Three Years and $3 Million to Break Even

The longer you’ve been in cataloging, the more variations you will have heard for this month’s rule of thumb. Over the years I’ve heard two years and $2 million, four years and $4 million, even five years and $5 million—but all variations seem to agree that it takes several years and about the same number of millions of dollars for a new catalog to reach breakeven.

How reliable is this rule? Are there exceptions? Or has launching a successful catalog truly become a millionaire’s game these days? We’ll find some answers in this column, beginning with a precise definition of our rule:

The Rule of “Three Years and $3 Million to Break Even”:

If you launch a new catalog and do everything fairly intelligently, you’ll still need to invest three years and $3 million dollars before you reach the first year in which annual revenues equal annual costs.

Is this rule of thumb actually true?

In logic, a proposition is disproved by finding a single exception, and in that sense, this rule of thumb is surely false, since a few catalogs do achieve profitability on their very first mailing.

But it’s also true that those catalogers are definitely the exceptions—Most new catalogs nowadays are unprofitable at launch, and remain unprofitable for several years.

Is “breakeven” a fixed point for a catalog?

No. There are actually two basic points at which a cataloger chooses to break even.

The first is when the housefile (prior buyers plus catalog requesters) has grown just large enough to generate enough profits from each mailing to pay for designing, printing and mailing the next catalog drop to housefile names only. This is the first break-even point a new cataloger will reach, and most catalogers will choose to ignore it, since achieving breakeven at this early point requires stopping all prospect mailings. However, many non-catalogers (e.g., bank loan officers) become excited when they see this break-even point arrive, and recommend (or even insist) that a cataloger stop and achieve minor profitability at this point, by stopping all prospect mailings. This leads inevitably to a shrinking housefile and eventual business collapse (yes, I’ve seen it happen).

The second break-even point occurs when a cataloger’s housefile has grown large enough for each mailing to generate enough profit to pay for mailing to the housefile and to enough prospects to replace housefile attrition. This is the second break-even point most new catalogers arrive at. Most catalogers choose not to stop at this second break-even point, but instead opt to continue prospecting, at a loss, well past it to grow the housefile.

Of course, the ultimate business goal for most catalogers is to reach the third point on our scale—a point well beyond breakeven. At this level, the catalog business could be considered mature, enjoying healthy economies of scale, with a housefile large enough to pay for substantial prospecting mailings while still dropping a healthy profit to the bottom line.

Why does it take so many years to break even with a catalog?

It’s caused by some simple marketing arithmetic, which goes like this: When you launch a new catalog, you have no prior buyers, so each catalog goes to a prospect. A typical prospect response rate to a moderately sized, reasonably targeted catalog is 1 percent (ie., you mail 100 catalogs, you get one order.) A realistic in-the-mail cost for a moderately sized new catalog is $0.50 (creating, printing, mailing). A typical cost-of-goods percentage is 50 percent, a typical average order size might be $75 and a typical cost to take and fulfill an order is $10 (excluding outbound freight). So from each $75 order, you must subtract $50 in catalog costs (that’s the $0.50 cost of each catalog times the 100 total catalogs you must mail to get one order at a 1-percent response rate), plus $37.50 (50 percent of $75) in cost of goods, plus $10 in telemarketing/fulfillment costs. That totals $97.50 in costs, from which we subtract our $75 in revenue, to arrive at a loss of $22.50 on each order.

For future reference, this loss can be viewed as the cost of adding one new buyer to your housefile.

Breakeven for Prior Buyers

That’s for prospects. Now doing the same math for mailing to prior buyers, the only number we need to change is the response rate. But look at what a difference that change makes.

A typical response rate for prior buyers is perhaps 5 percent (averaged over three years worth of buyers). Which means you must mail (and pay for) just 20 catalogs to get each order. This drops your catalog creation cost from $50 to just $10 per order (since you must mail only 20 catalogs to get one order, not 100 catalogs as before). All other costs stay the same, so your total costs for a sale to a prior buyer are now $10 + $37.50 + $10= $57.50, which when subtracted from your gross revenue of $75 leaves you with a healthy profit of $17.50 on each order from a prior buyer.

This demonstrates the truth so well known to most catalogers: mailings to buyers are profitable, mailings to prospects aren’t, and a catalog program achieves breakeven when its list of prior buyers becomes large enough to earn enough profit from each mailing to offset the catalog’s prospecting losses and operational costs.

