Zappos: Hybrid Mode

Please view slide #14 of the presentation below. Allow me to repeat the message. Please view slide #14 of the presentation below.

Now granted, the data is three years old, but the data represents a CLASSIC DIRECT MARKETING RELATIONSHIP. (assuming they calculate repeat purchase rate the same way most of us calculate repeat purchase rate). Remember, Acquisition Mode happens when your annual retention rate is 1% to 39%, Hybrid Mode happens when your annual retention rate is 40% to 60%, Retention Mode happens when your annual retention rate is 61% or greater. Any business can be run profitably in any mode. Zappos is in Hybrid Mode, just like so many of the businesses we manage.

Project the data out, and you're looking at a direct marketer with an annual retention rate in the mid or maybe upper 50s, with customers ordering between 2-3 times per year. That's the kind of loyalty many of our direct B2C and B2B companies have, businesses that are stuck at $50,000,000 or $125,000,000 a year.

This tells you that, while loyalty and repeat business are important, new customer acquisition is critical. If there were no new customers, you'd see this business erode, dramatically and rapidly.

So, if you want to be like Zappos, and some of you send me e-mails asking me for the secret sauce that allows you to be the next Zappos, go do what they do --- offer a huge # of skus with rapid delivery (and that's key --- get the customer the item tomorrow or Wednesday) for $3 an item and free returns and great customer service and a "Hybrid Mode" annual retention rate and high volume customer acquisition via tens of millions of dollars of annual search marketing spend and social media. This doesn't guarantee profitability, of course. But you'd be like Zappos.

Zappos -- Underground 4 Presentation -- Getting to $1 billion

View more OpenOffice presentations from zappos.

Benchmarking Repurchase Rates

We enjoy comparing ourselves to others, don't we?

Now you might not be able to pull annual repurchase rate out of your web analytics or business intelligence solution. But you might be able to pull annual purchase frequency out of your information system.

The attached graph indicates a relationship between annual purchase frequency, and annual repurchase rate. Annual repurchase rate is important, because it determines if you are in Acquisition Mode, Hybrid Mode, or Retention Mode. The mode you are in determines the type of business model you operate. It determines your sole purpose in life as a marketer.

If your customers order fewer than 1.75 times per year, it is most likely that your business is in Acquisition Mode. You retain fewer than 40% of last year's buyers. Your job is to constantly "fill the funnel" with new customers, or your business won't grow.

If your customers order between 1.75 and 3.00 times per year, it is most likely that your business is in Hybrid Mode, the most enjoyable mode for an executive to operate. You balance customer acquisition and customer retention activities.

If your customers order more than three times per year, it is most likely that your business is in Retention Mode. Roll out the loyalty program, because you have to find a way to increase annual purchase frequency --- you're not likely to move the annual repurchase rate much.

The table below allows you to identify if your annual repurchase rate is above or below average. Here are approximate averages, given annual purchase frequency (your mileage will vary depending upon your customer acquisition strategy and merchandise assortment).

• 1.25 Annual Orders = 18% Annual Repurchase Rate
• 1.50 Annual Orders = 30% Annual Repurchase Rate
• 1.75 Annual Orders = 39% Annual Repurchase Rate
• 2.00 Annual Orders = 45% Annual Repurchase Rate
• 2.33 Annual Orders = 52% Annual Repurchase Rate
• 2.67 Annual Orders = 57% Annual Repurchase Rate
• 3.00 Annual Orders = 60% Annual Repurchase Rate
• 3.50 Annual Orders = 65% Annual Repurchase Rate
• 4.00 Annual Orders = 68% Annual Repurchase Rate
• 5.00 Annual Orders = 73% Annual Repurchase Rate
• 7.00 Annual Orders = 78% Annual Repurchase Rate
• 10.00 Annual Orders = 82% Annual Repurchase Rate
• 24.00 Annual Orders = 87% Annual Repurchase Rate.
  

The Long Term Impact Of Sluggish Sales In 2008

Many folks are telling me that business in the multichannel direct-to-consumer world is down an aggregate 15% to 25% compared to 2007.

Poor performance manifests itself in the short term, and in the long term. Worse, it manifests itself in a harsh manner across brands/channels in Retention Mode.

