The Mathematics of Circulation Analysis

Any discussion of catalog circulation and analysis requires a look at three very important topics:

1. Determining your break-even point on an incremental and fully absorbed basis;

2. Calculating how much you can afford to spend for a new buyer; and

3. Determining key ratios and the best format for your profit and loss statement.

Finding Your Break-Even Point

Break-even points are either incremental or fully absorbed. It is important to make a distinction between the two because not all mailings can be measured, as is commonly thought, strictly on an incremental basis.

The incremental break-even point includes direct costs only, and it generally applies to mailings sent to prospects. The formula is: net sales (minus) cost of goods sold (minus) variable order processing costs (minus) direct selling expenses.

The fully absorbed break-even point includes variable, as well as fixed, operating expenses and it applies to mailings to a current customer or house file. Its formula is: net sales (minus) cost-of-goods-sold (minus) variable order processing costs (minus) direct selling expenses (minus) fixed costs. That is, a fully absorbed break-even point is the incremental break-even point (minus) fixed costs.

Your house file will be the one to absorb your overhead expenses such as rent, electricity and telephone.

Using Your Break-Even Point

Keep in mind that if you were to apply a fully absorbed break-even point to prospect mailings, you would most likely find that you would have to eliminate all mailings to outside lists. That’s because mailings to prospects cannot possibly break even if expected to absorb overhead expenses. The revenue per catalog mailed is too low.

However, prospect names cannot be expected to cover both direct and indirect expenses. As a matter of fact, it is more likely that they will not even be able to cover your incremental expenses. If your prospect mailings were able to break even incrementally, you would be acquiring new buyers for no out-of-pocket cost!

Of course, this is not practicable. You will need to invest dollars initially in your prospecting without expecting to break even. Therefore, there will be a cost associated with the acquisition of a new buyer. Ultimately, the size and strength of your house file will determine how much prospecting you can afford.

Caution: Over-circulating catalogs to prospects could have a devastating impact on your bottom line. You should always maintain a careful balance between mailings to prospects and mailings to your customer list.

Let’s look at a hypothetical situation. Assume, for example, that your incremental break-even point is $1.24 per catalog mailed, and your fully absorbed break-even point is $2.20 per catalog mailed.

In this example, you decide not to mail to any outside prospect lists generating $1.24 per book or less. But how about the house-file segments generating between $1.24 and $2.20 per book? Should you mail to these segments of your house file? While these house-file segments are below the fully absorbed break-even point ($2.20), they are above the incremental break-even point ($1.24). Therefore, you should definitely send mailings to these names. This is especially true considering you already own the names!

How Much to Spend for a New Buyer

It is common for catalogers to feel they need to break even incrementally on the initial purchase by a new buyer. Although this seems like an admirable goal, it is not a realistic one, given the economics of the catalog business today. You should look beyond the initial purchase costs to the future value of the new name you want to acquire. In other words, you need to consider the lifetime value of the buyer.

Providing that your cash flow will allow for it, you should think in terms of a 12-month payback. Although initially you may acquire the buyer at a negative contribution to profit and overhead, by the end of the first 12 months that same buyer will be generating a positive contribution to profit and overhead as a result of repeated purchases made during this period of time.

Let’s consider a few examples of expected contribution to profit and overhead, from a typical customer, over a given period of time. Shown at left are three examples that lists the contribution value over a 12-month period.

As you can see in Example A, this cataloger spent $6.78 (based on incremental cost) per new buyer. A total of 1,500 new buyers were generated from this mailing to 100,000 prospects. Over the next 12 months, these 1,500 new buyers received 10 additional mailings as shown in Example B. These mailings, in turn, produced a positive contribution of $13.16 per customer to profit and overhead. If we combine the results of Example A with the results of Example B, the contribution per customer at the end of a 12-month period is a positive $6.38 for the full year, as seen in Example C.

Therefore, $6.78 was spent initially for a new buyer, but by year’s end, the investment in that new name was positive by $6.38 per buyer, due to the repeat purchases made during the year.

If you want your business to grow and be successful, you will need to prospect below your incremental break-even point. As long as you know there is a reasonable payback—i.e., less than 12 months—you should maximize your prospecting efforts.

If you expect to break even on the initial purchase, you will not be able to do much, if any, prospecting.

You will probably only have a few lists—representing the smaller universes—that meet or exceed your incremental break-even criteria. This kind of short-sightedness will negatively impact the growth rate of your business. Ultimately, the key to your success is maintaining an ever-growing house file.

Determining and Using Key Ratios

The format for your profit and loss statement and the management of key operating ratios are critical. One method is to separate, or isolate, the direct selling expenses—creative cost, paper, printing, postage, lists, merge/purges, etc.—on the income statement. The operating expenses then follow the direct selling expenses on the profit and loss statement, as shown in the chart to the right, “Typical Profit and Loss Statement for a Consumer Catalog.”

In this example, shipping and handling revenue is shown net of freight, as part of the operating expenses. Also shown are expense-to-net-sales ratios for a typical consumer catalog company.

Direct selling expenses should represent about 30 percent of net sales; operating expenses are typically 19 or 20 percent of net sales. As a general rule, the higher the gross margin, the higher the direct selling expense-to-sales ratio—or, the lower the margin, the lower the selling expense-to-sales ratio.

For example, in a highly competitive catalog business, such as brand-name hunting and outdoor equipment, the gross margin ratio is typically in the low 30-percent range. Selling expenses for this type of business can be as low as 20 percent of net sales.

However, for a catalog business like personalized stationery, which typically has a gross margin of 70 percent or higher, the direct selling expense-to-sales ratio can range from 35 percent to 40 percent of net sales. Although the key ratios shown on this chart will vary from business to business, they serve as a useful guide for any consumer catalog company.

The key to any successful business is to manage by ratios. Increasing your level of prospecting will cause your selling expense-to-sales ratio to increase. Obviously, this will impact net income.

You may want to vary your marketing plan from year to year. For example, one season you may find it feasible to focus on increasing your customer base at the expense of your bottom line. The following season you may opt to reduce your level of prospecting in order to increase profits.

Regardless of how you plan your prospecting, there is a direct relationship between the amount of prospecting you do and your direct selling expenses-to-sales ratio. Balancing these two aspects of your business is an important factor in increasing your profitability.

Stephen R. Lett started Lett Direct Inc. in 1995 after spending the first 25 years of his career with leading catalog companies. Lett is on the faculty of Indiana University where he teaches direct marketing at the MBA level, and he has served as chairman of both the Catalog Council and B-to-B Council of The DMA. Lett can be reached at (317) 844-8228.