171 DM Questions – What are the economics of DM?

60. How do I determine my marketing budget?

Budgeting depends to a large extent on how much money you have. The longer you can afford to wait for a profit, the more you can afford to invest in getting new customers.

The essential calculation is how much a customer is worth over the lifetime of your relationship with that customer. That’s what we call lifetime value.

Invest up to 40% of calculated lifetime value to acquire a new customer. Expect to show a profit in two to three years.

However, if you are not a big fat firm, or if you don’t have enough historical data to calculate what a lifetime value is, you should aim to try and break even on your first sale – you don’t make any money, but you don’t lose any money either.

61. How do I work out what I should spend to get a sale?

How to analyse individual sales or responses.

Direct marketers refer to ‘cost per thousand’ – how much does it cost you to mail a thousand people, or reach a thousand readers of a publication?

They analyse results by working out how many orders they get per thousand inserts, mailings or door drops, which they usually express in percentages.

They think in terms of allowable cost per order. How much can we afford to spend? This is reached by building a profit and loss account for an average sale (or response).

62. How do I calculate a break-even?

Break-even is the point at which you don’t make any money and you don’t lose any money. It is very important, obviously, to work out what you can afford to spend.

First of all write down your selling price, take away the cost of the goods plus the cost of sending them out plus any additional costs like bad debts, people who don’t pay or returns – people who have asked for their money back.

If your product is a successful one you are unlikely to get more than 3% returns. If you do, then conduct some research to find out why. By doing this calculation you can see how much money you can afford for promotions and profit – if you are aiming to make a profit. Very often you may simply be aiming to reach breakeven to acquire new customers, or even to lose money.

Once you have done this calculation you can begin to work out what sort of percentage response you need to get from a mailing or how many replies you need from an advertisement. Clearly the percentage response will depend upon the cost of your advertisement or mailing.

You should also remember that there are other factors to take into account apart from the simple ones I have given above. Thus you will undoubtedly have overheads of one kind or another; these should be allowed for.

63. How do I work out my allowable cost per order?

The breakeven we have explained in the previous answer. The allowable is how much you have determined you can afford to spend. It will depend upon whether you want to make money or not. But the calculation is essentially the same as in the previous question.

64. What is the financial effect of offering an incentive?

Victor Ross, former chairman of Reader’s Digest Europe said that in his experience relevant incentives have never failed.

The cost of the incentive is more than made up as a result of the increased number of units sold – which in itself may lead to economies of manufacturing scale.

In one example the combined result of a sweepstake and a price reduction increased sales by 37.5%, with revenue increasing almost pro-rata.

65. How soon should I aim to make a profit?

Budgeting depends to a large extent on how much capital you have. The longer you can afford to wait for a profit, the more you can afford to invest in getting new customers.

The essential calculation is how much a customer is worth over the lifetime of your relationship with that customer. That’s what we call lifetime value.

Big marketers use lifetime value to plan budgets. To calculate projected value, use historical performance data, or the likely results from future marketing.

Invest up to 40% of calculated lifetime value to acquire a new customer. Expect to show a profit in two to three years.

However, if you are not a big fat firm, or if you don’t have enough historical data to calculate what a lifetime value is, you should aim to try and break even on your first sale – you don’t make any money, but you don’t lose any money either.

66. What is customer lifetime value? How do I work it out?

You need to know how much you can afford to pay to get a customer.

The only reasonably foolproof way of doing this is to analyse past transactions with customers. Since in many cases, if not most cases, customers will stay with you for an average of 5, 6 or 7 years this requires a fair amount of historical data.

Moreover, different types of customers have different values.

The important thing though is to understand that you are dealing with the value of a customer not the value of a sale or a one-off profit when looking at your revenues.

67. How much profit should I aim to make?

This is entirely a matter for your judgment, which may be conditioned by the requirements of shareholders, partners or investors.

However, you certainly have to make enough money to keep reinvesting in your business, and in continually testing new approaches, product ideas, etc.

You are very wise to think first whether you have sufficient margin. For products costing under £20 you need a great deal; the cost should preferably be no more than 1/4 of the selling price, preferably less.

For more expensive products or services, the margins can be less – but do not imagine direct marketing is possible on very narrow margins. It rarely is.

68. How much better will mailing to customers do versus a cold list?

Unless your customers are unhappy – which implies you are not likely to be in business very long – they will always be infinitely more profitable than people who are not customers.

Moreover, when you are mailing your own customers you do not have the same costs – list rental for instance – so even if the response rate were the same you would do better.

In fact it would be surprising if a customer list did not do three times better than a list of similar non-customers. In recent examples we have seen a difference of 300-350% when mailing customers as opposed to competitors’ customers.