CEO Questions About Online Marketing And Profitability

There are two hot CEO topics in 2009, based on my e-mail inbox:

1. Help me reduce advertising expense without a drop in sales.
2. Help me calculate the true profitability of my online marketing efforts.

Online marketing experts ... your fifteen year run of management by conversion rate is coming to an end. And that's a good thing!

The discussions are different than they used to be. Lately, the online marketing employee is being considered a scarce resource. Allocation of scarce resources is becoming a trendy topic ... and it should be, given the scarcity of employees after layoffs.

One individual asked it if was ok to add the human costs associated with managing a blog and maintaining a presence on Twitter to the variable costs associated with the website traffic generated by those activities, and then link those costs to the variable costs associated with picking, packing, and shipping merchandise generated by those activities.

Another individual wanted to know if she could calculate the incremental variable cost of each website visit, and then allocate that expense against visitors that browse the website on a frequent basis, calculating the true profitability of "best" customers.

A CEO wanted to allocate the cost of all website visits driven by an e-mail marketing campaign back to the e-mail campaign that caused the visits to happen --- holding e-mail marketing accountable for the 19 of 20 visits that did not result in a conversion but did chew up website expense.

So the scarcity of employees is causing a renewal of focus on activities that generate profit over buzz.

Ten years ago, the catalog industry went through a transformation. All expenses were carefully monitored, and all revenues were carefully tied to the catalog marketing effort that may have been responsible for generating the sales. This was the genesis of the matchback algorithm. The popping of the internet bubble resulted in a new era of accountability.

Today, the online / e-commerce industry is about to go through a similar transformation. The popping of the housing bubble is leading us to a new era of accountability.

Profit

Here's a quiz question to offer to your staff on this first Monday of December:

"You spend $1,000 on a paid search campaign. 3,000 users click through to your site, with 1% converting to a purchase. Customers spend a total of $3,000. 30% of the sales flow-through to profit. Was the paid search campaign profitable?"

Profit is missing from the language of marketing.

I reviewed the language of the twenty-five most popular marketing bloggers. During the life of the blogs on the list, the average marketing leader mentioned the word "profitable" in a median of just six blog posts ever, "profit" in a median of just thirty blog posts ever (and that includes the phrase "non-profit", and includes press releases about corporate profit). In fact, fifteen of the twenty-five bloggers used the phrase "profitable" three or fewer times ever --- and that's across an average of 250 to 1,000 posts.

These are your favorite marketing experts. The majority seldom if ever talk about profit.

Profit becomes part of the DNA of a business. It has been my experience that profit knowledge is kept in small tribes.

• Business Intelligence. BI employees are great at creating and querying cubes. Too often, the components of profit are not contained in the cubes.
• SAS Programmers. A completely different family of employees than BI experts. These crafty workers revel in writing neat code more than they focus on measuring profit. Of all employees, this is the one place where everything could be brought together.
  
• Web Analytics. This KPI-enamored throng of earnest employees use software that can, but frequently doesn't integrate profit components. So we've created an entire generation of good analysts who do not have profit as part of their DNA.
• E-Mail Analytics. Our e-mail community thinks about return on investment, and that is good! Because e-mail is almost free on a variable cost basis, there hasn't ever been a need to teach profitability. E-mail is always profitable.
• Catalog Circulation. These folks measure profit down to the penny, and for good reason. When you spend $0.75 sending out catalogs, your finance team requires that you become excellent at calculating profit.
• Paid Search. Another group that is really good at measuring profit, and for good reason. When you spend $0.75 per click, your finance team requires that you become excellent at calculating profit.
• Portal Advertising. This group can measure profit, but requires really good systems in order to build this discipline.
• Affiliate Marketing. Since you pay a commission, this style of marketing is generally profitable, and as a result, profit isn't always measured.
• Social Media. By and large, these folks do want to measure influence.
  
• Brand Marketing. By and large, these folks do want to measure influence.

More than anything, a profit culture requires a leader, somebody who wants to understand how everything fits together. The problem isn't solved by combining silos, it is solved by a passionate leader. The emergence of e-commerce and then social media have only served to further fragment the ability of a company to create a profit culture.

So why couldn't you be the profit expert? Sit down with your finance team, learn each piece of the profit and loss statement, and start measuring profit!

Shocking Multichannel Profitability Findings

The blogosphere tells us we're supposed to use compelling subject lines if we want to get your attention.

You should run this query against your own customer information. You probably won't find this information on your corporate customer information dashboard. Click on the image to enlarge it. Here's how we obtain the data necessary to run the query.