How many names must I have on my housefile to achieve that kind of breakeven?

Extending the above calculation, if your housefile contains 15,000 buyers (over the past three years), and if you mail each of these buyers four times per season at an average response rate of 5 percent per mailing, you’ll generate a total profit of 15,000 x 4 x .05 x $17.50 = $52,500, which is enough to cover the loss on 2,333 prospect orders, meaning you can pay for a total prospect mailing quantity of about 233,333 (at a 1-percent prospect response rate). Adding this prospect mailing quantity to our prior buyer mailing of 60,000, we get a total print run of about 300,000. And figuring that you’ll receive about 10 catalog requesters on your housefile for each buyer, your gross housefile count will consist of 15,000 buyers plus about 150,000 non-buyers, giving you a total housefile size (buyers plus non-buyers) of 165,000.

And that represents a pretty typical picture of a cataloger who has just achieved the second kind of breakeven. How many years and dollars did this cataloger have to invest to get there? The total cost is easy to calculate: We saw above that we were losing $22.50 on each order from a prospect, and we saw that this loss could be viewed as our cost to add a new buyer to our housefile. So adding 15,000 new buyers to your housefile will cost you $22.50 x 15,000 = $337,500. And to get those 15,000 prospect orders, you’ll need to have mailed a grand total of approximately 1.5 million total catalogs (at a 1-percent response rate).

Doesn’t that show that you can achieve breakeven on a total investment much lower than $3 million?

Yes. In the real world I find that new catalogers who do everything reasonably well can achieve profitability in year three or four, on a total investment of around $500,000.

If all I need is 15,000 prior buyers on my housefile to achieve breakeven, why spend three years acquiring them? Why not get them all at once with a single huge prospect mailing in my first year?

That’s theoretically possible, but risky in the real world, since you would be gambling everything on your first catalog. First catalogs are seldom optimized in terms of presentation, product line, offer, list selection or operations. It usually takes several seasons to wring all the misconceptions and errors out of a new catalog program. So it makes more sense to begin, not with a huge initial mailing designed to get 15,000 buyers in one swoop, but with a test program large enough to be statistically significant, yet small enough to conserve cash and avoid bankruptcy during the learning process.

I want to break your rule of thumb and achieve profitability on all mailings, including my first. How can I do this?

The holy grail for all new catalogers is a catalog program that is profitable on every mailing, including the first. I usually hear it phrased like this: “I want to finance my second catalog with the profits from the first.”

Mature catalogers usually chuckle when they hear this, but some catalogers do achieve it. How? Broadly speaking, they share the following characteristics:

1. A fairly unique product line.

2. A product line highly desired by consumers.

3. A target audience that can be found and mailed fairly economically.

4. Good-value price points.

5. Sound telemarketing and fulfillment operations.

6. A tendency to make very few mistakes—They learn about cataloging in advance from books, magazines, and/or industry leaders and experts, rather than from costly trial and error.

7. They are tightwads (ie., they control costs very aggressively).

Here are three other characteristics that such catalogers often have, though not always:

8. A product line that has a naturally high price point (leading to an average order size higher than $100).

9. A widely recognized and respected brand.

10. A cost-of-goods percentage less than 50.

So is our $3 million/three-year rule of thumb totally invalid?

Actually, it depends on how large you want your catalog business to become. It’s certainly true that a well-conceived, soundly executed catalog business can reach a point of small but sustainable profitability on a total investment of less than $1 million.

However, the business at that point will probably not be large enough to excite much interest. Experienced catalogers often remark that cataloging only starts becoming comfortable at around $10 million in annual revenue. At that point many economies of scale are starting to work: unit postage costs are becoming reasonably low, fixed costs to create the catalog are becoming low enough to justify more extravagant design and call volume is becoming large enough to justify a reasonable in-house call center and fulfillment operation. How much does it cost to grow a catalog to that size? Answering that takes more space than this article provides—but obviously, it involves the “many millions of dollars” envisioned by our rule of thumb. So maybe our $3 million/three-year rule isn’t so far off after all.

Susan McIntyre is president of McIntyre Direct, a catalog consulting company based in Portland, OR. She can be reached at (503) 735-9515.