March 16, 2008

Profit Week: Three Customer Segments

This week, the topic is profit.

Enough talk about the economy being lousy (ask the folks at Urban Outfitters if they think the economy is lousy! Heck, check out the Urban Outfitters blog if you want to see innovation from a retailer).

Enough talk about postage increases. It happened a year ago, it was damaging. Time to move on.

Enough talk about third parties and their contempt for various forms of direct marketing.

The only way to stay in business is to generate profit. Lots of profit.

Direct Marketers are transitioning to a new reality, one that views the customer in three different, unique ways:
  1. Customers who do not purchase unless they are advertised to.
  2. Customers who are advertised to, then research product, then purchase product.
  3. Customers who are self-sufficient, purchasing without the need for advertising.
Guess which customer segment is most profitable?

Guess which segment of customers we focus our efforts on?

We do everything in our power to identify customers who require advertising, then invest all of our energy in deciding how to advertise as efficiently as possible to this audience.

We spend almost no energy thinking how to move customers along the direct marketing customer continuum. We need to figure out how to facilitate the process whereby customers simply love us, trust us, and support us.

Here is a typical profit and loss statement for a segment that is dependent upon advertising.

Demand
$100,000
Net Sales 80.0% $80,000
Gross Margin 55.0% $44,000
Less Adv. Expense
$16,000
Less Pick/Pack/Ship 11.5% $9,200
Variable Op. Profit
$18,800
% of Net Sales
23.5%

Now let's take a look at the same segment of customers, a segment not dependent upon advertising.

Demand
$100,000
Net Sales 80.0% $80,000
Gross Margin 55.0% $44,000
Less Adv. Expense
$0
Less Pick/Pack/Ship 11.5% $9,200
Variable Op. Profit
$34,800
% of Net Sales
43.5%

Now the critic will use the traditional phrase "yabut" to express the fact that historically, a direct marketer had to market to the customer to get the customer to purchase something.

The world is different today. Your e-commerce site is more like a retail store than a traditional direct marketing piece. Think of your own behavior. You don't need a lot of direct marketing to shop at Home Depot. You need something to kill weeds in your lawn, you go to the Home Depot. Websites serve a similar function. You need shoes, you go to Zappos.com. Sure, Zappos uses online advertising. But they get a ton of volume from word of mouth, a ton of volume just because "they are Zappos".

In the chart at the top of this post, Zappos has a customer base that is split between the middle box, and the box at the far right.

Most catalogers cultivate a customer base that requires advertising in order to purchase something. Catalogers spent the past decade proving (via matchbacks) that customers needed advertising. Via this self-fulfilling prophesy, catalogers are now at a significant disadvantage, because all of the costs associated with advertising are increasing. Simultaneously, customers are moving from the left to the right side of the direct marketing customer continuum slide.

In the short term, direct marketers need to cope with recessionary issues and expense inflation.

In the long term, direct marketers must migrate their customer base from an "advertising-needs" customer to a "self-serving customer", one that doesn't require advertising. This is where a boatload of profit exists --- profit that can be pocketed, or reinvested in free next-day shipping or other customer-friendly strategies.

For those of you about to say "yabut", this can be done. Pay attention to Zappos, Blue Nile, Amazon. Use Multichannel Forensics to see if your current customer is willing to make this transition with you.

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