Take a look at the table below:

Long-Term Impact Of Bad Performance In 2008
	Retention	Retention	Acquisition	Acquisition
	Mode	Mode	Mode	Mode
	No Cuts	And Cuts	No Cuts	And Cuts
2008	-20.2%	-23.9%	-19.4%	-23.3%
2009	-9.6%	-16.8%	-6.6%	-7.4%
2010	-7.0%	-11.9%	-2.8%	-3.5%
2011	-4.3%	-8.7%	-1.9%	-1.9%
2012	-2.8%	-6.1%	-1.1%	-1.1%

A business in retention mode (annual repurchase rate > 60%) feels the pain much longer than a business in acquisition mode (annual repurchase rate < 40%).

In the table above, we compare what happens when 2008 is down about 20% to 2007, but the business immediately rebounds to normal levels for 2009 - 2012.

The retention mode business is down almost ten percent in 2009 because of a bad 2008, down seven percent in 2010 because of a bad 2008. And then factor in our natural reaction to cut marketing expense --- which accelerates the downturn in 2009 - 2012. This is where many of our retention mode businesses are heading, especially those trimming marketing expense to "get through 2008".

Notice that the acquisition mode business is not hurt nearly as bad. Because this business depends upon new customers, it rebounds quickly.

In an economic downturn, knowing the mode your business is in (Retention, Hybrid, Acquisition) means everything to making marketing expenditure decisions. Run the metrics, and understand what current day decisions mean to the long-term health of your business.

Can A Catalog Brand Survive As An E-Commerce Pure-Play?

The April survey question was "Can A Catalog Brand Survive As An E-Commerce Pure-Play, One That Does Not Mail Catalogs?" Here's how you responded to the survey question:

Can a catalog brand survive as an e-commerce
pureplay, one that does not mail catalogs?
Yes, Customers Will Just Shop Online	44%
Yes, But Sales Will Plummet	35%
No, The Cataloger Will Soon Be Out Of Business	21%

The reasonably even distribution of answers is congruent with the data I see across various Multichannel Forensics projects. Some companies would be out of business within a few months. Some companies would see a dramatic decrease in sales. And some companies would thrive.

Yes, Customers Will Just Shop Online:

• Brand has a retail channel that is dominant.
• Online channel is more than fifty percent of direct-to-consumer sales.
  
• Online channel has a broader merchandise assortment than the catalog has.
• Customer never enters catalog key-code when ordering online.
  
• Brand is not "over-mailing" customers.
• Brand is in "Retention Mode".
• Catalog is in "Transfer Mode".
• Customer is largely urban or suburban, age 18-45.
  
• E-Mail and Paid Search performance improves in mail/holdout tests.
  

Yes, But Sales Will Plummet:

• Brand does not have a retail channel, or has a small retail channel.
• Online channel is less than fifty percent of direct-to-consumer sales.
  
• Online channel has the same merchandise assortment as the catalog.
• Customer sometimes enters catalog key-code when shopping online.
  
• Brand is in "Hybrid Mode".
• Catalog is in "Equilibrium Mode".
• Customer is largely suburban, age 35-55.
  

No, The Cataloger Will Soon Be Out Of Business:

• Brand does not have a retail channel.
• Online channel is less than thirty percent of direct-to-consumer sales.
• Customer always enters catalog key-code when shopping online.
• Brand is in "Acquisition Mode".
• Catalog is in "Isolation Mode".
• Customer is largely rural, age 50-80.
  

In my experience, these general guidelines hold up pretty well. We could get away from a catalog marketing program at Nordstrom because our customers largely fell into the first classification --- middle-aged, urban/suburban customers offered a better merchandise assortment online and in stores. But if you are a cataloger of fine cheeses with an older/rural customer base, you'd be out of business without your catalog.

Multichannel Forensics: The Building Blocks

We'll start our Multichannel Forensics series with a quick refresher course.

There are three loyalty modes for every product, brand or channel.

• Retention Mode: When at least 60% of prior year customers purchase again this year (if your business doesn't support a twelve month repurchase period, use a timeframe that is appropriate.

• Hybrid Mode: When between 40% and 60% of prior year customers purchase again this year.

• Acquisition Mode: When fewer than 40% of prior year customers purchase again this year.

We need to classify each product, brand or channel into one of these three modes, so that we can understand the primary way that growth will happen. So many brands are in "Acquisition Mode" and don't realize it, depending heavily on customer acquisition for long-term health.

There are also four Migration Modes that each product, brand or channel fall into.

