How do you improve the value of your business? It’s a big topic, because it dovetails with what company owners work to do every day. But since we’re in the business of selling large direct marketing companies, we understand the special characteristics that drive higher valuations in an M&A process, and we can provide some insight.
Let’s look at the fundamentals, and then zoom in to examine those factors a multichannel direct marketer should be thinking about to maximize value over time.
Business value stems from earnings — not just last year’s or this year’s earnings, but the present value of those earnings out into the future. While nobody can calculate value based on uncertain projections, most buyers of businesses focus on certain criteria that give confidence in long term earnings stability and growth.
Earnings and revenue stability come from stable revenue and gross margins. If revenue bounces up and down from year to year, there is less predictability in the future cash stream.
The wonderful thing about direct marketing is that there usually is excellent predictability year-to-year, because the 12-month buyer list and rental prospects tend to perform reasonably consistently. Most direct marketers behave like fly wheels because of that consistent performance of the customer list — buyers of direct marketing companies appreciate this quality.
Here are two examples of stability: Many consumer gift catalogs tend to have boom-and-bust cycles based on gift trends and economic cycles. This volatility reduces value. On the other hand, a company such as upscale home goods mailer Frontgate started as a gift catalog but has shifted from being a gift business to predominantly selling goods for self-consumption. This shift helped Frontgate improve customer retention/repeat purchasing and establish more stable revenue.
Earnings and revenue growth are just as important as stability. Earnings growth inevitably must track with revenue growth. That is because you can improve margins for only so long before you reach the theoretical limit. Five percent revenue growth is considered healthy, 10% is strong, and 15% growth or higher will generate real buyer enthusiasm.
To be confident of earnings growth, a buyer will look at underlying trends — in particular, the growth in the 12-month buyer list. If the list is growing 5% or more, it demonstrates an ability to prospect efficiently, that it hasn’t run out of available names, and that it has sufficient reactivation of the house list.
A buyer will typically like to see a 60% repurchase rate; in other words, 60% of last year’s 12-month buyers have ordered again this year. We have seen businesses with strong values that have lower repurchase rates, but it is increasingly problematic when the rate falls below 50%. What drives growth? A real value proposition for the consumer that brings them hunting for your Website. A high average order and high contribution margin that allow aggressive prospecting and list growth.
As a discipline, you should always maximize growth each year by mailing no deeper than a basic six-month to 12-month payback on the worst performing segments (“six- to 12-month breakeven”). Never “save” money by cutting back circulation below a six-month breakeven.
Gross margins are an important measure of the health of a direct marketing business. High margins reflect unique merchandise or other barriers to entry that allow the marketer to avoid highly competitive pricing. Merchandising is the heart and soul of a consumer marketer, and companies with a strong point of view, lifestyle theme, or other unique angle that inspires the consumer tend to achieve higher margins on a consistent basis.
Business-to-business marketers similarly need to deliver a product mix with special added value. Proprietary products and house brands can be part of that unique product mix that brings higher margins than “me-too” products.
To improve gross margins, you have to start from where you are today. Source more goods in China, improve your product designs to pack in more value and raise pricing, or consider other changes to your mix.
Square-inch analysis to steadily substitute higher margin products for lower is a great discipline, but is only incremental. You need to make sure your merchandising concept is creative and unique in its totality, making a complete statement to the consumer — don’t focus just on finding winning items. As gross margins improve, a little each year, you will be able to spend more to mail deeper into your rental lists and grow a little faster.
The industry has many examples of unique merchandising that can drive higher margins. Here are two in the crowded home decor/furnishings market: Roomservicehome.com is a charming site that has a wonderfully consistent point of view throughout its wide product range. It inspires the visitor to create a vision of home furnishings around a cottage/vintage theme.
Another rich site with an interesting focus on unique linens and accessories is Frenchgeneral.com. These multichannel businesses have a unique point of view, and have each carved out a niche that doesn’t try to compete on price with Wal-Mart — never a good idea!
Marketing metrics are watched carefully by every direct merchant. But each business has its own economic model. You can’t say that sales per book should be more than $2 or average order over $50. There are businesses that do extremely well below those levels. For any business, however, improving those metrics year after year is an important discipline to building value. It will allow you to improve prospecting and mail deeper.
