Blue Nile: -20% In October 2008

Here's a link to the transcript from the investor conference call. See page four for comments about variable marketing costs being ten percent of net sales ... that's the total flex that Blue Nile has in their business model --- worse than catalogers, far better than retailers.

This is where magic happens, folks. We've never truly been asked to drive e-commerce sales increases ... everything we've accomplished has been on the updraft of a channel that cannibalized other channels.

Now we get busy. Now we innovate. And we'll be much better off for going through this experience. We are going to invent truly new and effective methods for driving online sales. Really!

Online Advertising And The Marketing Digital Divide

Using SpyFu, one can get very rough estimates of what leading brands spend on online advertising on a daily basis. The data is prone to errors and inaccuracy, but can be used to view general trends.

Take three companies that thrive on catalog marketing, namely L.L. Bean, Lands' End, and Pottery Barn. Here is what SpyFu suggests these companies spend in online marketing, on an annual basis.

• Annual Average Spend Across These Brands = $10,201,000.
• Average Annual Clicks Generated From The Advertising = 12,015,000.
• Average Cost Per Click = $0.87.

Next, look at three large retailers, namely Macy's, Nordstrom and Neiman Marcus. Here is what SpyFu suggests these companies spend in online marketing, on an annual basis.

• Annual Average Spend Across These Brands = $23,550,000.
• Average Annual Clicks Generated From The Advertising = 33,312,000.
• Average Cost Per Click = $0.78.

Finally, look at two larger-sizes online pureplays, namely Zappos and Blue Nile. Here is what SpyFu suggests these companies spend in online marketing, on an annual basis.

• Annual Average Spend Across These Brands = $40,654,000.
• Average Annual Clicks Generated From The Advertising = 63,483,000.
• Average Cost Per Click = $0.68.

Notice that as we progress from companies with a catalog heritage, to companies with a retail heritage, to companies with an online heritage, the amount of online spend dramatically increases --- and, the average cost per click actually decreases. This is counter to what analytical folks expect to see happen.

I tried to pick companies that had annual traffic that was directionally similar. How the businesses use advertising to drive web traffic is very different. What this does show is that there may be a marketing digital divide. There may be a way for catalogers and retailers to migrate advertising online, and actually see better returns on investment.

As postage escalates, traditional catalogers have an opportunity to emulate the techniques that the folks at Zappos and Blue Nile use. Over the next five years, there is an opportunity to transition advertising strategy from print to online. There is an opportunity to cross over the marketing digital divide.

The Marketing Digital Divide And The Catalog Industry

In the first quarter of 2007, sales of music compact disks declined by twenty percent verses last year, as consumers continue to abandon album-based compact disks in favor of ala-carte purchases/sharing of digital music files.

The music industry strongly believes that free file sharing is responsible for the decline in CD sales. The labels are flexing their muscles where they can, to maintain their system of monetizing music even if it means heavily penalizing a new channel where music fans are enjoying music.

The crash of television and radio, the ascension of the internet, and the convenience of the iPod changed the music industry forever. Multichannel Forensics suggest that consumers "transfered" their behavior from CDs to MP3s during the late 1990s through the past few years.

Once consumers landed in a new world of music, they stayed there. In Multichannel Forensics, we call this "isolation". No matter how hard the music industry tries to bring consumers back to the old method of monetized music, the effort is futile. Consumers have moved on.

As consumers, we have a unique, God-given ability to identify trends in the marketplace. We can literally see the future, and react accordingly.

As business leaders, we have a unique, God-given ability to identify trends in the marketplace. We can literally see the future. However, we don't react accordingly. Instead, we dig in our heels, and demand that consumers and business partners come back to our way of thinking.

My beloved catalog industry falls into this category. Our customers can see the future, and are anywhere between 20% and 80% of the way toward evolving their behavior. At this time, customers are generally in "equilibrium" --- the state where they go back and forth between channels. They use catalogs and purchase over the telephone. They use catalogs and purchase on our websites. They ignore our marketing activities, use Google, and purchase on our sites. The combine our marketing activities with Google, and purchase on our sites.

Google recognizes this, and gobbles up properties that allow them to have an end-to-end marketing relationship with our future customers. Their version of an end-to-end marketing relationship does not include paper.

Over the next five years, our catalog customers will leave "equilibrium" mode, shifting to "transfer" mode. They will define a new way of interacting with brands, a new way of shopping. When that happens, what will become of what has been known for more than a hundred years as "the catalog industry"?

We can dig our heels in, and continue lauding the importance of sending paper to our customers as a way of generating sales. In this process, we must fight postal reform.

