Catalog Analysis: The Internet/Catalog Financial Model

During the past few months, we’ve looked at several financial models, both consumer and business-to business. One of our conclusions is that there is no single model that is right for all catalogers. Every company’s financial structure, and therefore its analytical model, is dependent on many variables, including the cost of goods and gross margin; the cost of getting the catalog in the mail (creative, printing, and mailing); fulfillment costs; and administrative structure (general and administrative costs).

Another conclusion that was reached: It is critically important for every cataloger to understand its financial model and to use the model in strategic planning and for benchmarking annual progress.

This month we want to take our financial modeling a step further — into the future, if you wish — and look at the impact of a growing reliance and interdependence of catalog success and the Internet.

In many ways, the Internet has given cataloging a significant boost in acceptance among consumers and has increased the direct seller’s ability to find customers and grow revenue and profit. In fact, today we hardly discuss cataloging without also talking about the Internet. The two selling channels, while not interchangeable, are intertwined and interrelated. And, of course, some marketers are adding the third leg of the tripod, stores, to the mix for even greater success.

Let’s look at the financial model for a company that is highly Internet oriented and driven. No, it’s not a pure-play Internet seller, but a greater percentage of its sales is being generated via the Web. The chart below shows us the differences that start to accrue as a greater portion of revenue is Web related.

Catalog model vs. Internet model

For the sake of example, we have taken the consumer catalog financial model discussed in the January 2003 issue of Catalog Age and added a column labeled “Internet/Catalog.” The example looks at three hypothetical industries — gifts/hard goods, apparel, and electronics — and contrasts the difference between a financial model strictly oriented to catalogs and a second where there is an equal mix of catalog and Internet orders. Note how many of the differences affect the profitability of the business.

Consumer Gifts/Hard Goods Internet/Catalog Gifts/Hard Goods Consumer Apparel Internet/Catalog Apparel Consumer Electronics Internet/Catalog Electronics
GROSS MERCHANDISE SALES 113% 113% 135% 135% 113% 113%
Less returns 5%-10% 5%-10% 15%-25% 15%-25% 5%-10% 5%-10%
Less cancellations 2%-3% 2%-3% 5%-10% 5%-10% 1%-3% 1%-3%
NET SALES 100% 100% 100% 100% 100% 100%
Less cost of goods 45%-47% 45% 50% 50% 60% 60%
GROSS MARGIN 53%-55% 55% 50% 50% 40% 40%
Less fulfillment 12% 8% 15% 10% 10% 7%
Less advertising 25% 17% 17% 14% 12% 10%
CONTRIBUTION TO OVERHEAD & PROFIT 16%-18% 30% 18% 26% 18% 23%
Less fixed costs (overhead) 8% 8% 8% 8% 8% 8%
PRETAX PROFIT 8%-10% 22% 10% 18% 10% 15%
AFTER-TAX PROFIT 4%-5% 11% 5% 9% 5% 8%
  • Returns and cancellations for the two types of business are substantially the same.

  • Cost of goods (and gross margin) are also the same under each example — but the cost of goods can increase if Web sales are overly promotional.

  • Fulfillment costs, or the operational costs of receiving, entering, and shipping an order, change as more of the orders are placed via the Internet. There should be a notable savings in call center staffing costs (inside or outside) and order entry costs as more online customers input their orders directly into the system — provided that orders can actually be processed online and aren’t merely batched for rekeying by call center staff later. By the same token, telephone line and equipment costs should decrease.

  • Some of the largest savings come from creative and marketing. For one, the page count of the print catalog can be somewhat reduced. Testing a catalog with fewer pages makes sense. The catalog then functions in large part as a traffic driver for the Website, where customers and prospects can find more information and a broader merchandise assortment.

Then, too, the Internet/catalog marketer can make greater use of push e-mail campaigns to supplement or replace print mailings. Many successful catalog and Internet multichannelers are becoming expert at capturing e-mail addresses of customers and prospects and reducing mailings by as much as one-half and replacing them with hard-hitting, offer-driven e-mail campaigns.

Another positive aspect to the growth of Web sales is that direct marketing is reaching segments of the population that are not traditional catalog shoppers. Several recent match studies we have developed for clients indicate that as many as 70% of the Internet buyers are new to direct. Significant breakthrough!