Fixed and variable costs are a place to focus much effort. Drive out cost by taking your call center costs per order down 10 cents. Improve the flow in the warehouse and take out 15 cents per order. As you squeeze down your variable costs, you will be able to mail deeper and spend more on keyword search because your breakeven calculation has been changed for the better.
VALUE BY CHANNEL
Multichannel performance is typically uneven for every business. The most valuable companies have well-developed performance in several channels that reinforce one another. Let’s look at a few key channels and what to do to improve value.
Internet channel: For many direct marketers, catalogs pull the train, and the Internet is only an order channel. If you’re skeptical of Internet marketing, you must force yourself to examine your blind spots.
Reach out to an Internet consultant to build sophisticated organic search and paid-keyword search programs. A good paid-search program can return $6 to $15 of revenue for every dollar spent per month. It’s absolutely a must as marketing shifts to the Internet.
The worst postage increases of 2007 are behind us, but the increases continue, and paper goes through periodic spikes. It is inevitable that marketing will increasingly shift to the Internet, and you must be there or you will be a victim of rising costs. The Internet should also be used to develop a direct relationship with your customer. Start a dialogue that you can share with all your customers.
For some examples, visit Twopeasinabucket.com, a popular scrapbooking site. You can see how other customers used products purchased on the site, read a blog, take a tutorial. It’s an interactive world. Bodybuilding.com, one of the top nutritional fitness and muscle building sites, has nearly 20,000 pages of useful content written by experts. The site has a bulletin board for its community of customers to communicate with one another. The Internet has potential for so much more than a static site to order products. You should use the Web to experiment constantly.
Retails: If you have stores, here are some ideas that drive value. A store’s cash flows should pay back the initial investment in that store within three years or less. Otherwise, your store model will not allow you to grow profitably over a long period of time.
Usually when this calculation is done, the initial investment excludes the cost of real estate, but includes leaseholds, inventory (net of offsetting payables), and pre-opening expenses. The cash flows are “four-wall” EBITDA, and include rent. If the payback isn’t two and a half to three years, then the stores may be too big, too small, too expensive, or need to be more profitable per square foot. Eliminate expensive, low-margin products from your store mix, and add higher-margin, high-turnover items.
Catalogs: Catalogs can be used to drive traffic to the Web. As paper becomes more expensive, it’s increasingly difficult to display your entire product mix in the catalog. The Internet is much more cost efficient for demonstrating your whole range of products. One strategy we’ve seen is using more frequent, but smaller catalogs to stimulate Internet shopping.
Coordinated self-reinforcing channels: A common error of multichannel retailers is poorly coordinated channels. Retail stores should capture the names and addresses of every sale, and those customers should receive catalogs and blast e-mails. Your Website should offer incentives for customers to visit your stores.
E-mail programs targeted at store customers can inform regarding new products or special deals, integrating store and electronic mediums. Post cards mailed to the existing house file in a new store’s trade area can turbo charge grand opening sales. There are many ways to reinforce sales across channels that go beyond the scope of this article, but there is always more to do in this regard, and continuous improvement is the rule.
Examples of coordinated multichannel merchants include Williams Sonoma and Restoration Hardware. You can order online and return to the store, you can find stores online, and name capture at the stores is sophisticated.
As a direct business grows, it needs new people to develop a higher sophistication level in the organization. A major mistake we see is reluctance on the part of company owners to bring in outside marketing or merchandising executives who can bring a fresh perspective and take the business to a new level.
A similar mistake is made when a CEO doesn’t counsel out mediocre managers. As a business owner you know who your weak players are — why haven’t you taken action?
When buyers see a company with a strong-minded entrepreneur but weak secondary management, it is a major concern. That entrepreneur has not developed the organization, and it is a one-person operation. As a founder or CEO, you should think about management succession when you’re 50, not when you’re 60.
Allow top talent to rise, eliminate mediocre managers, and bring in fresh blood. It is quite common to see people mistakes, and they are usually at the heart of underperforming organizations.
David J. Solomon is co-CEO of Lazard Middle Market (www.lazardmm.com), a subsidiary of financial advisory firm Lazard Ltd. His team has sold or financed such companies as Dr. Leonard’s, SkyMall, and Potpourri Group.