Every activity of a catalog, direct marketing or e-commerce business impacts the ultimate, tertiary valuation of the business enterprise, the resultant financial worth of the business at the execution of the exit strategy.
For more than a century, the direct marketing industry has prospected for new customers based on the short-term dynamics of response and immediate return on investment. Now it can be suggested that a different view and a new strategic direction are essential for those forward-looking business shareholders desiring to influence and structure their endgame business valuations for maximally abundant and satisfying “harvest events.”
The historic view of prospecting. Prospecting for new customers has traditionally been predicated on the amount of money available in the annual budget for prospecting, an intellectual non sequitur that has always been benignly enigmatic on the surface and, perhaps, insidious underneath.
Determining the number of new customers to be acquired on an annual or periodic basis has, most often historically, been determined by the total number of mailings necessary to create the total number of new customers necessary to create – within a prescribed level of expenditure – the approvals of the CEO and the board of directors.
Inevitably, the new customer prospecting plan was created from the bottom line up; seldom was the prospecting plan derivative of the top line or a defined strategy. This historical and largely unspoken dichotomy can be comparatively phrased as the philosophic difference between, “How many new customers can we afford?” and “What is the future value of a new customer acquisition to the future value of the enterprise?” Stated another way, the difference between “short-term, quarterly earnings-driven companies” and “tertiary, endgame, value-driven companies.”
To understand the broad history of prospecting attitudes and, therefore, activity, it is essential to view prospecting through the eyes of the catalog business owner of the 1950s to 1970s entrepreneurial management era. This period was characterized by strong, individualistic entrepreneurs who possessed proprietary knowledge about both niche markets and direct marketing techniques.
In both the consumer and business-to-business arenas, dominating entrepreneurs/owners pioneered and mastered the fundamentals of what is now nostalgically called “mail-order marketing.” Often a seat-of-the-pants style of management, the balance between growth and profitability was maintained by the masters through close management of cash flow, inventories and prospecting. The hallmarks of this era of direct marketing were high response rates, high margins, high number of inventory turns, low overhead and low advertising costs resulting in above-average levels of profitability. The predominant management structure was marketing-focused.
The entrepreneurial management era evolved a cash-conscious, autocratic prospecting ethos. The owners, often first-generation, start-up operators, prospected up to the level of their operating cash comfort tolerance. This period was marked by its dominant prospecting strategy, “Put a lot of stuff in the mail and people send you money!” As long as adequate cash was on hand to meet payroll and keep up the second mortgage on the house, the comfort level on prospecting could be moved up. Buying product was secondary since delivery times were three to six weeks; when the money came in, the products could then be purchased to fill the orders. Major corporations were built on the formulaic certainty of prospect response, the financial leverage of inventory-on-demand and the simplistic prospecting strategy of “mail more.”
With the entrepreneurial prospecting attitudes of this era as the antecedent of today’s prospecting state-of-the-industry, it is clear that the industry has been, and continues to be, influenced by the short-term view. The past owners taught the present owners; the seasoned, present-day senior managers – who came into the industry in the 1970s – learned from the entrepreneurs. And they learned well. The catalog and direct marketing industry has flourished and grown by magnitudes under their leadership. However, prospecting strategy and business valuation are still upside-down.
Business valuation. The only accurate valuation is the one assigned by the marketplace itself: The business is worth what someone will pay for it. The hallmark of value, however, has always been earnings. A business with high earnings generally has a high valuation; a business with low or no earnings generally has a low valuation. If you summarize broadly, you can speculate that an average catalog company with average earnings will be worth anywhere from four to seven times earnings (earnings before income taxes, depreciation and amortization). Consequently, if $1 from prospecting can be added to EBITDA, that $1 is worth $4 to $7 at the “harvest event,” the sale of the business. Put another way, every $1 resulting from a successful investment prospecting strategy puts an additional $4 to $7 in the shareholder’s pocket when the business is sold.
This quite startling revelation often causes owners to view every activity of the catalog company with fresh motivation. A seven-time return on any activity is positively stimulating to many; for the very first time, some owners begin to lead a “life examined.” And that examination inevitably leads to the realization of the truth of the value premise: The only reason for any strategic and tactical decision is the outcome impact on endgame business valuation. Start with and focus intensely on that concept and you begin to understand the supreme importance and value significance of “endgame strategy.”
