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.

An Example Of The Direct Marketing Customer Continuum

This one comes up all the time. Take a look at catalog performance, over a four year period of time.

Evolution Of Segment Performance
		HHs	Phone	Online	Total	Profit	Change
2004	Catalog Only	10,000	$5.00	$0.20	$5.20	$0.81
	Catalog + Online	3,000	$2.00	$2.00	$4.00	$0.45
	Online Only	2,000	$0.05	$1.75	$1.80	($0.21)
	Total Segment	15,000	$3.74	$0.77	$4.51	$0.60
		HHs	Phone	Online	Total	Profit
2005	Catalog Only	9,000	$5.00	$0.20	$5.20	$0.81
	Catalog + Online	3,500	$2.00	$2.00	$4.00	$0.45
	Online Only	2,500	$0.05	$1.75	$1.80	($0.21)
	Total Segment	15,000	$3.48	$0.88	$4.35	$0.56	-3.4%
		HHs	Phone	Online	Total	Profit
2006	Catalog Only	8,000	$5.00	$0.20	$5.20	$0.81
	Catalog + Online	4,000	$2.00	$2.00	$4.00	$0.45
	Online Only	3,000	$0.05	$1.75	$1.80	($0.21)
	Total Segment	15,000	$3.21	$0.99	$4.20	$0.51	-3.5%
		HHs	Phone	Online	Total	Profit
2007	Catalog Only	6,000	$5.00	$0.20	$5.20	$0.81
	Catalog + Online	4,000	$2.00	$2.00	$4.00	$0.45
	Online Only	5,000	$0.05	$1.75	$1.80	($0.21)
	Total Segment	15,000	$2.55	$1.20	$3.75	$0.37	-10.8%

Again, I see this one all the time. Traditional RFM performance illustrates a segment that is "dying", performing progressively worse over time.

What is actually happening is quite different. Customers are shifting their status along the Direct Marketing Customer Continuum.

Catalog-Only customers require advertising. Notice that their performance hasn't changed over time.

Catalog + Online (those vaunted Multichannel Customers) are in the middle of our continuum, using advertising and search and word of mouth to buy merchandise. Notice that their performance hasn't changed over time.

Online-Only (customers that are self-serve customers, not needing advertising, have not changed their performance over time.

So the three key segments that multichannel brands track are all performing the same, over time. Yet in total, the performance of the total segment is dropping like a rock.

What is happening is that customers are moving along the continuum. Look at the number of households in each segment, from 2004 to 2007. Customers are shifting from needing advertising to not needing advertising.

Yet, while customers shift their behavior, the multichannel brand continues to do the same thing (mail catalogs), then wonders why productivity is dropping.

Simple solution: Take your RFM segment, and split them out by recent (not lifetime) purchase behavior --- catalog-only, catalog+online, online-only. If you see this phenomenon occurring, your problem is solved. Mail fewer catalogs to the online-only and multichannel audience, and improve the profitability of your brand.

Honestly --- for most multichannel brands, it isn't more challenging than that. And for those of you who are more advanced, go ahead and do the incremental mail/holdout tests we talk about all the time, you'll see different results than you see in your matchback reporting.

Simplifying The Direct Marketing Customer Continuum

Let's simplify this message a bit.

You are a direct marketer.

Whether direct marketers understand this or not, direct marketers simultaneously manage three distinct segments of customers.

One segment requires advertising in order to purchase merchandise. This customer wants to be led, wants to be inspired. In our hearts, we believe that all of our customers fall into this category.

A second segment of customers combines advertising, paid/natural search, social media, and word of mouth. This segment of customers might reflect the average customer we market to in 2008.

A third segment of customers buy out of brand loyalty. Think of the customer who wants to buy a book, visits Amazon.com, and buys the book. No advertising, no e-mail campaigns, no marketing was required. Think of the customer who wants to buy a pair of shoes, visits Zappos, and makes the purchase. Again, no catalogs, no e-mail marketing, just an inspiration followed by a website visit.

Direct marketers want customers to feel our passion. We believe customers love our marketing. You wouldn't see catalog CEOs handing catalogs to you if this weren't the case. You wouldn't see a hundred different e-mail marketing blogs if this weren't the case.

But during the past decade, the internet caused customer behavior to change ... dramatically change.

Retailers have always dealt with this. By simply opening a store in a popular shopping center, customers showed up, and sales poured in. Retailers know that marketing plays, at best, a small role in the success or failure of retailing.

Direct marketers never had to deal with this.

Now we have no choice but to start dealing with this.

If you are a business intelligence expert, SAS programmer, web analytics expert, statistician, or a query manager, start splitting your customer base into these three groups. Use your tools and techniques to identify which segment your customers fall into.

If you are a catalog executive, online marketing executive, or e-mail marketing executive, challenge your analytical folks to define these three groups for you. And then market to each group appropriately, the way the customer wants you to speak to her, not the way you want to speak to your customer.