We can also give up. We can sell our businesses, getting out before big changes happen.

Or we can build a five-year plan for the future of our industry. We can be like a pilot, who takes an airplane down from 30,000 feet to a gentle landing. We can work with our customers as we reduce our dependence upon catalogs, building an infrastructure that allows customers to pull information from us.

We must thoroughly evaluate how Zappos, Endless, Piperlime, Blue Nile, and Amazon drive sales without paper. We need to emulate what they do well. We need to use our experience to capitalize on what they don't do well. We must chart a path to the future.

Folks in the music industry are actively talking about a path to the future. It's our turn to do the same. It will require a leap of faith, right over that pesky Marketing Digital Divide.

L.L. Bean

Let's fast forward to January 1, 2009. Mailing catalogs is now cost-prohibitive, due to a 300% increase in postage brought on by another round of postal reform.

You're an executive at L.L. Bean, the venerable catalog giant located in beautiful New England. You just completed fiscal 2008, a year in which you drove $900,000,000 in net sales via your website, and $600,000,000 via the telephone. Maybe you spent $250,000,000 marketing catalogs to your customers.

Take away the catalogs, and the expense associated with them.

Here's a series of questions for you:

• Could you re-allocate $250,000,000 via online marketing? Where would you spend it?
• Do you have any confidence that e-mail could replace catalog as the primary sales driver? How would you change your e-mail strategy?
• Your website generated $900,000,000 in net sales in 2008. What is your forecast for web sales in 2009, sans catalog?
• You generated $600,000,000 in net sales in 2008 via the telephone --- folks who read the catalog, and called a sales associate to place an order. Without a catalog, what is your sales forecast for 2009, over the telephone?
• You had 115,000,000 website visits in 2008. How would you change your marketing strategy to capitalize on this enormous informational resource known as www.llbean.com? How much would your traffic change if your catalogs didn't exist?

Of course, the USPS isn't going to make catalog marketing impractical in 2009.

That being said, if you went through this exercise, could you recover your sales via the marketing techniques that Amazon or Zappos or Blue Nile uses --- companies on the other side of the Marketing Digital Divide?

At minimum, your executive team should have answers to these questions.

Virtual CEO: Blue Nile

Blue Nile, an online retailer of jewelry, has an interesting set of challenges to face in the future.

During a recent call with analysts to discuss third quarter results, management made several interesting observations.

• Ad spend as a percentage of revenue is four percent, and has held constant in spite of increases in the cost of online marketing.
• With brands moving online to advertise, management has decided to not compete by spending more on online advertising. Management states they lowered prices instead. The reduction in prices resulted in twenty-four percent increase in year-to-date net sales. However, gross profit only increased by eleven percent, due to price reductions. Gross profit is about twenty percent of net sales.
• Management is focusing on increasing conversion on the website, believing this is a key driver of future profitability. Management states that conversion rates are improving, compared with last year.
• Repeat purchasing skews toward non-engagement merchandise (which has better gross margins than engagement merchandise).

Time for you to play Virtual CEO. If online marketing costs are going to continue to increase, what would you do to grow your business?

• Follow the updraft in online marketing costs by spending more for the same amount of traffic.
• Lower prices, and accept the risk of a less-affluent audience. In other words, are you willing to trade your target audience for one that is less affluent, as a way of combating increased online marketing expenses?
• Do you have a different strategy you would employ?

Online pureplay retailers face the potential for long-term profitability decreases as the cost of online marketing increases. How would you strategically attack this problem? What marketing tactics would you employ to drive repeat business (which yields a higher gross profit)?

Blue Nile, Chicos, PetSmart and NASCAR

A few tidbits from recent investor conference calls, courtesy of 123Jump.

At Blue Nile, management states that it measures market productivity by summing sales in a market (San Francisco), and dividing sales by the number of people living in the market. In markets like San Francisco, they claim to generate $2.00 sales per person. In rural markets, they claim to drive maybe $0.30 per person.

At Chicos, management discussed a change in advertising strategy, yet another one that benefits compiled databases, and spells doom for television and magazines. A quote, "the company was not able to quantify any real positive effect from television advertising". Management also states that coupons are the number one driver of sales for the company.

At PetSmart, the business generated 5.5% EBIT on sales of just over $3 billion dollars, through nine months. Management stated that they spend 2.4% of sales on marketing. That sounds small until you realize that, though nine months, the total is over $60 million dollars.

Ever wonder if NASCAR is a cash cow? International Motorsports, which owns many of the tracks NASCAR races at, earned $182.4 million in operating income on net sales of $544.9 million, through nine fiscal months. My goodness. How do I get a job there? That's simply stunning.