• Isolation Mode: This happens when the customers in a product, brand or channel do not migrate to other products, brands or channels. For instance, customers who purchase Mens apparel are unlikely to buy Womens apparel. Mens apparel buyers are in "Isolation Mode".

• Equilibrium Mode: This happens when the customers in a product, brand or channel are willing to try other products, brands or channels. For instance, customers who purchase Womens apparel might purchase Mens apparel for their spouse. Womens apparel buyers are frequently in "Equilibrium Mode". This mode is common, and is responsible for all of the interesting dynamics that occur when customers shift from one product line (DVD Players) to another (Blu-Ray DVD Player).

• Transfer Mode: This happens when the customers in a product, brand or channel are actively switching loyalty. Over the next decade, automobile purchasers will actively transfer loyalty from gas-guzzling cars to hybrid cars and other technologies. CEOs need to recognize this mode, and react in a positive way in order to protect jobs.

• Oscillation Mode: Sometimes, customers switch back and forth between products, brands or channels. This is known as "Oscillation Mode". Computer buyers purchase software and peripherals, then switch back to buying a new computer, then switch to software and peripherals, resulting in "Oscillation Mode".

The combination of Loyalty Mode and Migration Mode yield the unique situation a product, brand or channel resides in.

Maybe you are a catalog CEO. If your catalog channel is in "Acquisition/Transfer" mode, your job is to scale back on catalog advertising over time, as your customers won't allow you to grow this channel anymore.

Maybe you are a Merchandise EVP. If your product is in "Retention/Isolation" mode, you thoroughly control your merchandise line. Your customers are loyal to your products, and do not switch loyalty to another merchandise line. You have the potential to be a rock star.

Maybe you are the General Manager of the Online Channel of a Multichannel Brand. If your channel is in "Hybrid/Equilibrium" mode, you have a very interesting channel to manage. Your customers want to shop your store channel, but aren't avid store customers. Strategically, you can influence your customers by the marketing techniques you use. Do you want your customers to shop online, in stores, or anywhere? In many ways, you get to decide!

This week, we'll look at several case studies, examples that help CEOs understand how to manage multichannel complexity!

Zappos And Repeat Customers

A quote from Tony Hsieh of Zappos, cited in Catalog Success:

"When we first started, we did what ever other dot-com did: Spent a lot of money on ad campaigns to acquire as many customers as possible. This is a good idea if your goal is to lose as much money as possible. Instead, we started focusing on repeat customer behavior." Zappos.com increased the percentage of customers who buy again within the next 12 months from 20.5 percent in 2001 to 51.3 percent in 2006.

Recall that in the Multichannel Forensics framework, a 51.3 percent annual repurchase rate places Zappos in "Hybrid Mode". This means that Zappos has to balance customer retention and customer acquisition activities, in order to be successful.

It is easy to move the annual repurchase rate from 20 percent to 50 percent in a new business. Once the business model is established, the annual repurchase rate is unlikely to ever move more than +/- 10 percentage points in a year.

Which means that, in order for Zappos to grow, the strategic focus swings back to ... customer acquisition!

Multichannel Forensics And Executive Leadership

Recall that there are two key elements in Multichannel Forensics.

First, how well do you retain your customers?

• If you retain more than sixty percent of last year's customers (in other words, more than sixty percent of last year's customers purchase again this year), you are in Retention Mode.
• If you retain between forty and sixty percent of last year's customers, you are in Hybrid Mode.
• If you retain less than forty percent of last year's customers, you are in Acquisition Mode.

Second, what do you customers do after they purchase from you?

• Do they only purchase your products, brands or channels (called Isolation Mode)?
• Do they like to try out other products, brands or channels (called Equilibrium Mode)?
• Do they switch to other products, brands or channels (called Transfer Mode)?
• Do they switch back and forth between products, brands or channels (called Oscillation Mode)?

The combination of modes determines the business strategy for a product, brand or channel.

Let's evaluate Circuit City, as an example. It is well documented that customers shop Circuit City via the online channel, then either purchase merchandise in-store, or purchase online and pick up product in the store.

Retail executives manage channels that have very different dynamics:

• The retail channel frequently operates in Retention/Isolation Mode. In other words, last year's store customers purchase in-store again this year, and are not likely to shop other channels.
• The online channel frequently operates in Acquisition/Transfer Mode. In other words, last year's online customers are unlikely to purchase online this year --- instead, the customer shifts purchasing to the store channel.

