Selling Expense to Sales Ratio … How Low is Too Low?
By: Steve Lett
Direct selling expense to sales ratios have been the subject of several articles I have written over the years. That’s because this ratio is critical to profitability and to the growth of a catalog business. It should be tracked monthly on your income statement just like you focus on other key ratios. A healthy consumer catalog company will have a ratio of approximately 30% of net sales. This means that $.30 out of every dollar of net revenue is spent on printing, postage, service bureau, prospect lists, etc. A business-to-business ratio will typically range from 15% to 25%.
As the direct selling expense to sales ratio increases, profitability will likely decrease. This is true unless your gross margin ratio is high enough to support a higher selling expense ratio. But what happens if the selling expense ratio is low? Can it be too low? You may think that the lower the selling expense to sales ratio the higher the contribution to profit and overhead. If you drive down this ratio don’t be too quick to pat yourself on the back and say, “good job”.
Consumer catalog companies that focus on reducing their selling expense to sales ratio below 30% will improve profitability short term. But it could hurt the business long term. For example, the first year you purposely reduce this ratio, your profits will increase assuming all other ratios stay the same. What happens to the business in year two and beyond?
The actions required to reduce the selling expense to sales ratio below industry standards could be harmful to the business. For example, marketing cuts need to be made in order to reduce the ratio. Take prospecting, for example. Typically, 40% of total circulation is going to prospects in order to grow the house file. Eliminating all or most of the prospecting will help to decrease the selling expense to sales ratio by lowering printing, postage and list costs. This action will also reduce the number of 12-month buyers. As the year progresses, there will be fewer buyers on the house file to mail. These 0–12-month buyers yield the highest revenue per catalog (RPC) on the house file.
Another example of an action that could be taken to reduce the selling expense to sales ratio is to eliminate mailing marginal house file names. And/or to eliminate buyer reactivation programs designed to put these previous customers into the 0–12-month category again. These actions can improve the selling expense ratio by reducing mailing costs and house file names that generate a lower RPC. But once again, this action will result in fewer buyers to mail especially in the 0–12-month category.
I am all for taking actions to reduce the selling expense to sales ratio as long as the 0–12-month file is not impacted. As an example, we could change the weight or grade of the paper in order to save money. Or we could make a slight change to the trim size of the catalog. These are actions that should already have been done as a normal course of doing business.
I know what you are thinking. You’re thinking that you can offset the impact of eliminating prospecting using digital marketing programs. In other words, more digital and less catalog marketing programs. It sounds good but the quality of new buyers acquired from web marketing doesn’t compare with the quality of new buyers acquired from print catalog programs. The web buyers are not as loyal and their repeat purchase factor in lower. I would encourage you to compare the life-time-value of a catalog buyer vs. an internet buyer.
If you reduce catalog marketing programs to reduce the selling expense ratio from, let’s say, 30% to 25% then what will you do in year 2 and beyond? In other words, can the reduced ratio be sustained in subsequent years? I don’t think so. Cutting catalog marketing every year is not the way to the promised land. My mentor several years ago, repeatedly told me that you can’t slash your way to prosperity. It takes well-planned and properly executed marketing programs to grow both the top and bottom lines.
The important takeaway from this article is to maintain the proper balance of mailings to your house file and to prospects. Tipping the scale one way or the other will impact your business. Over-mailing runs the risk of sacrificing profitability. And under mailing runs the risk of reducing the size of your house file. If a 30% selling expense to sales ratio is good for your business, strive to maintain it. Watch the ratio and focus on maintaining the right balance.