So how much is a customer really worth? Ultimately, all decisions in direct marketing rely on this question being answered.
Hence this blog intends to provide a simple, yet broad viewpoint of how marketers approach the maths of direct marketing and how small businesses can obtain real value from using it.
The main objective is to introduce the importance of measuring direct marketing and to bring about some accountability for your marketing efforts, which should be music to every small business owner’s ears!
The mathematics of direct marketing primarily rests on three key elements:
- Sales
- Marketing Costs
- Contribution Costs (e.g. Overheads)
Now there is no clear-cut balance for these elements as any direct marketing activity needs to be tailored and fine tuned according to each business. This is why I will never state off-the-cuff a direct marketing response rate for any business or industry type as there are significant variables involved such as the product itself, the demand for it, market preference and the nature of the offer.
Another point I need to make is that the mathematics used is underpinned by the belief that the future will be similar to the past. Hence if any variable within the equation changes significantly (e.g. magazine circulation significantly declines), then you have to expect a different response rate.
So to dive straight into it, I’ve listed below a few essential calculations which every small business should use:
Calculating the Allowable Using Your DM Budget
This equation lets you calculate the amount of money you need in order to make one sale. This is really important to know!
Revenue Selling Price: $1000
Minus Costs Production: $500
Overheads: $150
Postage & Handling: $50
The Breakeven allowance is $300 (the money you are allowed to spend to acquire a customer).
NOTE: If your business requires 10% profit, then your allowable would effectively be reduced to $200.
Using the Allowable to calculate your DM budget
So using our allowable recruitment spend per customer x target No. of Sales
= $200 x 100
Marketing Budget = $20,000
What happens if you don’t make the sales required?
All I can say is that it is essential to test the market first using a small quantity before rolling out the entire campaign. Typically your allowable is based on what resources are required to acquire a customer already, plus I would expect some form of marketing research carried out in order to understand the size of your potential market. It is also important to include contingencies within your marketing activities if you don’t make the required sales. I always save 10% of my budget if something goes wrong. Or better still, if a potential list I’m targeting returns a huge ROI, then I have a bit left over to chase the money and market these top prospects again.
Measuring Costs, Responses and Sales
Here are a few very simple, yet essential equations to help measure costs, response and sales:
Cost per Unit:
Total cost / Total Quantity = Unit Cost
e.g. $20,000 / 4,000 = $5
Response Rate:
(Total Responses / Total Mailed) x 100% = % Response
e.g. (200 / 1,000) x 100% = 20%
This equation is exactly the same as measuring the Conversion Rate which would be Converted Leads / Total Leads Contacted
Cost per Sale:
Total Cost / Total Sales = Cost per Sale
e.g. 20,000 / 500 = $40
Example: Let’s say you were a travel insurance broker wanting to advertise in the local newspaper to sell premium travel insurance for $500 per person. I’ve listed some assumed sales and marketing costs to acquire a customer:
Advertising Cost: $7,800
Promotional Cost: $5 per lead (e.g. Call centre costs)
Total Marketing Cost for 100 leads is therefore: $8,300
A scenario has been outlined in the attached spreadsheet so you can follow the calculations used. You should study it before reading any further: travel-insurance-profit-index
Now the Cost per Inquiry or Sale will vary depending on the response rate, which you won’t know until you advertise. But the main focus on advertising is to achieve a required level of profitability in order to justify the expense. I like to refer to it as measuring the Profit Index. (This is exactly the same as using your allowable to calculate the number of sales you require in order to justify any marketing spend).
Profit Index (%) = Total Marketing Cost / Total Revenue
In this instance the Travel Insurance company requires 20% profit from print advertising. If my profit Index falls below 20%, then the advertising is deemed unprofitable. I’m so harsh!
Hence, 21 travel insurance premiums need to be sold to meet a profit index of 21%.
In other words, the allowable DM Budget would be set at $8,300 for advertising in the Local Newspaper.
Using Spreadsheets to Negotiate Spend
If you’ve seen the spreadsheet then you’ll wonder why I’ve highlighted the cost fields – Ad Cost and Promotional Costs. Promotional Costs are harder to change in the short term, but negotiating advertising costs can be extremely effective. You’d be amazed to discover that by saving 10% of advertising you drive down your Profit Index, which means your advertising dollar doesn’t have to work as hard to acquire customers or sales. In the example used, you would only have to sell 19 Travel Premiums in order to meet the minimum profitability requirements. It also does hurt asking for a trial advertising rate to test the viability of a product in a publication. Some account managers will assist if it means you become a regular advertiser.
Now for those who want to know how to calculate the Long Term Value of The Customer, then I’m saving this for my next blog, as it deserves one all to itself. (Plus it can get a little complicated).
In the meantime however, there are a couple of examples which the above calculations can be applied to in order to gain some further perspective for your next lead generation campaign.
Lead Generation Conversion Programs
1. Generally the more time you have to qualify an enquiry, the more it costs to generate. For example, if your telesales representative took 15 minutes to convert a prospect, while others may take only 5 minutes, then this will drive your overall costs to acquire a customer, and must be factored into your overheads or marketing costs.
2. Lead generation lists (Prospect Lists) can also support repeat conversion contacts, but you’ll always get a reduced response rate with each effort. For example, if you mailed 1,000 prospects, it may generate 250 leads. The second time you mail the list (minus the 250 leads you generated the first time round), you might get another 100 leads. This means you have generated a total of 350 leads from the prospect list. But we wary that if you use the list too many times then it will get to the point of being unprofitable.
As a general rule of thumb, you should change a portion of the DM piece the next time you mail (e.g. The offer, or a larger discount), as customers may respond to varying aspects of your direct marketing campaign, which is why it is always important to test.
A final note…
You may hear direct marketers talking about list building, and how much of their time is dedicated to developing a database of qualified prospects and customers. These lists, as described in my previous blog on data driven marketing, are in fact a key ingredient which differentiate direct marketing from traditional marketing.
But I will say that typically, a list of present customers will respond much better or at a higher rate to a new product compared to non-qualified, or “cold” prospects.
I think it’s also important to point out that while companies always depreciate their expenses over time such as equipment, machinery and inventory, they almost never capitalise what could be their most important asset, their customer. Therefore, small business owners should view their customers as investments and be able to measure and monitor customer data, and capitalise on it for the future.
Just remember that the maths of direct marketing sets it apart from all other marketing disciplines!!
Until my next instalment……
Craig