When business units operate under vastly different modes, leaders are needed to complement the mode of the business unit.

The leader of the online channel should be collaborative, one who does what is best for the total business. Her bonus structure should be based on her ability to facilitate customer purchases within any channel, not just her channel. The strategic development of her channel should be crafted around the natural behavior of her customer --- to shop in stores in the future.

The leader of the retail channel can be a different individual. Teamwork skills and collaboration may not be as important, because this individual has customers who are not likely to switch to the online channel --- and if the customer does switch, it is only to get information about retail merchandise.

Multichannel retailing is all about exploiting the strengths of each channel. It is not about "sameness", not about replicating the customer experience the same way in every channel.

This holds true for the leaders of each product, brand or channel.

In the Circuit City example, it may make sense to have a very experienced leader manage the online channel. This leader should be well versed at collaboration, consensus, humility, leading through others. This leader should be comfortable with not getting credit for all the good she does to make other leaders look good.

Conversely, it may make sense to have newer executives work in products, brands or channels that are in "isolation mode". In these instances, the leader has control over things, and has fewer moving parts to worry about.

All too often, we assign new leaders to smaller business units, business units with the least "risk". In reality, we should think about putting our most talented leaders in the most challenging roles. Those roles tend to happen in "equilibrium" or "transfer" mode.

Where Are Your Customers Going? Part Three Of Multichannel Forensics

If you didn't fall asleep during the first and second installments of my introduction to multichannel forensics, tonight's exploration may be a bit more intriguing.

Recall that we explored how repurchase rates determine how customers flow through your business.

Repurchase rates above sixty percent put you in 'Retention Mode'. Your business will grow from getting customers to purchase more often, and to add items to their purchases.

Repurchase rates between forty and sixty percent put you in 'Hybrid Mode'. These are fun businesses to run, because you can grow via customer acquisition, by getting customers to purchase more often, and by getting customers to add items to their purchases. Of course, customers have to want to purchase more often, or add items to their orders!

Repurchase rates under forty percent land you in 'Acquisition Mode'. These businesses require leaders who have a singular focus on finding new customers.

Yesterday, we talked about an example where catalog customers were migrating online. Today, let's see how catalog, online and retail customers behave.

Migration Probability Table
	Catalog	Online	Retail
New Customers	3,442	9,350	5,937
Repurchase Rates
Corporate	57%	44%	49%
Catalog	29%	4%	3%
Online	35%	33%	5%
Retail	13%	14%	45%
Repurchase Indices
Catalog	51%	9%	6%
Online	61%	75%	10%
Retail	23%	32%	92%
Total Corporate Repurchase Rate =			46%

The repurchase indices are calculated as the repurchase rate divided by the corporate repurchase rate for that channel. Three primary modes, and one secondary mode appear. Let's look at our example.

Isolation Mode: This occurs when all of the repurchase indices are below twenty percent. This means customers are not likely to cross-shop any product, channels or brands. The retail channel is in Isolation Mode. Retail customers have a low catalog index (6%) and a low online index (10%). The retail index (92%) is not used.

Equilibrium Mode: This occurs when at least one repurchase index is above twenty percent, and no repurchase index is above fifty percent. The online channel is in this situation. The catalog index is 9%, so online customers do not cross-shop catalog. However, the retail index is 32%. This means online buyers are likely to cross-shop retail.

Transfer Mode: Executives leading businesses in transfer mode have problems. Transfer Mode occurs when at least one index is above 50%. Look at catalog. The index for retail is 23%, moving catalog to equilibrium mode. However, catalog moves to transfer mode with a 61% index for the online channel. Catalog customers are likely to cross-shop retail. Catalog customers move their loyalty to online.

The catalog executive is sunk. Her customers migrate online at dramatic rates. Her job is to facilitate this transition. She should not expect her business to grow.

The online executive has a mixed blessing. He is fed customers from the catalog channel, this helps grow his business. Notice that his channel is the number one source for new customers. This means he has that as a growth vehicle. However, his customers cross-shop retail.

Because retail operates in isolation (retail customers typically don't cross-shop online or catalog channels in this example), retail is likely to grow and be healthy. It gets customers from catalog, it gets customers from the online channel. Retail does not send customers to other channels.

Your homework assignment: For the products, brands or channels you are interested in, run the table illustrated above, and consider the dynamics surrounding your business. Where do customers come from, where do the migrate to, which products, brands or channels have the best potential for growth?