Query, Step 1: Identify all customers who purchased during 2006.

Query, Step 2: Sum 2006 demand/sales, sum 2006 channels purchased from, for each customer.

Query, Step 3: For the customers in Steps 1-2, sum 2007 demand/sales, also sum 2007 advertising expense allocated to each customer.

Query, Step 4: Bucket each 2006 customer into one of five quintiles, based on 2006 spend.

Query, Step 5: For each combination of total channels purchased from in 2006, and demand/spend quntile in 2006, calculate the average 2007 demand/sales for that segment, average advertising spend, and average profit.


What Do The Trends Suggest?

Learning #1: Multichannel customers are not the best customers. Would you rather have a customer in the second quintile who bought from one channel, or a customer in the third quintile who bought from three channels? Historical multichannel activity is not nearly as good an indicator of future demand/profitability as is historical spend.

Learning #2: Multichannel customers are not necessarily the most profitable customers. Why? Because each additional channel a customer purchased from in 2006 resulted in an incremental increase in advertising to that customer in 2007. In fact, take a peek at the information. Customers from 21% to 60% (40% of last year's customer file) are less profitable in 2007, in spite of having purchased from more channels in 2006. Many multichannel marketers over-advertise to the "best" customers, actually reducing corporate profitability.


Recommended Strategy: If your brand has customers who exhibit this behavior, this requires a re-think of your multichannel marketing strategy. Do you send catalogs, postcards, e-mail campaigns, RSS feeds etc. to the same multichannel customer, announcing the same sales event, or do you cut back on your ad-spend across this audience, focusing on finding new customers that generate future sales? I recommend the latter.


If you don't believe what is illustrated here, run the query against your own customer data. See if you identify similar trends. If you don't host your own customer database, have the co-op or database organization that hosts your database run this query for you.

Tell us what you learn!

Unified Multichannel Metric

A pet project over the next few months is the development of a Unified Multichannel Metric.

Why?

If you executed a multichannel marketing campaign, how would you know if it worked or not?

• If customers responded to the campaign at significantly increased rates, but the number of multichannel customers did not increase, was the campaign successful?

• If the series of campaigns, across channels, generated a loss, but increased the number of multichannel customers, was the campaign successful?

• If a retailer went from having 100 stores to 200 stores, thereby doubling the number of multichannel customers, was the brand successful at generating multichannel customers?

• If a cataloger reduced circulation by fifty percent, dramatically increasing profit, but reducing the number of multichannel customers, was the marketing plan a success?

• If a online pureplay used multiple online advertising vehicles, lowering response and profitability across all campaigns, but increased the number of customers buying, was the multichannel advertising campaign successful?

It's probably time for a Unified Multichannel Metric.

Profit Week: Three Customer Segments

This week, the topic is profit.

Enough talk about the economy being lousy (ask the folks at Urban Outfitters if they think the economy is lousy! Heck, check out the Urban Outfitters blog if you want to see innovation from a retailer).

Enough talk about postage increases. It happened a year ago, it was damaging. Time to move on.

Enough talk about third parties and their contempt for various forms of direct marketing.

The only way to stay in business is to generate profit. Lots of profit.

Direct Marketers are transitioning to a new reality, one that views the customer in three different, unique ways:

1. Customers who do not purchase unless they are advertised to.
2. Customers who are advertised to, then research product, then purchase product.
3. Customers who are self-sufficient, purchasing without the need for advertising.

Guess which customer segment is most profitable?

Guess which segment of customers we focus our efforts on?

We do everything in our power to identify customers who require advertising, then invest all of our energy in deciding how to advertise as efficiently as possible to this audience.

We spend almost no energy thinking how to move customers along the direct marketing customer continuum. We need to figure out how to facilitate the process whereby customers simply love us, trust us, and support us.

Here is a typical profit and loss statement for a segment that is dependent upon advertising.

Demand		$100,000
Net Sales	80.0%	$80,000
Gross Margin	55.0%	$44,000
Less Adv. Expense		$16,000
Less Pick/Pack/Ship	11.5%	$9,200
Variable Op. Profit		$18,800
% of Net Sales		23.5%

Now let's take a look at the same segment of customers, a segment not dependent upon advertising.

Demand		$100,000
Net Sales	80.0%	$80,000
Gross Margin	55.0%	$44,000
Less Adv. Expense		$0
Less Pick/Pack/Ship	11.5%	$9,200
Variable Op. Profit		$34,800
% of Net Sales		43.5%

Now the critic will use the traditional phrase "yabut" to express the fact that historically, a direct marketer had to market to the customer to get the customer to purchase something.