Downsides of more Internet orders

Of course, there are some negatives when seeking a higher mix of Internet to phone and mail orders:

  • Many companies are experiencing lower average order values (AOVs) on Web orders — some as much as 25% — due to slower download times, poor navigation, and the lack of a customer service upsell/cross-sell, or what we term the “shop vs. buy” phenomenon in which customers shop the catalog but pinpoint the item and buy online.

  • Internet buyers tend to be more discount driven — looking for bargains and special sales.

  • Incentives and discounts such as free shipping are commonplace online.

The three points above can work in combination to hurt the Internet/catalog financial model, as customers spend less online while the cataloger spends more for the purchase through margin-eating discounts and free shipping offers.

The chart on the next page illustrates how the lower online AOV can hurt the bottom line, despite savings in other areas. Our example assumes that online AOV trails traditional channel AOV by 15%, or that phone-in AOV is $100 and online AOV is $85. At the same time, fulfillment costs online are typically 30%-50% lower than for traditional channels because of the lower labor costs involved in processing catalog orders from the Web. So we’ll assume a net fulfillment cost of $7 per order for the catalog and $3.50 per order for the Web. Finally, we’ll assume cancellations and returns combined account for 5% of sales and that the cost of goods sold is 50% of sales.

Catalog order %
Gross sale $100.00 105%
Returns/cancels ($5.00) 5%
Net sale $95.00 100%
Cost of goods sold ($47.50) 50%
Gross margin $47.50 50%
Net fulfillment ($7.00) 7.3%
Contribution to advertising, overhead, and profit $40.50 42.6%
Internet order %
Gross sale $85.00 105%
Returns/cancels ($4.25) 5%
Net sale $80.75 100%
Cost of good sold ($40.38) 50%
Gross margin $40.37 50%
Net fulfillment ($3.50) 4.1%
Contribution to advertising, overhead, and profit $36.87 43.4%

Based on these assumptions then, the cataloger would see a 9% drop in contribution per order when a customer is converted from a catalog buyer to an Internet buyer.

You must ask then whether it makes sense to convert catalog customers to Web buyers “because it’s less expensive to process orders online.” It gets even worse if the cataloger offers, say, $5 off any online order. The net result in that case would be a 21% drop in contribution to profit, overhead, and advertising per order.

Let’s take this example a step further. Consider a mailing of 1 million catalogs with an overall response rate of 3.5%, or 35,000 orders. If the Internet represents 15% of sales, then 5,250 orders (or 15% of 35,000 orders) were converted from the catalog to the Web. Those 5,250 orders would represent nearly $19,100 in lost contribution directly related to driving customers from the catalog to the Web. The loss spikes to more than $45,000 if you account for the $5 online offer.

All this doesn’t mean that catalogers are making mistakes by pushing orders to the Web. It means that you must understand the metrics behind the medium.

For example, you can improve online AOV through site enhancements. Many catalogers have had success in matching or exceeding the catalog’s AOV online by incorporating “smart” cross-sells and upsells using the software that drives the e-commerce site at the time of checkout. Others have improved AOV by changing the site’s navigation so that moving from one product to another or from the shopping cart to more items is fast and easy.

Other considerations to watch for when generating more Internet orders:

  • Experience indicates that online buyng behavior may indicate lower lifetime values.

  • Internet catalog requesters tend to lose interest or become dormant more quickly than prospects generated from space ads, card decks, or referrals. Instead of a 12- to 18-month window to convert traditional catalog requesters (generated from space, referrals or direct mail,) the timing will be more like 6-12 months for Internet catalog requesters.

  • Capturing e-mail addresses is essential to Web marketing success.

Don’t let all this talk of Web marketing’s downsides distract you from the fact that an Internet/catalog marketer’s savings from fulfillment and creative and marketing can account for a 5%-10% gain in contribution to overhead and profit.

And what cataloger is not interested in improving the bottom line, finding new customers, and building long-term loyalty with existing buyers? Identifying new ways to creatively and economically use the Web will in every direct marketer’s best interest. Building a new catalog/Internet financial model is one of the best ways of exploiting this new multichannel concept.

Jack Schmid is president and Steve Trollinger is vice president, client marketing of J. Schmid & Associates, a Shawnee Mission, KS-based catalog consultancy.

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