Breakeven analysis is one of the most difficult tools for new catalogers and Web marketers to understand. As with the forecast, you typically perform a breakeven analysis before implementing a promotional campaign. You can also use breakeven analysis after a campaign to measure its overall success or to determine the performance of individual list segments, such as rental lists, Web catalog requests, or various selections of the house file list that may have been segmented by recency, frequency, monetary, and product category (RFMP).
The analysis essentially works as a profit-and-loss “backword solving” for two important variables: 1) the response needed for the mailing to break even; and 2) the sales per catalog mailed needed to break even. The latter (sometimes expressed as sales per 1,000 catalogs mailed, or $/M) is the critical measurement of a catalog’s success.
Breakeven analysis in action
You should do a breakeven before each season to reflect the latest changes to the cost structure of the business. The breakeven is done by individual average order — in other words, by the estimated order size from your best customers, your prospects, or your catalog inquirers. The following checklist includes assumptions that you must update and enter into each new breakeven:
- average unit selling prices
- average units per order
- cost of goods
- fulfillment cost to receive, enter, and ship an order
- shipping and handling revenue for each order
- cost of the catalog in the mail — both variable costs and fixed costs.
Breakeven analysis identifies the precise response rate at various average order values at which a mailing makes money or loses money (or contributes to overhead and profitability). In other words, what response rate do you need to achieve for a rental list if the average order value (AOV) is $50? Or $75? Or $100? The equation determines the sales for each catalog mailed by individual list segment.
Objectives of various list segments vary widely. For instance, when mailing to prospects, your goal is generally to acquire the best-quality customers while minimizing the cost. Similarly, when mailing to catalog inquirers or requesters, you should focus primarily on converting them to first-time buyers. These mailings should not be responsible for producing profits or covering overhead costs.
On the other hand, when mailing to your best customers, you want to maximize the profitability and return on investment. These mailings are burdened with most of the fixed and variable advertising costs as well as overhead costs. And in mailing to inactive customers, you should aim to cover variable and overhead costs while getting those buyers back to an active status.
In keeping with the varying objectives per circulation segment, you should typically perform breakevens at several levels — or to put it another way, you should define “breakeven” in several ways:
Level #1: variable cost level, or 0% level. This is where you will typically judge prospects. The breakeven covers all variable costs, but no overhead or no contribution to profit.
Level #2: overhead level, or 7%-10% level. (The exact number will correspond to your overhead costs. For instance, if your overhead is 8% of net sales, then use 8%.) This level applies to older-year customers and nonbuyer house names. The breakeven covers all variable costs and overhead but no profit contribution.
|Average unit price||$50.00||$50.00||$50.00|
|Average units per order||2||2||2|
|Average order value (AOV)||$100.00||$100.00||$100.00|
|Net sales per order||$89.00||$89.00||$89.00|
|Net cost of goods sold (50%)||$44.50||$44.50||$44.50|
|Fulfillment cost per order||$12.00||$12.00||$12.00|
|+ Shipping and handling income per order||$5.00||$5.00||$5.00|
|Net fulfillment cost per order||$7.00||$7.00||$7.00|
|Contribution before promotion, overhead and profit|
|Contribution @ 0% (variable costs only)||$37.50||$37.50||$37.50|
|Contribution @ 10% (Variable and overhead costs)||$28.60|
|Contribution @ 20% (Variable and overhead and profit)||$19.70|
|Advertising cost per piece||$0.50||$0.50||$0.50|
|Breakeven = 0% (variable level)||1.33%|
|Breakeven sales per catalog||$1.19|
|Breakeven = 10% (variable + overhead level)||1.75%|
|Breakeven sales per catalog||$1.56|
|Breakeven = 20% (variable + overhead + profit level)||2.54%|
|Breakeven sales per catalog||$2.26|
Level #3: fully loaded level, or 17%-20% (again, the exact percentage depends on the overhead costs). This breakeven assumes that you are seeking a 10% pretax profit. This breakeven is applicable to the best catalog buyers, typically 12-month customers. The breakeven covers all variable costs, overhead, and 10% pretax contribution.
The breakeven analysis chart below shows the three levels of breakeven and the calculation for solving for percentage of response and sales per catalog. The three examples are exactly the same except for the calculation to solve the breakeven at the three levels.
- The examples assume an average unit price of $50 in the catalog and an average of two units per order. The AOV therefore is $100.00 ($50 × 2 = $100.00).
- Cancellations are expected to be 1% (1% of $100 = $1). Returns are expected to be 10% (10% of $100 = $10). Net per order is therefore $89 ($100 minus $1 minus $10 = $89).
- Cost of goods is 50%, or $44.50 (50% of $89 = $44.50).
- Fulfillment is $12 per order, with shipping and handling income at $5 per order. Net fulfillment expense is therefore $7 ($12 minus $5).
- Contribution before promotion, overhead, and profit is what is left over to pay for advertising. At the 0% level the calculation is: $89.00 minus $44.50 minus $7.00 = $37.50
- Advertising cost per piece is $0.50. (This represents the variable cost of printing, postage, binding, and mailing but no list rental expenses and no fixed creative costs. Some companies will add fixed creative to this calculation.)
- Now, to figure out the 0% level breakeven response, divide the per-piece advertising cost by the contribution: $0.50 divided by $37.50 = .01333, or 1.333% response.
- Finally, determine the sales per catalog needed to break even by multiplying the percentage response by the net order sale, or 1.333% of $89.00 = $1.19 sales per catalog mailed.
The breakeven analysis has just solved for the two key variables: the percentage response and the sales per catalog mailed by which one can judge new customer acquisition.
- You can then compute the other levels of breakeven in a similar manner. To arrive at the contribution, multiply the overhead level by the net order sale and subtract it from the 0% contribution level. For instance, in Example B, 10% of $89.00 = $8.90; subtract $8.90 from the 0% contribution of $37.50, and what’s left is $28.60, to pay for advertising, overhead, and profit. For Example C: 20% of $89.00 = $17.80; $37.50 minus $17.80 = $19.70.
- From there, you can calculate the breakeven response per catalog. For Example B: $0.50 divided by $28.60 = .017482, or 1.75%. Example C: $0.50 divided by $19.70 = .0253807, or 2.54%.
- And again, to calculate breakeven sales per catalog, multiply the percentage response by the net order sale. Example B: 1.75% × $89.00 = $1.56 revenue per catalog mailed. Example C: 2.54% × $89.00 = $2.26 revenue per catalog mailed.
The breakeven calculation is a perfect application for a spread sheet and lends itself to doing “what if” observations: What if the AOV is $120? What if cost of goods is 45%? What if the promotion cost is $0.60?
Above all, breakeven analysis provides a reality check. Do these numbers make sense? Are they within the realm of reality?
From there, you can use the numbers to hone your catalog’s prospect and customer circulation plans. By calculating each circulation segment’s response rate, AOV, and sales per catalog and then comparing the expectations with the breakeven, you can quickly tell which lists can be tested, mailed deeper, or not mailed at all.
You can also use the breakeven as a leverage with your merchants to urge them to reduce the cost of goods while improving the product mix to attain a higher AOV.
And finally, the breakeven focuses on a review of the printing costs and seeing where you can realize savings.
Next month, we will look at breakeven from a broader perspective and see what happens when we include list rental and fixed creative costs in the promotion cost.
Jack Schmid is president of J. Schmid & Associates, a Shawnee Mission, KS-based catalog consulting firm.
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