The world is different today. Your e-commerce site is more like a retail store than a traditional direct marketing piece. Think of your own behavior. You don't need a lot of direct marketing to shop at Home Depot. You need something to kill weeds in your lawn, you go to the Home Depot. Websites serve a similar function. You need shoes, you go to Zappos.com. Sure, Zappos uses online advertising. But they get a ton of volume from word of mouth, a ton of volume just because "they are Zappos".

In the chart at the top of this post, Zappos has a customer base that is split between the middle box, and the box at the far right.

Most catalogers cultivate a customer base that requires advertising in order to purchase something. Catalogers spent the past decade proving (via matchbacks) that customers needed advertising. Via this self-fulfilling prophesy, catalogers are now at a significant disadvantage, because all of the costs associated with advertising are increasing. Simultaneously, customers are moving from the left to the right side of the direct marketing customer continuum slide.

In the short term, direct marketers need to cope with recessionary issues and expense inflation.

In the long term, direct marketers must migrate their customer base from an "advertising-needs" customer to a "self-serving customer", one that doesn't require advertising. This is where a boatload of profit exists --- profit that can be pocketed, or reinvested in free next-day shipping or other customer-friendly strategies.

For those of you about to say "yabut", this can be done. Pay attention to Zappos, Blue Nile, Amazon. Use Multichannel Forensics to see if your current customer is willing to make this transition with you.

E-Mail And Catalog Profit Visualization

"Back in the day" at Lands' End, we had a team that measured the profitability of every spread in our core catalogs.

Even though this information was stored in a database for easy retrieval, the most effective presentation of the profitability of each spread (in my opinion, or IMHO to use the parlance of the day) occurred in a conference room.

Each spread was adhered to colored tag board.

• Gold Tag Board = 30% or better variable operating profit for that spread.
• Green Tag Board = 20% to 29.9% VOP for that spread.
• Blue Tag Board = 10% to 19.9% VOP for that spread.
• Red Tag Board = Worse than 10% VOP for that spread.

When we sat down to review a catalog, each spread was posted in the conference room, in order, from page 2-3 to the back cover.

Instantly, the "profit story" became clear. Visually, a rookie database marketer like myself could see what worked, what didn't work. Visually, I could see how merchandising and creative themes interacted to generate profit. I could see how one model yielded gold/green results, while another model turned customers off.

If you are an e-mail marketer, and you wish to effectively communicate with old-school marketers at your company, give this strategy a try.

Maybe you sent 20 e-mail marketing campaigns last quarter. For each campaign, sum the performance of all of your targeted versions, and adhere the main creative treatment to a piece of colored tag board. Do this for each of the twenty campaigns, and post the performance for all to see.

Each targeted version gets real estate on the tag board as well, with its own background color (gold, green, blue, red, or whatever scheme you wish to employ). Most certainly, you're measuring the profitability of each targeted version of an e-mail campaign, rolling the profit of each version up to a total level of profitability, right?

Invite your old-school CMO into the conference room, and review your twenty campaigns in this manner. Stop talking about open rates, click-through rates, conversion rates, landing pages, Outlook 2007, HTML vs. Text, rendering problems on mobile phones, and all the other gobbelty-gook that causes your old-school CMO to tune out. Simply focus on the colors. Explain how you're going to do more "gold and green" strategies. Explain why the CMO's recommendations resulted in "blue and red" performance.

And then, behind the scenes, build an OLAP-styled repository to store your historical results. Store open rates, click-through rates, conversion rates, dollars-per-e-mail, sales driven to the telephone, sales driven to stores, test results, profitability, and "gold/green/blue/red" status.

By the time your CMO is comfortable with your presentation style, you might even be able to surprise her with your OLAP-styled repository. Ok, maybe not!

And if you practice web analytics for a profession, would it be so hard to apply these principals to your landing pages, so that you can bridge the gap between all of your fancy data and the old-school marketers who don't understand what you're talking about? Give it a try!

Profitability

Profit is the reason we are allowed to remain gainfully employed. Conversion rate doesn't keep us employed. Profit keeps us employed.

How often do we hear e-mail marketers talk about, or ever demonstrate the profitability of their activities? I'm not talking about "ROI", nor an 8% improvement in open rate. How often do these industry experts talk about "profit"? Same for search marketers, or other online marketers.

In some ways, a generation of marketers are being trained to look at the business in unique and different ways. That's good. However, this generation isn't always focused on the metric that matters most.

"Back in the day", Lands' End measured the profitability of every spread in a catalog. Every major catalog was analyzed by a team of merchandising, creative, inventory and circulation staffers.

