October 19, 2010

Incremental Sales Week: Free Shipping

Let's say that you have a business that generates $2,000,000 of sales in a normal month.

This month, you want to "drive sales", you want to increase business. So you offer customers a promotion ... free shipping if the customer enters promo code "FREESHIP" during his/her order.

At the end of the month, you have the following facts:
  • You did not execute a test to identify the incremental sales generated by free shipping.
  • Total monthly sales were $2,250,000.
  • 70% of sales were attached to a "FREESHIP" promo code.
  • 12,600 orders had a "FREESHIP" promo code.
  • 40% of sales convert to profit.
  • Each order that had a "FREESHIP" promo code lost $10 of shipping and handling revenue.
Ok, armed with this information, we can estimate profitability. First, we have to identify incremental sales, sales that would have been generated above-and-beyond normal circumstances. In our case, that amount is $2,250,000 - $2,000,000 = $250,000. Even though 70% of sales were attached to a "FREESHIP" promo code, sales only increased by $250,000, so that is the amount of incremental sales we perceive to be generated by the promotion.

Next, 40% of the $250,000 converts to profit, so $250,000 * 0.40 = $100,000 of contribution.

Third, there were 12,600 orders that received free shipping, those orders lost an average of $10.00 shipping/handling revenue, for a marketing cost of $126,000.

Finally, profit is calculated as $100,000 - $126,000 = a loss of $26,000.

Too often, we attribute all 12,600 orders to the sales line, causing us to believe that the promotion was profitable.

Instead, we have to have some marketing discipline. We can only take credit for the incremental sales we generated. We must take credit for all expenses caused by the promotion.

The result is a loss. Our marketing activities caused us to lose money, the exact opposite outcome desired by a marketing activity.

1 comment:

  1. Anonymous2:24 AM

    "We can only take credit for the incremental sales we generated. We must take credit for all expenses caused by the promotion."

    That's a statement to print and hang on every wall in the office.

    ReplyDelete