Once you learn these relationships, how might you alter your marketing strategy to capitalize on the natural flow of customer behavior that your business exhibits?

More On Loyal Customer Behavior Using Multichannel Forensics

Ok, you worked with your friendly programmer yesterday, and identified your overall company repurchase rate.

What was it? Sixty-three percent? If that's the case, your tend to have a loyal customer audience that is in 'Retention Mode'. When this happens, your business tends to grow by getting existing customers to purchase more often, and to purchase more items per trip. Anytime the annual repurchase rate is above sixty percent, your business is in 'Retention Mode'.

If the repurchase rate was between forty percent and sixty percent, you're in 'Hybrid Mode'. These business models are a lot of fun for executives to manage. You can grow by increasing the retention rate, by acquiring a lot of new customers, by increasing purchase frequency, or by adding items per trip.

If the repurchase rate was less than forty percent, you're in 'Acquisition Mode'. Your business will grow by a relentless quest for new customers.

Now that you have this metric for the whole business, your next step is to measure the repurchase rate for each product, brand or channel.

For instance, assume you are a multichannel retailer that has a catalog, online and retail channel. Your overall repurchase rate is fifty percent. Your overall business is in 'Hybrid Mode'.

Now, take one of your channels (i.e. catalog). Measure the repurchase rate for last year's catalog buyers, at a company level, and within each of your channels.

For instance, your catalog buyers might look like this:
*** Company Repurchase Rate For Catalog Buyers = 57%.
*** Catalog Repurchase Rate For Catalog Buyers = 29%.
*** Online Repurchase Rate For Catalog Buyers = 35%.
*** Retail Repurchase Rate For Catalog Buyers = 11%.

This tells a compelling story. Catalog buyers are loyal to the total company, in 'Hybrid Mode'. However, within the catalog channel, these buyers have a twenty-nine percent repurchase rate, putting them in 'Acquisition Mode'. These buyers tend to migrate to the online channel. To grow catalog, there must be a huge infusion of new catalog buyers. Online directly benefits by having a big catalog file of customers that migrate from catalog to the online channel.

Your homework assignment for tonight: Run the above table for every product, brand or channel you have. Tomorrow, we'll talk about the meaning of the individual percentages in the table above, and how to strategically understand the importance of those percentages.

Measuring Loyal Customer Behavior Using Multichannel Forensics

How do you define whether your customer base is 'loyal' or not? If a customer purchased eight times at Wal-Mart last year, is the customer loyal? If a customer purchased eight times at H20Plus last year, is the customer loyal?

In reality, every business, even those with a poor management team, have very loyal customers. It becomes important to understand how customers behave over time.

The majority of businesses can measure customer loyalty over the course of a year. Management categorizes all customers who purchased during, say, 2005, and measures how many customers purchased again during 2006. This metric is called the 'repurchase rate', and is a very important metric for management to understand.

There are three modes that any corporation, product, brand or channel fall in to. They are:

• Retention Mode: When sixty percent or more of last year's customers purchase again this year, your business is in Retention Mode. These businesses have loyal, repeat purchasers. Management can focus on increasing the purchase frequency of customers, as well as encouraging customers to purchase more items per order.

• Hybrid Mode: When between forty percent and sixty percent of last year's customers purchase again this year, your business is in Hybrid Mode. These businesses are among the most enjoyable for executives to manage. They have a multitude of levers to pull to increase sales. It is possible for management to increase retention rates into Retention Mode. It is possible for management to increase purchase frequency, or to encourage customers to purchase more items per order.

• Acquisition Mode: When less than forty percent of last year's customers purchase again this year, your business is in Acquisition Mode. This mode is surprisingly deceptive to executives, because it flies in the face of customer feedback. Management reads letters from loyal customers who love your product. Yet, the average customer is unlikely to purchase again next year. Management running businesses in Acquisition Mode have no choice but to continually find large sources of new customers to fuel future growth. Surprisingly, many web-based businesses that don't have the sku breadth of Amazon.com fall into Acquisition Mode. These businesses may struggle when the flow of customers transitioning from catalog businesses slow down over the next five years.
  

Your homework assignment is this: Talk to your resident programmer, and ask her to identify all customers who purchased in 2005. Of those customers, measure the percentage who purchased during 2006. Once you have that metric, identify which of the three modes your customer base falls into. We'll talk more about this tomorrow.