If I remember correctly, each spread in the catalog was grouped into one of four categories.

• Spreads that generated 30% or better variable profit (profit before fixed costs) were coded "GOLD".
• Spreads that generated 20% to 30% variable profit were coded "GREEN".
• Spreads that generated 10% to 20% variable profit were coded "BLUE".
• Spreads that generated less than 10% variable profit were coded "RED".

Each spread was hung on the wall of a conference room, in sequential order, hung on tag-board of different colors ... the color representing the profit category the spread fell into. At the bottom of the spread, the profitability of each item in the spread was itemized --- demand, fulfillment rate, return rate, net sales, gross margin, marketing cost, and pick/pack/ship expense.

Visually, a story was told in that conference room. One could visually understand why a catalog worked, or why it didn't work. We'd have a discussion about how to present merchandise, how to merchandise the front of the catalog (an important factor that more folks could pay attention to).

Fast forward to today. How many online marketers can give you, the direct-to-consumer executive, a set of metrics that clearly and easily tell you the profitability of items online. Do you have any reporting that tells you the profitability of a landing page? How about the home page?

Every employee should intuitively understand the connection between selling merchandise, marketing merchandise, and generating profit.

Seriously ... take a spin through the e-mail marketing and search marketing literature/blogosphere/vendor-speak. Count how many times you see the word "profit" mentioned.

Let's help these bright marketers make the connection between their efforts, and the profitability of the businesses we manage. We're failing these individuals, we're not training them to be the accountable leaders we need them to be. We need to protect the future of our industry.

Return On Investment (ROI) In Direct Marketing

Click on the image to enlarge it.

We hear a lot of talk about ROI, or "Return On Investment", when evaluating direct marketing programs.

Catalogers know that paper drives more total sales, and more total profit, than any other form of direct marketing.

E-Mail marketers know that e-mail drives the best "ROI", measured as "total profit divided by total cost". E-Mail marketing has almost no cost associated with it, making it a tool marketers must use, and use properly.

Paid Search marketers know that they reach customers at a "time of need", thereby providing the most "efficient" form of advertising known to-date. No other form of advertising cuts out the waste of uninterested shoppers like paid search ... except I guess for natural search, which has no cost associated with it.

Portal marketers know that they make the brand known to customers who have not purchased previously. They know their investment is best measured on a "lifetime value" basis ... short-term metrics are not appropriate for portal advertising.

In the table attached to the top of this article, each form of advertising has various strengths and weaknesses. Your job is to evaluate your advertising objectives.

Objective: Drive large volume of sales/profit from existing customers.
Solution = Catalogs.

Objective: Precisely target merchandise to existing customers.
Solution = E-Mail, Paid Search.

Objective: Precisely target merchandise to customers in-need.
Solution = Paid Search.

Objective: Make your brand aware to potential customers.
Solution = Portal Advertising.

Objective: Acquire new customers.
Solution = Catalog, Portal Advertising, Paid Search

I didn't even talk about affiliate marketing or shopping comparison marketing, which also fit into this story.

Obviously, there are many different objectives and solutions, my list above is abbreviated and short. Strategically, consider what you want to accomplish, and allocate your advertising mix on the basis of total sales, total profit, and your objectives.

Don't be swayed by folks who tell you that one form of advertising is "better" than another. Each type of advertising has a purpose. Each type of advertising excels within one specific set of metrics.

Catalog Profitability

Click on the image to enlarge it.

One of the challenges catalogers have to manage is determining the right circulation depth, and the right page count in a catalog.

Circulation depth is pretty easy to determine, once the number of pages are assigned. A straight forward calculation of sales and profit determine the right number of households to circulate to.

Page count presents more challenges. Merchants like to add pages, offering the customer more merchandise to purchase. Creative folks occasionally want to reduce density, adding pages that are less dense, easier to read.

More pages = more cost.

Are more pages better?

In the example at the top of this page, last year's catalog had 80 pages, and was mailed to 1.5 million households. The catalog drove $7,000,000 demand through the telephone and online channels.

When planning this year's catalog, the analyst builds a relationship between pages and demand. As pages increase, demand increases, but at an ever decreasing rate. Therefore, demand is maximized by sending as many pages as possible to as many households as possible.

Using a straight forward profit calculation, notice where profit is maximized. Based on last year's results, profit is maximized by sending a smaller catalog to as many households as is possible.

Here's a fundamental truth in catalog marketing:

• Increased Circulation Depth > Increased Pages

In other words, given the choice between adding pages to a catalog, or mailing a smaller catalog to as many households as possible, try to mail a smaller catalog to as many households as possible.

