How Much Should You Spend to Acquire New Buyers?

When looking at your income statement, it’s tempting to cut prospecting to save money. But is that really the right thing to do?

You have to invest in converting prospects to buyers. How much to pay for a new buyer depends on what you can afford and how fast you want to grow.

Overspending to acquire a new buyer and trying to grow too fast can lead to financial ruin. On the other hand, not investing in housefile growth can have a negative effect on your business. This month I’ll examine how much to spend to acquire a new buyer.

Invest to Grow

Some catalogers say they don’t want to prospect below the incremental break-even point (net sales less cost-of-goods-sold less direct selling expenses) on a cumulative basis. They want to be sure all prospect lists they mail perform at least at breakeven or more.

While that’s a good goal, this philosophy can limit growth severely, because it’s unlikely you’ll find enough good lists that perform above breakeven to sustain a desired level of growth or even maintain the same sales from one year to the next. You must be willing to invest in acquiring new buyers. This can be accomplished only by mailing below the incremental break-even point.

The real question is, how far below? And how much should you spend for a new buyer? What’s a reasonable payback period for the investment you make?

There’s a certain attrition rate on any housefile. Customers stop buying for myriad reasons: economic conditions, poor service, older customers who pass on. It’s important to at least replace those customers with fresh buyers so your zero-to-12-month file doesn’t decline. If you want to grow, your prospecting amount must exceed your normal housefile attrition rate.

For example, let’s assume 50 percent of a typical customer file will purchase again next year. At a minimum, you must replace the 50 percent who don’t buy so the active housefile doesn’t decline. This includes a combination of adding new buyers and bringing previous buyers onto your zero-to-12-month file. If you want to grow, your percentage of new-to-files has to be even higher than your normal attrition rate.

Take a look at how much you can afford to spend for a new buyer based on what you expect in return. Again, I’m talking about spending money (i.e., making an investment in acquiring a new buyer). Catalogers often say a payback of one year (or less) is considered a reasonable investment payback period. (The payback for some companies might be even longer.)

Some catalogers say they want to base the cost to acquire a new buyer on the expected lifetime value. This is a reasonable approach, but most prefer to take a shorter-term view. While it’s unrealistic to expect to prospect in total (on a cumulative basis) at or above the break-even point, it is reasonable to try to pay back that investment in one year. How much can you afford to spend for a new buyer, assuming a one-year payback?

Let’s assume your goal is to break even within a year after you acquire a new buyer (i.e., a one-year payback). In the year of your initial mailing to prospects, you acquire 1,500 new buyers from a mailing to 100,000 outside names. As you can see in the chart Cost Per Buyer, these 1,500 new buyers generated 898 orders the following year, for $60,143 in additional revenue. When you combine the initial mailing results with the repeat purchases made in the first year, you see a breakeven. In the example, the cost per new buyer was $12.14 initially.

Therefore, if your goal is to break even on your investment after one year, you can afford to invest up to $12.14 to acquire a new buyer. As you can see in the chart, the year after your initial investment is made, your contribution to profit and overhead is a positive $8.15 per buyer. And if you consider customer lifetime value, the contribution in the second and third years (and beyond) would be even greater.

The point is that new buyers are the lifeblood of any catalog company, and you must be willing to invest to acquire them.

Maximize Your Prospecting Efforts

The time of year you prospect affects your economics. To get the most out of your prospecting, consider implementing the following steps:

* Prospect the heaviest in your strongest drops. In my last column, I addressed the importance of testing new lists and prospecting during your best season or period (see “When Should You Prospect?” October 2004 Catalog Success).

* Prospect when you have the cash flow to do so. But prospect wisely and not beyond your means.

* It’s always best to expose prospects to new merchandise offerings, especially if they have seen your older products.

* Mail prospect tests in your strongest drops. This gives you the best chance for success. Be sure you allow enough lead time to read results and roll out in your strongest drops.

* Capitalize on the new buyers added to your continuation lists. These names are sure to be winners.

It’s unlikely you can prospect in total above the incremental break-even point. So be willing to invest in acquiring new buyers and in your company’s growth. When looking at an income statement, it’s tempting to cut prospecting to save money and put more profits on your bottom line. But is that really the right thing to do? Probably not. It’ll cause a downward spiral, and the 12-month buyer file will start to decline.

At a minimum, be willing to prospect at a rate that will enable you to maintain your current level of sales. If you want to grow beyond that level, the amount of prospecting you do must increase. Again, view this as an investment in the future of your company. Sacrificing the long-term growth and good of your company for short-term profits never is wise. Be as concerned about the change in your 12-month buyer file — from one period to another — as you’d be about the results shown on your income statement. The change or growth of your 12-month file will give you a good idea of the health of your business.

Invest in your future by generating new buyers. But invest wisely and be careful not to over mail.

Stephen R. Lett is president of Lett Direct, a catalog consulting firm specializing in circulation planning, forecasting and analysis. He spent the first 25 years of his career with leading catalog companies. He can be reached at (302) 537-0375, or by e-mail via his Web site: www.lettdirect.com.