Given that number crunching is a core competency of any cataloger and Internet marketer, I believe that all employees in a catalog company should have a reasonable understanding of what drives financial success and how the numbers work in a profitable business. That’s not to say every copywriter, art director, and merchandiser must be able to prepare elaborate spreadsheets, circulation plans, or lifetime value formulas for customers. But they should understand the basic catalog financials, such as
- what a financial model is and how to use it as a benchmark;
- how to use the financial model to better manage the business;
- what goes into a profit-and-loss (P&L) statement and who is responsible for each part of the P&L;
- the practical uses of financial modeling and the P&L in managing a catalog business.
The chart below shows examples of financial models for three types of consumer catalogs: gifts/hard goods, apparel, and electronics. These models represent an ideal that a mature cataloger in each industry segment would like to achieve.
Line by line
The elements of a catalog financial statement include
- pretax profit
The bottom-line goal of every mature consumer cataloger should be at least 10% pretax profit or 10% EBIT (earnings before interest and taxes). New ventures should strive to meet this level by the fifth year, although some catalogs take 10 years and others just three years. If your projections don’t come close to a 10% pretax profit by the fifth year, you need to seriously question the venture’s feasibility.
- gross merchandise sales
These represent gross demand by customers for your products, or the sum total of all customer orders — filled or not. You must track demand for goods even though you will always have some returns and cancellations. For gifts/hard goods companies, gross demand is typically about 13% higher than net sales, or 113%.
- returns
This represents products being returned for credit or a refund, which must be deducted from gross sales. (Merchandise exchanges are not a reduction of gross sales, but they are included with fulfillment costs.) Returns occur throughout the promotional cycle. For the gifts/hard goods model, returns typically account for 5%-10% of all orders. Note the dramatic differences of returns by type of company, especially apparel, in which return rates of 25% are not uncommon.
- cancellations
Another reduction from gross sales, cancellations come in two types: credit or check related, and product availability or inventory related. If a customer gives you a bad check or his credit-card number is wrong, maxxed out, or fraudulent, you can’t complete the sale. Merchandise-related cancellations may occur if product is not available at the end of the selling cycle. In the gifts/hard goods example, cancellations of 2%-3% are normal.
- net sales
This is what is left from gross demand after deducting returns and cancellations — or simply put, it’s the dollars you take to the bank. Final net sales cannot be truly read until all demand is complete and returns are in, usually about six months after the start of a campaign. In all cases net sales are the starting point from which all other costs are figured. In each of the financial models, net sales is 100%.
- gross cost of goods
This number represents the total cost of product, including freight to your warehouse (freight-in), plus any expenses incurred for markdowns and remaining merchandise at the end of a season. You should also include certain credits or incomes here, such as co-operative allowances given by vendors for promoting their products and discounts for early payment of accounts. Cost of goods varies dramatically by type of company. In the case of consumer electronics, cost of goods might be in the 60% range. For gifts/hard goods catalogs, cost of goods in the low- to mid-40% range is typical.
- gross margin
The cost of goods subtracted from net sales is gross margin. Improve the margin by 1% and that gain drops directly through to contribution to overhead and profit. Lose a single point in margin and it directly hurts the bottom line.
- fulfillment
The total cost of receiving customers’ orders, inquiries, and catalog requests, and shipping products to them. Fulfillment also includes the cost of order entry; computer hardware and software; warehousing; product picking, packing, and shipment; and returns processing, as well as fees for credit-card authorization. You should include shipping and handling revenue from customers here as a credit to fulfillment, rather than as gross sales. Most mature marketers have net cost of fulfillment in the 10%-15% range.
- advertising
The leverage of advertising is three-fold. For one, fixed costs of creating the catalog or the Website and developing color separations are enormous for marketers mailing only a few thousand books. For example, if your fixed cost is $50,000 and you’re mailing only 200,000 test catalogs, fixed costs represent $250/M, or $0.25 per book mailed. If you mail the same catalog with the same $50,000 fixed cost to 1 million names, fixed costs drop to $50/M, or only $0.5 per book.
Second, the higher the response, the lower the advertising cost as a percent of sales. Let’s say a cataloger in prospecting mode mails 90% of its books to rental names, spending in variable printing, mailing, and postage $600/M ($0.60 per piece) to mail 500,000 catalogs, or $300,000. It pulls 1% with a $100 average order, or 5,000 orders and $500,000 in revenue. Advertising as a percent of sales = 60%. Another cataloger mails mostly to customers, sending 60% of its books to buyers. It has the same variable printing, mailing, and postage cost of $600/M or $0.60 per piece to mail 500,000 catalogs or $300,000. It pulls 3% with a $100 average order, or 15,000 orders and $1.5 million in revenue. Advertising as a percent of sales = 20%.
And finally, the more catalogs mailed, the lower the unit costs. Catalogs with smaller quantities will always fight a higher per-piece cost in the mail, while more-mature marketers have better bargaining power and more leverage to reduce the cost in the mail because of their higher volumes.
- contribution to overhead and profit
This is simply what’s left from gross margin after subtracting fulfillment and advertising costs. Since most direct marketers like to keep fixed costs to 6%-8%, this line in the financial model is an important control point. To realize an overall goal of a 10% pretax profit, you must achieve this contribution line in the model.
- list rental income
Rental of buyer names is generally, but by no means always, limited to 12-month buyers, and it is not uncommon for a strong, in-demand list to turn its 12-month-buyer list rentals 20 or 30 times a year. List rental income is normally reported at the bottom of the financial model after contribution to overhead and profit.
- pretax profit
The starting point as a goal and the ending point after all expenses are deducted from revenue, this line is sometimes referred to as EBIT. Every company’s tax situation is different, so this is typically the line for which a catalog’s general management is held accountable.
Next time, we will look at a business-to-business financial model and see some of the differences between that and the consumer counterpart.
Jack Schmid is president of J. Schmid & Associates, a Shawnee Mission, KS-based catalog consultancy.
CONSUMER CATALOG FINANCIAL MODEL
| Gifts/hard goods | Apparel | Electronics | |
|---|---|---|---|
| GROSS MERCHANDISE SALES | 113% | 135% | 113% |
| Less returns | 5%-10% | 15%-25% | 5%-10% |
| Less cancellations | 2%-3% | 5%-10% | 1%-3% |
| NET SALES | 100% | 100% | 100% |
| Less cost of goods | 45%-47% | 50% | 60% |
| GROSS MARGIN | 53%-55% | 50% | 40% |
| Less fulfillment | 12% | 15% | 10% |
| Less advertising | 25% | 17% | 12% |
| CONTRIBUTION TO OVERHEAD & PROFIT | 16%-18% | 18% | 18% |
| Less fixed costs (overhead) | 8% | 8% | 8% |
| PRETAX PROFIT | 8%-10% | 10% | 10% |
| AFTER-TAX PROFIT | 4%-5% | 5% | 5% |