You can clearly see this when evaluating circulation plans. Businesses that like to mail catalogs with many pages tend to have shallow circulation, tend to be unable to do a lot of prospecting.

Businesses that are parsimonious with pages tend to circulate to many households, have robust prospecting programs, and a healthier housefile.

How Much Investment Is Too Much Investment?

Click on the image to enlarge it.

There are a series of fundamental truths about direct marketing that, while generally understood, are not actively practiced.

We all know that if you don't market to a customer, generating significant sales and profit become unlikely.

We also know that if you market too much to a customer, customers rebel, or the marketing is highly unprofitable.

The best direct marketers measure marketing effectiveness over time. In other words, the best direct marketers segment customers at the start of the year (calendar or fiscal). Next, customers are placed into different test groups. Some customers receive almost no direct marketing. Some customers receive too much direct marketing. At the end of the year, the direct marketer measures the repurchase rate, spend per repurchaser, average spend, and average profit, based on the contact strategy test the customer participated in.

Click on the attached image. This is what test results typically look like. In this case, customers received anywhere between six and sixty-six catalogs during a twelve month period of time.

At just six catalogs (one every other month), the customer segment had an average response rate of ten percent. The annual repurchase rate was 46.9%. The average customer generated $15.00 of profit.

At twelve catalogs (one per month), the customer segment had an average response rate of 7.1%. This is a very common situation --- by adding catalogs, we artificially cause each catalog to perform slightly worse. However, the annual repurchase rate increases from 46.9% to 58.5%. Better yet, annual profit increases from $15.00 per customer to $17.70 per customer.

Clearly, it is better to mail twelve catalogs than it is to mail six catalogs.

The table shows that profit is "maximized" at eighteen catalogs.

Now take a look at the scenario where twenty-four catalogs are mailed. Response rates continue to deteriorate. Annual repurchase rates continue to increase. Annual profit begins to decrease.

It is at this point that things become very interesting in your average catalog-based business. As you go from twenty-four to thirty catalogs (in this example), profit begins to erode, faster and faster as catalogs are added to the contact strategy.

There is an unusual dynamic that occurs in catalog companies that reach this stage. The CFO quickly points out that the "ad-to-sales" ratio is increasing at an unacceptable rate. The CFO might even want to cut back on catalog mailings.

Your merchants might view things differently. Merchants are charged with increasing sales --- one of the ways to do this is to increase pages, or increase the number of mailings. A merchant might recommend a new catalog title, focusing on a slightly different assortment of merchandise, targeted to a slightly different customer. The merchant might recommend six additional mailings, asking for a two year trial to see if sales can be grown, to see if a new target audience can be harvested.

Often, two or three merchants recommend this strategy. Suddenly, there are thirty-six or forty-two mailings in the catalog plan.

The merchants are under pressure to "grow sales". The way to do this is not to spend a ton of time prospecting for new customers. The way to do this is to mail "best customers".

This strategy artificially lowers catalog response rates, increases annual repurchase rates, and lowers profit per customer.

Eventually, something gives. If the business fails to meet plans by maybe ten or fifteen percent, the CFO gets enough power to enact change.

If the CFO isn't as strong a leader as the merchants are, circulation changes come in the form of cuts in circulation depth --- instead of mailing 1,000,000 customers per mail date, circulation depth drops to 850,000 customers per mail date. This is a short-term fix ... profit is slightly improved. The long-term problem of having too many catalog in the mail plan causes us to invest too much in our "best customers".

If the CFO is a strong leader, an excellent communicator, then real change can happen. Various catalog titles are dropped, various in-home dates are dropped.

Things get interesting when going down this path. Taking this approach cases the annual repurchase rate to decrease. This dynamic causes a reduction in the strength of the "housefile". With fewer active buyers, next year's sales potential is reduced. This will cause various leaders to want to advertise more next year, or the year after, in order to grow the housefile back to a level of perceived strength.

Of course, the way to balance this dilemma is to manage customer acquisition and customer reactivation activities in a manner that fuels total file growth.

But at an executive level, the concepts of customer retention, customer reactivation, and customer acquisition are too "geeky" to pay attention to. It is easier to think about adding catalogs, developing new products, presenting products differently, or to find new "target" audiences.

In almost every company I've visited or worked for, investment in direct marketing is overly focused on "best customers". Catalog mailings, e-mail mailings, loyalty programs, postcards, you name it --- everybody marketer wants to be successful. The best chance for success is with "best customers", right? Or is it?