There are several alphas and omegas of endgame strategy. A catalog owner likely begins by being an early product master and then evolves into a marketing master; along the way, masteries of catalog creative, lists, circulation and offers are accumulated; over time, one masters pagination subtleties, fulfillment and e-commerce, as well as a litany of lesser skills. The resulting catalog master is, however, but an operating master. Several other masteries are necessary to produce the fully furnished and fire-burnished master cataloger: finance must be learned; people management must become innate; acquisitions must be experienced; international expansion must be tasted; and, in the end, succession and mortality must be faced and recognized. That is the essence of the mastery of the endgame and the recognition of the value premise: The only reason for any strategic and tactical decision is the outcome on endgame business valuation.
Generally within the first 10 minutes or so of a conversation with an owner or CEO, you obtain an indication of the level of mastery that has occurred. Focus on product, or market, or creative processes indicate “mastery in progress.” Focus on the endgame harvest indicates an awareness of the value premise. To speak of strategic directions for business building is vastly different than speaking of strategic directions for wealth harvesting. The point: Unless the multiple of earnings (EBITDA) is understood and the value premise has been integrated into the stable financial performance of the business, the business is not ready for harvest. For that reason, the critical issue for many, if not most, owners remains investment prospecting.
The two prime metrics. There exist two prime metrics having influence on the value premise and, therefore, on the basis of investment prospecting:
o The cost to acquire a customer, to the penny, in every channel, by every promotion, and in the aggregate, known weekly for 20 consecutive business quarters at the minimum.
o The EBITDA value of that customer, at a logical, fixed, harvest point in the future, to the enterprise value of the business.
If these two metrics are known, every prospecting decision becomes inextricably linked to the future invested value of the business; in effect, present prospecting is determined by future EBITDA outcome, by definition a more beneficial strategic premise than the customary, seat-of-the-pants, “back door” method cobbled together to obtain short-term approbation for next quarter’s mailing plan.
With the two prime metrics in hand, much can be accomplished. The financial plan for the enterprise can be created with solidity and a specific goal: future wealth harvesting for the shareholder(s). What else is there?
The financial plan – developed in concert with the strategic plan – allows the owner or CEO of the catalog company to view and plan prospecting expense within the value premise and to establish EBITDA outcome hurdles at a specific point in the future at which wealth is to be harvested. “If I spend $1,000 in investment prospecting today, I obtain $7,000 in EBITDA in three years.” With this clear goal in view, the owner or CEO then has the responsibility of determining the prospecting mail plan that accomplishes that clear and defined goal.
The media partner. For many organizations having senior catalog marketing managers schooled in the traditional method of media and mail planning, it will be difficult to create an understanding of the value premise; these veterans are conditioned to short-term profits. With a full explanation and a strategic repositioning, however, it may be possible to influence the thought and planning processes. The media partner is an essential element in the equation.
The difference between a prospecting plan for orders and a prospecting plan for future EBITDA is enormous. Few traditional list brokerage houses will even understand the difference, much less be able to calculate the potential using your pro forma EBITDA financial projections. But, before you can harness expertise, you must share your financial plan.
Many years ago, we assembled all of the suppliers to the catalog business and outlined our financial plan for EBITDA at five years in the future. Every key player was at the table and was included in the “success stake.” The objective suddenly was no longer, “get a prospecting catalog out” but “create a cooperative prospecting effort that will deliver $700,000 additional EBITDA in five years.”
The list broker delivered a prospecting mailing plan that was markedly different. It was created not with response objectives, but with EBITDA objectives. A self-imposed hurdle had been set that focused on lists and carefully thought-out segmentations that would produce future wealth, not just short-term orders. That was a significant process change and a significant strategic enhancement. The brokerage firm no longer “rented names” but rather, “created wealth” for our catalog.
With this strategic partner approach, the catalog not only met its five-year objective, but it also exceeded it by nearly 1,000 percent. The point: The creation of a fully furnished financial plan, born out of the value premise, in concert with an effective strategic plan, shared with vendors that are committed to understanding and achieving a higher strategic intelligence, is the surest path to the desired maximally abundant and satisfying harvest event.
Owners, board members, CEOs and shareholders… go forth and harvest.
pull quote no. 2: The only reason for any strategic and tactical decision is the outcome on endgame business valuation.
Donald R. Libey is co-founder of Libey-Concordia, Haddon Heights, NJ, an investment banking firm to the catalog industry.