Customers on the left side of the slide need/enjoy advertising. So send your catalogs or e-mail campaigns to these customers. Revel in the fact that these customers love interacting with you.

Customers in the middle of the continuum are fascinating. Let go of the old rules that suggest our marketing strategies are solely responsible for their purchases. Observe these customers, research their activities, ask them why they behave the way they behave.

Customers on the right side of the slide no longer need marketing. Identify these customers, and stop mailing your catalogs and postcards. Stop offering 20% off your next order. Scale back your e-mail marketing to this audience. Bathe yourself in profit instead of bathing yourself in marketing ego.

This self-sufficient audience is hard for us to let go of. We want to attribute their voluntary orders to all of our marketing activities, thinking that without us, these loyal customers would not buy from us anymore. Let go of these customers!

How do you see these principals impacting your business, your customers? Do you have the analytical tools necessary to identify these distinct audiences?

The Direct Marketing Customer Continuum

Please click on the image to enlarge it.

I'm about to eclipse one year as a multichannel forensics proprietor. If there is one thing I've learned during the past year, it is that customers who shop website and catalog brands have fundamentally changed their behavior over the past ten years.

The concept of a "customer" fundamentally changed. Multichannel Forensics projects repeatedly illustrate a pattern of customer evolution, one that progresses from advertising as the reason for sales increases to one where the customer purchases because of faith and trust in a brand.

This process, what I call the "Direct Marketing Customer Continuum", can be hard to understand. We've been trained to analyze campaigns. We blast an e-mail to 794,000 customers, we get 1,000 orders. We achieve a $30 cost per order on a paid search campaign. We send a catalog to customers and observe a surge in website orders. My goodness, we're a multichannel brand, everything we're doing works!! We think customers love interacting with us in a multichannel manner.

Until you view this from the perspective of a customer.

See, the customer is simultaneously progressing through a relationship with a brand, and with technology, a collaborative relationship that has fundamentally changed over the past decade.

In the image at the beginning of this post, the upper-left portion of the image reflects a customer at the start of the continuum. This customer requires advertising to place an order. Catalogers and e-mail marketers love this customer! This is the customer we've always known. We controlled this customer.

But then a funny thing happens. The customer discovers that the internet can be used to help determine if she is making the right decision. At this point, catalog and e-mail marketing are augmented with search campaigns, a true multichannel nirvana.

And just when we think we've mastered multichannel marketing, the customer moves even further along the continuum. This move is frustrating for us, because the customer no longer needs our advertising. She starts researching what other customers say, in blogs or on MySpace. As she participates in these forums, her behavior shifts even further away, to Facebook, and then to 140 character mini-conversations in Twitter. She trusts the opinions of her virtual friends, choosing to buy from us because she trusts us, she trusts technology, and she trusts her virtual friends.

This is where we mess up the whole relationship. The customer buys from us for completely different reasons, but we "match back" her purchase to our marketing strategies. Our measurement abilities and ego attribute her purchase to our brilliant marketing strategies, when in reality, she purchased for completely different reasons.

So the customer moves ever closer to a place where she buys from us simply because she trusts us. She doesn't need marketing anymore. She's ready to be "hyper-profitable" to us. Yet we market to her even more, making her "less profitable" to us.

We have four different things happening, all at the same time.

1. We execute marketing campaigns because that's what we've always done, it is the way customers have always interacted with us.
2. Customers are no longer static, their behavior moves along a direct marketing customer continuum, making it harder for us to understand what it is that motivates the customer.
3. Customer acquisition completely changed. We used to market to a static audience that we controlled. Now, customers jump into this continuum anywhere the customer wants to. This lowers response to marketing. We blast a catalog to a prospect who now uses Facebook to learn what others think about us --- of course the catalog is going to be thrown out! In some cases, we observe this via lower response rates. In other cases, we mistakenly match the order back to our advertising. In either case, we're wrong.
   
4. You simply cannot move a customer from the upper left portion of the image to the lower right portion of the image overnight. The customer decides when she wants to move from one box to another.

More and more, catalogers and e-mail marketers tell me that certain marketing strategies "don't work", especially those in the lower two rows of the image. There's no way these strategies can work if the customer base still resides in the top row of the continuum.

Conversely, the marketer is trapped, because a large portion of the population is silently moving from the top row to the bottom two rows of the continuum. As this happens, response to marketing activities tailored to the top row of the continuum drop. This disconnect has catalog and online brand executives worried.

It is becoming obvious that future opportunities reside in identifying where our customers reside on the direct marketing continuum.

• Traditional marketing can focus on customers in the top row of the continuum.
  
• Online marketing focuses on the middle row of the continuum. All of the emerging social media opportunities focus on the bottom row of the continuum.
  
• The bottom row represents the biggest opportunity, because these customers buy because they trust us, not because we market to them. We eliminate marketing waste among this audience, greatly increasing profitability.
  

I believe this is the direction our customers are taking us in. Our current tool set and mindset are not yet calibrated for the direct marketing customer continuum.

Your thoughts?