Three Ways To Increase E-Mail Sales

Businesses with customers who purchase fewer than three times a year seldom benefit from trigger-based e-mail marketing campaigns (with the notable exception of shopping cart prompts, which often work well).

There are at least three key factors that can be managed, to grow e-mail sales.

Factor #1 = Incremental List Size, Managed By Contact Frequency

Factor #2 = Incremental Demand Per Contact, Managed By Contact Frequency

Factor #3 = Demand Per E-Mail, Managed By Number Of Targeted Versions


Incremental list size is ultimately determined by the number of e-mail campaigns sent per week. When a customer is contacted too often, too many customers unsubscribe, driving down the total size of the e-mail list. Strategically, management may choose to execute "x" campaigns per week. Mathematically, the number of e-mail contacts per week can be determined by the number that still cause a healthy increase in the number of valid names available to be e-mailed. In the table below, you'll see that two e-mails per week are optimal, as the e-mail list continues to grow.

Incremental demand per contact is also important. As you increase e-mail frequency, you will decrease the performance of any one e-mail contact. Increased frequency will probably cause cannibalization between e-mail campaigns. The table below shows that the combination of unsubs and performance dictate two e-mail campaigns per week.

Targeted versions of an e-mail are important as well. Few retailers have the ability to dynamically create unique e-mail campaigns for each customer. As a result, management creates "x" versions of an e-mail campaign, offering different merchandise in each version. The analytics team decide which version of an e-mail campaign the customer receives, on the basis of past purchase behavior, stated customer preferences, clickstream history, and other factors. From a staffing standpoint, it could be a challenge to produce numerous versions.

In the table below, I assume that a company managed one version of an e-mail, one time per week, to the entire e-mail file. This strategy yielded $20,700 of demand per week.

Going from one campaign a week to two campaigns per week kept the file size increasing, reduced volume per e-mail, but resulted in $30,030 of demand per week. Clearly, this is a better strategy than sending just one e-mail campaign per week.

Going from one version per campaign to nine versions per campaign drove $40,040 of demand per week. Assuming this strategy can be managed with existing staff at minimal cost, this strategy could work.

Notice that the combination of list size (dictated by frequency), demand per contact (dictated by frequency), and version contribution cause a doubling in e-mail volume, on a weekly basis.

Catalogers have long mastered this type of analysis, assigning profitability to each strategy. With e-mail, profitability is not as big an issue, so if one can avoid the fixed costs associated with incremental staffing, a move to moderate frequency with increased versions can yield a significant increase in e-mail sales.

Obviously, there are many ways to increase e-mail volume. These three basic strategies almost guarantee a positive return on investment.

No Targeting Strategy
Contacts	List	New	Unsubs	Net	$ per	Weekly	Total
per Week	Size	Subs	& Invalids	Names	E-Mail	Demand	Demand
1	100000	1000	650	100350	$0.20	$0.20	$20,070
2	100000	1000	900	100100	$0.15	$0.30	$30,030
3	100000	1000	1150	99850	$0.12	$0.36	$35,946
With Targeting Strategy: 2 Contacts Per Week
Targeted	List	New	Unsubs	Net	$ per	Weekly	Total
Versions	Size	Subs	& Invalids	Names	E-Mail	Demand	Demand
1	100000	1000	900	100100	$0.15	$0.30	$30,030
5	100000	1000	900	100100	$0.18	$0.36	$36,036
9	100000	1000	900	100100	$0.20	$0.40	$40,040

Contact Strategy Profitability

During a two-week period of time, you conduct an experiment. Customers are divided into four groups. The customers in each group are all "equal", in terms of quality.

Group 1 receives one catalog, and each of two weekly e-mail campaigns.

Group 2 receives one catalog, but does not receive any of the weekly e-mail campaigns.

Group 3 does not receive the catalog, but does receive each of the two weekly e-mail campaigns.

Group 4 does not receive the catalog, and does not receive either of the two weekly e-mail campaigns

The table at the bottom of this article illustrates the findings of the experiment. Which strategy would you employ (the strategy from Group 1, Group 2, Group 3, or Group 4), and why? Or, do you recommend a different strategy? Are you missing any information that you need to make this decision?

	Phone	Online	Total	Profit
Group 1 = Catalog + E-Mail	$4.39	$5.94	$10.33	$1.56
Group 2 = Catalog	$4.62	$5.71	$10.33	$1.58
Group 3 = E-Mail	$0.19	$4.46	$4.65	$1.14
Group 4 = No Marketing	$0.20	$3.99	$4.19	$1.05

Under Pressure

Profit is being squeezed out of our multichannel businesses, especially in the online and catalog channels.

