Do you measure how much it costs you to acquire a customer? The number of catalogers who don’t constantly amazes me. Internet pure-play marketers tend to be even worse—they don’t realize that knowing what it costs to acquire a customer is the first step in driving profitability.
Traditionally catalogs have relied on renting mailing lists to acquire customers, because lists are abundant in the U.S. and smart list brokers will suggest several options. Also, customers obtained through lists rented from other catalogs typically have a greater lifetime value than customers who come to the company from space ads, package inserts, or other media.
But as more catalogs have been mailed (more than 14 billion last year, according to the Direct Marketing Association), average response rates have fallen from about 2% to sometimes less than 1%. In response, more catalogers are turning to alternatives, such as magazine ads, package and billing inserts, card decks, trade shows, and public relations efforts.
In comparing any new prospecting medium with list rentals, you have two key measurement tools: the cost of getting a customer and the lifetime value of that new customer. This month we’ll focus on acquisition costs.
Knowing your customer acquisition costs lets you measure the relative value of one list vs. another, or of a list vs., say, a space ad. This, in turn, helps you decide how, or even whether, to change your acquisition tactics. Understanding what it costs to get a customer—and then the value of that customer over time—enables you to select the media combination that provides you with the best front-end cost and the best back-end value.
Step one: Calculating a one-step acquisition
Two key variables drive the calculations of customer acquisition costs: response rate and average order value (AOV). In general, it is far easier to manipulate AOV than to change response rates. Let’s start with measuring the cost of a one-step direct sale acquisition—a customer whose name you rented from another cataloger and who bought directly from the prospecting catalog you sent him.
Let’s say you mailed to 1 million prospects, had a 2% response rate, and had an average order of $50. Your margin before advertising was 35%, and the advertising cost per mailing piece, including list rental, was $0.60, or $600,000 when multiplied by 1 million. Now, to calculate the cost per name, follow these steps:
1) Multiply the response rate (2%) by the number of catalogs mailed (1 million) to obtain the number of buyers (20,000).
2) Multiply the number of buyers (20,000) by the average order ($50) to obtain the gross sales ($1 million).
3) Multiply gross sales ($1 million) by the margin before advertising (35%). Here, the result is $350,000.
4) Subtract from the above result ($350,000) the cost of advertising including list rental ($600,000). This gives you the profit contribution or loss—in this case, a loss of $250,000.
5) Divide the profit contribution or loss (-$250,000) by the number of buyers (20,000) to arrive at the cost or profit per name. Here, the cost per name is $12.50.
The two-step: More than a dance
The two-step acquisition process refers to generating a lead or a catalog request—for instance, by placing a space ad in a magazine that asks prospects to mail in a coupon requesting a catalog—and then converting that lead to a customer. The chart at left details how to calculate the cost of a two-step acquisition program:
1) Multiply total circulation of the ad by the response rate to determine the number of catalog requests.
2) Because at this point we are calculating only the cost of the catalog requests, there is no average order or gross sales to figure in. Instead, calculate the total advertising cost. Unless you require prospects to pay for the catalogs they request, your advertising cost will equal your contribution loss.
3) Divide the contribution loss by the number of responses to get the cost per name.
1) Assuming you’ve mailed a catalog to each requester, multiply the response rate by the number of catalogs mailed to get the number of catalog orders.
2) Multiply the catalog orders by the average order value to get the gross sales.
3) Multiply the gross sales by the margin before advertising to obtain the total margin before advertising.
4) Subtract the advertising cost of the mailed catalogs from the total margin before advertising to give you profit contribution (loss) of the mailing.
5) Subtract the initial lead generation cost (the contribution loss from Step 1) to give you total profit contribution/loss.
6) Divide by the number of buyers to get the profit or cost per name.
Determining what you can afford is a matter of balancing the cost of acquiring a customer against what a customer is likely to spend during the following three years, or customer lifetime value—the topic for next month’s column.
Jack Schmid is the president of J. Schmid & Associates, a Shawnee Mission, KS-based catalog consulting firm.