Variable, Not Fixed Costs

During the past 10 years, the catalog industry has continued to evolve in dynamic ways.

For example, if you’re like most of your colleagues, you’re struggling to find incremental names to mail. You’ve seen cooperative databases take the prospecting market by storm, accounting for millions of names rented every year. And you’re trying to more efficiently integrate e-commerce into your marketing and communications plans, especially since the Internet accounts for 20 percent to 50 percent of demand and orders for many catalogers.

Despite these marked changes in how you accept orders and acquire customers, one thing remains the same: how to correctly calculate a break-even demand per catalog. In this article, I’ll discuss how to calculate a break-even demand per catalog and the variables included in such a calculation. If you correctly calculate break-even demand per catalog, you’ll be able to identify many incremental names to mail in these challenging times.

To Get Started

You’ll need a couple of key variables to complete this calculation:

* gross-to-net margin, defined as the percentage of each demand dollar kept by the consumer (net sales);

* gross merchandise margin, defined as the percentage of each dollar of net sales that remains after deducting your cost of goods sold; and

* operations costs reflects the remaining costs, and includes the cost to fulfill an order; cost for the phone call; costs to pick, pack and ship orders; and any other customer service or variable administrative expenses incurred with each incremental order.

You must then subtract your operations cost from the gross merchandise margin to get a combined margin, the gross merchandise/operations margin, as they’re both represented as a percentage of net sales.

Fixed vs. Variable Costs

The key element in this discussion involves catalog costs and how you treat them to get to your break-even demand per catalog. A correct analysis of break-even demand per catalog focuses only on variable catalog costs and not fixed catalog costs. Mailers must separate their catalog costs into two categories:

* Fixed costs. Once you’ve decided to create and mail a catalog, some costs are fixed and therefore won’t change. Any cost that’s not dependent on the number of catalogs printed is considered a fixed cost (e.g., photography, creative).

Costs associated with these also are called “one-time costs” since they’re incurred once and won’t change, regardless of whether you print 1,000 books or 1 million. These items, and any others incurred just once, should be excluded from your break-even demand per catalog calculation.

* Variable costs. Items whose expenses increase as the volume of catalogs printed changes are considered variable costs (e.g., paper, printing, postage). These and other variable costs should be included in your break-even demand per catalog calculation, since these expenses rise with each additional book printed and mailed.

Below is a sample calculation to illustrate why it’s best to use only variable costs to select individuals to whom you should mail.

Step 1: Input Assumptions. Identify your historical catalog statistics/assumptions to get to break-even figures. In this example, gross-to-net margin is 70 percent, and gross merchandise/operations margin is 60 percent. The variable catalog cost is $0.70, and the catalog cost, with fixed costs spread across all of the catalogs printed, is $0.84.

Step 2: Determine Break-even Calculations. To discern your break-even demand per catalog, take your catalog costs and divide by your gross-to-net margin.

Then divide again by your gross merchandise/operations margin. So, your variable break-even demand per catalog calculation is:

$0.70 divided by 70 percent, divided by 60 percent, which equals $1.67 demand per catalog.

Similarly, your fixed break-even demand per catalog is calculated the same way, using the fixed catalog cost figure:

$0.84 divided by 70 percent divided by 60 percent, which equals $2 demand per catalog to break even.

Do you need $1.67 or $2 demand per catalog to break even? Let’s answer that.

Step 3: Analysis. Next, look at what each of these figures means with respect to a sample mailing (see chart “A Sample Mailing: One-time Buyers.” Based on the figures, if you were to use a fixed break-even approach, you would not mail to 13-to-24-month buyer names. The $1.89 demand per catalog would be less than your $2 fixed cutoff.

But if you used the variable cutoff, the $1.89 demand per catalog would meet the criteria of $1.67 demand per catalog, and those 13-to-24-month buyers would be more attractive to mail. From this sample, you can see that using the fixed-break-even approach would be incorrect.

Why? Because as discussed earlier, the $2 breakeven includes fixed costs that are unrecoverable once you’ve decided to mail a catalog. In fact, every name in the 13-to-24-month, one-time-buyer recency category who is mailed will generate $0.22 in incremental contribution ($1.89 demand per catalog minus $1.67 variable break-even demand per catalog) to pay off your fixed costs. Therefore, you should continue mailing the 13-to-24-month one-time buyers.

The same analysis holds true for the multibuyer segment (see chart “A Sample Mailing: Multibuyers” — please check back Jan. 12 to view chart).

While the fixed-cost cutoff of $2 would eliminate the 25-to-36-month multibuyers, the correct decision is to mail to these individuals, since the demand per catalog of $1.79 exceeds the variable catalog cost break-even figure of $1.67.

As is evidenced by the multibuyer chart, every 25-to-36-month multibuyer generates an incremental $0.12 toward paying off your fixed costs. The effect of using fixed vs. variable costs generates an incremental $1.83 million in demand for one-time and multibuyers.

As a result, mailing the 13-to- 24-month one-timers and 25-to- 36-month multis will lead to more than $65,000 in incremental contribution, thus improving your catalog’s profitability.

Conclusion

The battle to identify incremental names to mail can be won by using variable catalog costs. This strategy enables you to avoid undermailing to segments that have covered all their variable costs and, consequently, to generate the most revenue and contribution possible without incurring unnecessary mailing expenses.

Michael Grant is president of Michael Grant Direct, a catalog consultancy in Scarsdale, N.Y. He can be reached at (914) 722-4177 or at michael@michaelgrantdirect.com.