This is an example of what a reasonably healthy online/catalog profit and loss statement might look like today.

Demand	$50,000,000
Merchandise Fulfilled	$45,000,000
Returns	$11,250,000
Net Sales	$33,750,000
Gross Margin	$16,875,000
Less Catalog Marketing	$4,000,000
Less Online Marketing	$2,000,000
Less Pick/Pack/Ship	$4,050,000
Variable Operating Profit	$6,825,000
Less Fixed Costs	$4,050,000
Earnings Before Taxes	$2,775,000
EBT As A % Of Net Sales	8.2%

This business generates $2.8 million profit on $33.4 million net sales, yielding a healthy EBT of 8.2%.

Then, the USPS elects to make mailing catalogs more expensive. If you simply absorb the cost of this increase, your profit and loss statement might look like this:

Demand	$50,000,000
Merchandise Fulfilled	$45,000,000
Returns	$11,250,000
Net Sales	$33,750,000
Gross Margin	$16,875,000
Less Catalog Marketing	$4,360,000
Less Online Marketing	$2,000,000
Less Pick/Pack/Ship	$4,050,000
Variable Operating Profit	$6,465,000
Less Fixed Costs	$4,050,000
Earnings Before Taxes	$2,415,000
EBT As A % Of Net Sales	7.2%

The USPS increase takes a full percent of your Earnings Before Taxes.

Even more interesting, however, is the looming trend toward free shipping and free returns. Long-term, I don't think we can escape this trend. The customer will demand we provide this service for free. A customer will gladly pay $3.00 for a $0.60 cup of coffee at Starbucks, but she won't pay to have a dress shipped from Columbus, OH to her home in Portland, OR.

Free shipping and free returns will put a lot of pressure on the profit and loss statement. If free shipping and free returns drove enough top-line sales to offset the expense, every multichannel retailer would already be offering free shipping and free returns. Let's take a look at the future p&l, after absorbing the expense of free shipping and free returns.

Demand	$55,000,000
Merchandise Fulfilled	$49,500,000
Returns	$14,850,000
Net Sales	$34,650,000
Gross Margin	$17,325,000
Less Catalog Marketing	$4,360,000
Less Online Marketing	$2,000,000
Less Pick/Pack/Ship	$5,890,500
Variable Operating Profit	$5,074,500
Less Fixed Costs	$4,050,000
Earnings Before Taxes	$1,024,500
EBT As A % Of Net Sales	3.0%

Ooops.

Free shipping and free returns are likely to increase the overall return rate, and reduce shipping and handling income, costing our business another $1.4 million of Earnings Before Taxes.

Remember, our business was generating $2.8 million in profit before the USPS increases, $2.4 million after, and maybe $1.0 million after having to move to free shipping and free returns.

Business leaders will be put in a difficult situation. Expenses will have to be cut, in order to maintain a healthy level of profit. I see two areas where this is likely to happen.

First, catalog circulation will be dramatically cut, mostly in low-productivity areas like prospecting. This is why you see our vendor community so up in arms.

The second area will impact the customer. Items with high return rates will not be featured in advertising, and may not even be offered at all, in an effort to lower the overall return rate. Free shipping and free returns will encourage customers to take more risks, but it will encourage businesses to take fewer risks to make the p&l work. Ultimately, the customer is going to lose the breadth of merchandise assortment she has grown used to.

Multichannel CEOs and CMOs: Start planning today for the pending pressure our profit and loss statements will face in the future. This is a good time to test free shipping and free returns (for an extended period of time, not just a few weeks in December), and project the financial impact this will have.

Running A Business Without Discipline

We frequently read about the importance of "managing the brand", about providing a great brand experience for the customer.

In the catalog/online world, it is just as important to properly manage the fundamentals of the business, the 'back of the office' execution that can make all the difference in the world.

There are several elements that all must be executed in harmony, executed efficiently, for the business to produce profit.

Fulfillment Rate: It should be no surprise that having the right merchandise available is an important part of meeting customer expectations. Too much merchandise yields markdowns. Too little merchandise yields lost sales. I spent my formative years at Lands' End. They were really good at striking that all-important balance.

Return Rate: Businesses don't have a lot of control over what is returned. For instance, the return rate on a pair of shoes is very high. The return rate of an iPod is probably a lot lower. However, businesses can take steps to reduce the return rate. Quality control is important. Using text to describe merchandise is important. Color-matching is important, so that the customer knows she is getting a 'lilac' dress.

