April 26, 2007

Online Cannibalization

At the end of the golden era of catalog marketing (circa 1994), measuring cannibalization was straightforward, easy, and enjoyable. Your analyst would execute a test among catalogs. One group of customers would receive three catalogs, while the other group of customers would receive two catalogs. At the end of an appropriate period of time, the results would be measured. The table below illustrates a sample test:

Incremental Value Of A Catalog Mailing






Catalog 1 Catalog 2 Catalog 3 Totals
Group 1 $6.00 $6.00 $6.00 $18.00
Group 2 $7.00 $0.00 $7.00 $14.00
Increment ($1.00) $6.00 ($1.00) $4.00





Incremental %:
4.00 / 6.00 = 66.7%

The analyst illustrated that the additional catalog drove $6.00 of sales per customer. But in reality, two dollars were cannibalized from surrounding catalogs, yielding just $4.00 of true incremental value. The additional catalog was 66.7% "incremental". A profit and loss statement would be run on 66.7% of the "demand" that financial systems indicated the catalog generated.

Fast forward to 2007. You run an online business, with two merchandise divisions. You add a third merchandise division, adding new skus that did not previously exist.

In the month prior to the launch, you observe the following metrics:
  • Visitors = 1,000,000.
  • Conversion Rate = 4.00%.
  • Average Order Size = $100.
  • Total Demand = 1,000,000 * 0.04 * 100 = $4,000,000.
  • Merchandise Division #1 = $2,000,000.
  • Merchandise Division #2 = $2,000,000.
In the month following the product launch, you observe the following metrics:
  • Visitors = 1,050,000.
  • Conversion Rate = 4.20%.
  • Average Order Size = $105.
  • Total Demand = 1,050,000 * 0.042 * 105 = $4,630,500.
  • Merchandise Division #1 = $2,200,000.
  • Merchandise Division #2 = $1,900,000.
  • Merchandise Division #3 (New Merch) = $530,500.
The challenge in the online environment occurs when evaluating the $530,500 of demand attributed to the third merchandise division. What would have happened to merchandise divisions one and two, had the new merchandise not been offered?

On the surface, it appears that the new merchandise division helped increase visitors, conversion rate, and average order size.

What information/metrics would you like to see, to complement this analysis? If you had a meeting with your CEO, and your CEO wanted to know what the true contribution of the third merchandise division is to company demand, what would you tell her?