Limit Target Acquisition Costs
This theory not only is sound, it's almost always essential for revenue growth. That is, unless you spend too much money on your acquisition cost. Then you make back only part of your acquisition investment. You may be increasing sales, but you are eroding your margin.
How do you know whether your investment is sound? How do you determine whether you will ever turn a profit on that new customer? The key is correctly calculating your target acquisition cost.
Though many catalog companies don't know what their target acquisition cost should be, they do know how quickly they want new customers to turn a profit. Most companies want payback within 12 months. Some aggressive catalogers, meaning they have strong cash flow coupled with a strong back-end response, stretch this to 24 months. Of course, without knowing what their target acquisition cost should be, catalogers have no real way to know whether they are meeting their payback goals.
How to start. Determining target acquisition cost is easier than you think. You need only five numbers:
· Gross dollars per catalog mailed. Take your gross revenue of product purchases and divide it by the number of catalogs mailed. When calculating gross dollars, do not include shipping and processing revenues.
· Average promotional cost per catalog. Add all of your printing, letter shop, postage, list rental and creative costs, including layout, photography and copy writing. Divide this number by the number of catalogs mailed.
· Average cost of goods sold as a percentage of sales. Most catalogers average 35 percent to 40 percent. For the target acquisition formula, you will multiply your COGS percentage by your dollars-per-catalog-mailed figure.
· Variable fulfillment cost as a percentage of sales. After deducting shipping and processing revenues, how much does it cost to fulfill an order? For most successful catalogers this expense falls between 12 percent and 15 percent of gross sales. (Do not include fulfillment overhead in this number. Just use incremental costs per order.) Multiply your percentage by your dollars-per-catalog-mailed figure.
· Number of times in the mail. Count the number of times you will mail your new customer during your payback period. For comparison purposes, you may want to calculate your target acquisition cost with various payback periods, including one, two and three years.
The formula. Let's say that on average you gross $2.50 per catalog mailed. Your average promotional cost, including printing, postage and creative, is 70 cents. Your COGS averages 40 percent. Variable fulfillment cost is 13 percent, and you're going to mail new customers eight times in the next 12 months.
When we calculate each number for this formula, here's what it shows: Target acquisition cost = ($2.50 - $0.70 - $1 - $0.33) x 8. In this case, you can spend about $3.80 to acquire a customer.
Here's another example: Let's say you gross $10 per book. Promotional cost is $1.20. COGS is 40 percent. Variable fulfillment cost is 15 percent, and you'll mail new customers 16 times in your 12-month payback period. Your formula is: Target acquisition cost = ($10 - $1.20 - $4 - $1.50) x 16, which equals $52.80.
Putting it into practice. The next step is to calculate your actual acquisition cost for new customers by each prospect list.
Take the final results from a recent mailing where you mailed prospects. You should have the following response data for each prospect list: total promotional expense; number of orders; gross dollars of product sales; and cost of goods sold. You also will need your variable fulfillment cost percentage, which you will borrow from your target acquisition cost calculation.
For List A, you grossed $10,000. Your promotional cost, including list rental for mailing this list, is $14,000. Cost of goods sold is $4,000. Assume 13 percent is your variable fulfillment cost. Multiply your gross sales of $10,000 by 13 percent to get $1,300. Let's say you received 120 orders from List A.
The equation is: Actual acquisition cost = ($10,000 - $14,000 - $4,000 - $1,300) / 120. Your acquisition cost per new customer for List A is $77.50.
If your target acquisition cost is $52.80, you're probably overspending by $24.70 per new customer. These new customers from List A most likely will not reach profitability within your payback period. For this list, you may want to test different selects. Renting hotline names likely will bolster response over mailing the entire 0-12 month file. Perhaps adding a higher-dollar select will work.
If you have a seasonal business, you may be able to prospect only during peak times. The way List A is being mailed is not working, so consider testing a new strategy with that list or not mailing it in the future. n