Gross Margin: Closely related to fulfillment rate, gross margin is one of the most important profit drivers in a business. Gross margin is the difference between what the item sells for ($100) and what the item cost the business ($50). Markdowns are gross margin killers. Merchants who know 'what sells', and inventory managers who know 'how much to purchase' drive a lot of profit.

Pick, Pack 'n Ship Expense: Businesses should invest considerable effort in running an efficient call center and distribution center. Overstaffing either center results in too much expense. Inefficient ways to store merchandise result in added expense. This is an area that really good businesses focus a disproportionate amount of effort on improving.


When a business manages these areas efficiently, profit falls to the bottom line. When a business fails to manage these areas effectively, the business must significantly increase sales, in order to pay for its own inefficiencies.

In the table at the end of this article, one quickly notices that inefficiencies cause the business to have to sell nearly twenty percent more merchandise to achieve the same level of profitability. Think about that. When a business is run in a sloppy manner (the example below is not all that sloppy, by the way), customers need to spend twenty percent more just to help the business achieve the same amount of profit.

Leaders need to balance the importance of 'brand building' activities with the everyday tasks of running a business efficiently.

Profit And Loss Statement: Well Run Verses Sloppy Business
		Base Case		Sloppy
Demand		$5,000,000		$5,854,500
Fulfillment Rate	90.0%	$4,500,000	88.0%	$5,151,960
Return Rate	25.0%	$1,125,000	27.0%	$1,391,029
Net Sales		$3,375,000		$3,760,931
Gross Margin	50.0%	$1,687,500	48.0%	$1,805,247
Less Marketing Expense		$800,000		$800,000
Less Pick, Pack & Ship Expense	11.0%	$371,250	13.0%	$488,921
Variable Operating Profit		$516,250		$516,326
Percent of Net Sales		15.3%		13.7%
Required Increase In Volume To Achieve The Same Profit:				17.1%

Is An Item Profitable?

So many of us in multichannel retailing are asked to quantify how individual marketing activities perform.

We measure the effectiveness of an e-mail campaign. We prove that catalogs and direct mail drive business to the online channel.

Congratulations, we demonstrated that advertising works! Maybe.

Now it is time for us to measure how advertising influences the sales of individual items. I don't sense that our industry is doing the best job of measuring the profitability of an individual item, after factoring in the effect of advertising.

At the end of this post, I include a template for measuring the overall profitability of a specific item. In this case, we advertise the item through catalogs, through e-mail campaigns, and through online advertising (search, portals). During the course of an eight week period of time, we total the sales of the item, both online and over the phone. We also sum all advertising of that item.

What follows is a multichannel profit and loss statement for an item. This exercise should be replicated for every item sold by your business. Yeah, that's a lot of work. But how else are you going to know what sells, what sells because it is advertised, and what doesn't drive profit?

Quite honestly, the advent of the online channel has reduced our industry's zeal to understand the profitability of items. In catalog, it is easy to measure profitability. We need to have a passion for understanding which items truly work, across all channels.

Here, then, is a mocked-up template for the multichannel profitability of a single item. If you work for a business that also has a retail channel, simply add an additional section to the template for the retail channel.

Multichannel Merchandise Profit And Loss
Catalog Metrics
Catalogs Mailed		1,000,000
Total Pages in Catalog		124
Total Book Cost	$1.00	$1,000,000
Percent of Page Allocated		33.0%
Cost To Advertise This Item		$2,661
Total Responses		225
Response Rate		0.02%
Response per 000 Pages		0.07%
Units per Order		1.15
Total Units Sold		259
Price per Unit		$65.00
Total Demand		$16,819
Fulfillment Rate	88.0%	$14,801
Return Rate	25.0%	$3,700
Net Sales	66.0%	$11,100
Online Metrics
Total Visits To The Website		1,483,005
Total Visits, This Item		4,593
Total Website Cost, Non Adv.		$800,000
Cost Allocated To This Item		$2,478
Placed In Shopping Cart	25.0%	1,148
Total Responses	55.0%	632
Units per Order		1.08
Total Units Sold		682
Price per Unit		$65.00
Total Demand		$44,334
Fulfillment Rate	94.0%	$41,674
Return Rate	25.0%	$10,418
Net Sales	70.5%	$31,255
Multichannel Profit And Loss Statement
Multichannel Net Sales		$42,356
Gross Profit	48.0%	$20,331
Less: Book Cost		$2,661
Less: Website Cost		$2,478
Less: E-Mail Cost		$1,500
Less: Online Marketing Cost		$3,550
Less: Pick, Pack, Ship	11.5%	$4,871
Variable Operating Profit		$5,271
Profit as a % of Net Sales		12.4%