The Cost to Acquire a New Buyer
by Stephen Lett
There is a cost associated with acquiring a new buyer. Catalogers need to invest in converting prospects to buyers. How much you are willing to pay for a new buyer depends on what you can afford to spend and how fast you want to grow. Over spending to acquire a new buyer and trying to grow too fast can lead to financial ruin. On the other hand, not investing in growing your house file can have a negative affect on your business and future growth trend. Knowing how much to spend to acquire a new buyer is the subject of our column this month.
Some catalogers feel they do not want to prospect below the incremental breakeven point (net sales less cost-of-goods-sold less direct selling expenses) on a cumulative basis. They want to be certain that all of the prospect lists they mail perform at least at breakeven or above. While this is a nice goal to have, this philosophy can severally limit growth. That’s because it is unlikely you can find enough “good” lists which perform above breakeven to sustain a desired level of growth or to even maintain same sales from one year to the next. Catalogers need to be willing to invest in acquiring new buyers and this can only be accomplished mailing below the incremental breakeven point. How much below is the real question? And, how much should you be willing to spend for a new buyer? What is a reasonable payback period for the investment you are willing to make? There are logical answers to these excellent questions.
There is a certain attrition rate on any house file. Customers stop buying for any number of reasons. Economic conditions, poor service, “older” customers pass on, etc., all impact the buying decision. At a minimum, it is important to replace those customers with fresh buyers so that your 0-12 month file does not decline. If you want to grow, the amount of prospecting you do needs to exceed your normal house file attrition rate. For example, let’s assume that 50% of a typical customer file will purchase again next year. This means that at a minimum, we need to replace the 50% who do not purchase so that the active house file does not decline. This includes a combination of adding new buyers and bringing the “older” buyers on our house file into the 0 – 12 month category. If we want to grow the percent of new-to-files has to be even higher than our normal attrition rate.
Let’s take a look at how much we can afford to spend for a new buyer based on what we expect in return. Once again, we are talking about spending money, i.e., making an investment, in acquiring a new buyer. Catalogers often feel a payback of one year (or less) is considered a reasonable investment payback period. (The payback for some companies might even be longer.) Some catalogers might say that they want to base the cost to acquire a new buyer on the expected life-time-value. While this is not an unreasonable approach, most prefer to take a shorter term view. While it unrealistic to expect to prospect in total (on a cumulative basis) at or above the breakeven point, it is reasonable to attempt to payback that investment within one year. How much we can afford to spend for a new buyer assuming a one year payback is calculated below.
Lets assume in our example below that our goal is to breakeven within one year after we acquire a new buyer, i.e., a one year payback. In the year of our initial mailing to prospects, we acquired 1,500 new buyers from a mailing to 100,000 outside names.
These 1,500 new buyers generated 898 orders the following year, $60,143 in additional revenue. When we combine the initial mailing results with the repeat purchases made in year one, we show a breakeven in our example. Our cost per new buyer was $12.14 initially. Therefore, if our goal is to breakeven after one year on the investment we make initially to acquire a new buyer we can afford to invest up to $12.14 to acquire a new buyer in our example above. As you can see, the year after the initial investment our contribution to profit and overhead is a positive $8.15 per buyer. Obviously if we considered life-time-value the contribution in years two, three and beyond would be even greater. The point is, new buyers are the lifeblood of any catalog company and we need to be willing to investment spend initially to acquire them.
|COST PER BUYER|
|Number of New Buyers||1,500||1,500|
|Number of Times Mailed Annually||1||10||11|
|Average Order Size||$65.00||$67.00||$65.75|
|Number of Orders||1,500||898||2,398|
|Less: Returns @ 5%||$4,643||$3,000||$7,643|
|Less: Cost of Goods @ 47%||$43,643||$26,857||$70,500|
|Less: Direct Selling @ $.60||$60,000||$7,500||$67,500|
|Less: Variable Fulfillment @ 8%||$7,429||$4,571||$12,000|
|Cost/Contribution Per New Buyer||($12.14)||$20.29||$8.15|
|Note: Catalog cost in "Repeat" Column does not include
the cost for the rented name; house mailing only.
Maximize Your Prospecting Efforts
The time of year you prospect affects your economics. For this reason, it is important to prospect with full knowledge and understanding of what it takes to maximize your results. To get the most out of your prospecting, you might want to follow these suggestions:
- You should prospect the heaviest in your strongest drops – In our column last month, we addressed the importance of testing new lists and prospecting during your “best” season or period.
- When you have the money to invest in prospecting – Prospect when you have the cash flow to do so. But, prospect wisely and not beyond your means.
- When you have a new product offer - It is always best to expose prospects to a “new” merchandising offering especially if they have seen an older one.
- When your core continuations have new names for you to mail – Capitalize on the new buyers which are added to your continuation lists. These names are sure to be a winner!
- Mail prospect tests in your strongest drops - This give them the best chance for success and/or with enough lead time to read results and roll out in your strongest drops.
The main point of our column this month is to point out that it is unlikely you can prospect in total above the incremental breakeven point. This means catalogers need to be willing to invest in acquiring new buyers and in the growth of their company. When looking at an income statement, it is tempting to cut prospecting in order to save money and to put more profit on the bottom line. But, is this really the right thing to do? Probably not. Doing so will cause a downward spiral and the 12-month buyer file will begin to decline. At a minimum you should be willing to prospect to a level that will enable you to maintain your current level of sales. If you want to grow beyond that level, the amount of prospecting you do will need to increase. Again, this should be viewed as an investment in the future of your company. Sacrificing the long-term growth and good of your company for short-term profits is not wise. Be just as concerned about the change in your 12-month buyer file from one period to another as you would be about the results shown on your income statement. The change or growth of your 12-month buyer file will give you a good idea of health of your business. Invest in your future by generating new buyers. But invest wisely and be careful not to over mail.