In previous analysis columns, we’ve tried to demystify some of the analytical tools used by successful catalogers. Profitable and growing companies know and understand the marketing, database, and numbers side of the business well and use the techniques to manage their their mailings and build their customer contact strategy. But a surprising number of companies don’t regularly calculate some of the fundamental industry measurements.
At the very least, you need to determine how much it costs to acquire a customer from various media such as rental lists, space ads, package insert programs, trade shows, and card decks. You also must calculate the lifetime value (LTV) of these customers.
These two metrics are key to understanding the entire marketing process of getting new customers and maximizing the revenue from them by more regular contact.
A third measurement that is often omitted when prospecting is how much you can afford to spend to acquire customers. Of course, you can’t figure this out unless you’ve already determined the cost of getting a customer and your customers’ LTV.
It stands to reason that the greater the three-year lifetime value of a customer, the more you can afford to spend to get a customer. A rule of thumb for many catalogers is to use a 12-month payback period to determine the acceptable cost to acquire a customer.
In other words, if you can make $10 in positive contribution from new customers within 12 months of their first purchase, you can afford to spend $10 to get them in the first place. So if you calculate lifetime value over a three-year period and you can pay for customers’ acquisition in the first year, you can generate profit from those customers in years two and three.
Gathering the data
Now let’s look at a method of determining how much you can afford to spend to get new customers. Before we can present a formula, we need to know a few details that should be available to you through financial data or historical performance:
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Net contribution margin — represented as a percentage, this is the contribution to overhead and profit after all returns, cancels, bad debt, cost of goods, and net fulfillment costs have been accounted for (see box at right).
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Prospect advertising cost — the “in the mail” cost of a catalog sent to prospects. This can differ from the cost to mail customers a catalog for several reasons, including different page counts and the name rental cost associated with prospect catalogs.
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Customer advertising cost, 0- to 12-month buyers — the in-the-mail cost of a catalog sent to 12-month customers.
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Prospect average order value (AOV) — the average gross demand for prospects who have responded to the medium for which you are calculating acquisition cost. In other words, don’t use the AOV for space ad customers to determine the acquisition cost for a list name.
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Customer AOV, 0- to 12-month buyers — the “average” average order value for 12-month customers across all marketing contacts. If you mailed your 12-month file five times during the year, this would be the AOV across all of those mailings.
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Number of annual customer contacts for 0- to 12-month customer file — how many times you will mail the 12-month customer file during the next 12 months.
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Customer average response rate percent, 0- to 12-month buyers — the average response of 12-month customers across all mailings. For example, if you mailed the 12-month file twice in a year, and the first mailing generated a 1% response, and the second mailing generated a 3% response, the average response for the 12-month period would be 2%.
With this data in hand, you can start by calculating breakeven dollars per piece mailed and move into the acquisition cost. We do both because breakeven will give the baseline performance for a housefile name while the dollars per book associated with an acceptable acquisition cost will show us how much lower than breakeven is tolerable. We’ll use these two figures — breakeven dollars per catalog mailed and acquisition dollars per catalog — as barometer points when we’re conducting our analysis after a catalog mailing is complete.
Calculating breakeven and acquisition cost
For the cost to acquire a customer model, we’ll use the following assumptions:
- Net contribution margin (NCM) = 65%
- Ad cost, prospect (ACP) = $0.75 per piece
- Ad cost, 0- to 12-month customer (ACC) = $0.75 per piece
- Average order value, prospect (AOVP) = $80
- Average order value, 0- to 12-month customer (AOVC) = $105
- Number of annual customer contacts for 0- to 12-month customer file (MLGS) = four mailings
- Average response rate, 0- to 12-month customer (RRC) = 8%
So breakeven will be $0.75 divided by $0.65, or $1.15 per catalog mailed. (For more on calculating breakeven, see “Catalog Analysis” in the November and December 2001 issues of Catalog Age.)
Because we expect average order value for prospects from a given source to remain consistent, we’ll usually look at response rates to fluctuate and cause changes in dollars per book mailed (also calculated as response rate multiplied by average order value). This says that if we divide our breakeven dollars per piece by average order value, we’ll get the response rate required to meet breakeven. If this is the case, $1.15 divided by $80 tells us we need a 1.44% response to break even.
The fomula to calculate the cost to acquire a customer is (((RRC × AOVC) × NCM) – ACC) × MLGS. In English, that means multiply the 12-month customer’s dollars per piece mailed by the net contribution margin, then subtract the ad cost for the 12-month group, and multiply the answer by the number of mailings to the 12-month customers in a 12-month period.
In our example, the formula calculates to (((0.08 × $105) × 0.65) – $0.75) × 4, or $18.84. Given our assumptions, the average 12-month customer will contribute $18.84 to overhead and profit during the next 12 months of mailing. If our goal were to have a new customer pay back in 12 months, $18.84 would be the maximum we would be willing to spend on a new customer. For the next step, we’ll refer to this acquisition cost as ACQ.
To find the cost to acquire a customer per piece mailed, use [ACP / ((AOVP × NCM) + ACQ)] × AOVP. In other words, you want to divide the ad cost for prospects by the product of the average order value for prospects times net contribution margin plus the acquisition cost, and then multiply that answer by the average order value for prospects.
So we have [$0.75 / (($80 × 0.65) + $18.84)] × $80, or $0.85 per book mailed. If we divide the $0.85 by our $80 AOV we get 1.06% as the needed response rate to meet our acceptable acquisition cost.
To break even, then, a list must generate a 1.44% response at an $80 average order. But to hit the target acquisition cost, a list needs to generate only a 1.06% response — a 26% lower threshold. Also, as we evaluate the success of each prospect list after the mailing is complete, we needn’t put them under the burden of reaching the $1.15 per catalog breakeven level but only the $0.85 per catalog acquisition level.
By understanding the relationship of breakeven, lifetime value, and your historical prospect and customer data, you prospect smarter and make more-precise decisions on whether to mail certain lists or customers acquired from another media.
Jack Schmid is president and Steve Trollinger is vice president, client marketing of Shawnee Mission, KS-based catalog agency J. Schmid & Associates.
NET CONTRIBUTION MARGIN
| AVERAGE ORDER VALUE (AOV) | $80.00 | |||
| Cancellations | 1% | ($0.80) | ||
| Returns | 5% | ($4.00) | ||
| NET ORDER SALE | $75.20 | 100% | ||
| Cost of goods | 26% | ($19.55) | ||
| $55.65 | ||||
| Fulfillment cost per order | ($12.00) | |||
| + Fulfillment income per order | $5.00 | |||
| Net fulfillment expense/order | ($7.00) | |||
| NET CONTRIBUTION MARGIN | ||||
| Contribution to overhead/profit | $48.65 | 65% | ||