to $12.14 to acquire a new buyer in the first example. The year after the initial investment, your contribution to profit and overhead is a positive $8.15 per buyer. If you consider lifetime value, then the contribution in year two, three and beyond would be even greater. The point is, new buyers are the lifeblood of any catalog company, and you need to be willing to invest to acquire them.

Then be sure to know what your contribution to profit is — the amount of money left over to contribute to overhead expenses after you deduct for customer returns, cost of goods sold, direct selling expenses (e.g., paper, printing, postage, list costs) and variable order processing costs. Follow this formula:

gross sales - returns = net sales - cost of goods sold - direct selling expenses - variable order processing costs = contribution

Know Attrition Rate
A positive contribution to profit and overhead exists when there are excess funds available after this formula has been applied. A negative contribution to profit and overhead occurs when there’s a shortfall.

To figure out how many new buyers you need to generate a year, know your housefile attrition rate and desired growth factor as determined by management. For example, for the Acme Catalog Co., assume its housefile (buyers only) totals 164,286. Also assume that 60 percent of this file will make a repeat purchase during the next 12 months. This means that 64,714, or 40 percent of this file, need to be replaced simply to maintain the same file size (before any growth factor). Take a look at the second chart (below).

At an overall 2.12 percent average response, a total of 3.1 million prospect names need to be mailed to generate the 65,714 new buyers needed to maintain the file size. To grow by a factor of 10 percent, the company would need to mail 3.6 million catalogs to prospects. This is based on a slightly lower overall response rate of 2 percent, due to the increase in quantity.

Face it: Acquiring new buyers costs money, but it’s the lifeblood of any catalog business. Think of prospecting as an investment in your future. Know how much prospecting you need to do based on the attrition rate of your housefile. Consider adding a growth factor on top of that. Balance your circulation to prospects vs. the housefile to protect your bottom line.

Stephen R. Lett is president of Lett Direct Inc., a catalog consulting firm specializing in circulation planning, forecasting and analysis, and author of “Strategic Catalog Marketing,” a Catalog Success book published by Target Marketing Group Publications. You can reach him at (302) 537-0375 or via his Web site, www.lettdirect.com.