Catalog Analysis: The Cost of Acquiring a Customer Feb 1, 2001 12:00 PM
, Jack Schmid
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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:
Step 1:
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.
Step 2:
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.
To download a copy of this article in PDF format, complete
with chart, click here. This file requires Acrobat Reader,
which you can download for free at www.adobe.com.
