August 29, 2016

Healthy Business: Ad-To-Sales Ratio

It's 2002. I'm sitting in the CMO's office (my boss) at Nordstrom. We're setting budgets for 2003. I look at the profit-and-loss statement, and two rows stick out to me.

  • Net Sales = $8,000,000,000 (yup, that's eight billion).
  • Marketing Expense = $144,000,000.
I pull out my calculator (yes, I had a giant calculator back in 2002 ... the CFO of the online channel called it the 'Green Monster') ... and I performed a bit of math.
  • Ad-To-Sales Ratio = $144,000,000 / $8,000,000,000 = 1.8%.
I looked at my boss, the Chief Marketing Officer. I asked a simple question.
  • "Is that right? Our ad-to-sales ratio is 1.8%?"
She gives me this dumbfounded look, and says something along these lines.
  • "I'm sure we could find ways to cut the fat out and lower it, if that's what you are asking."
That wasn't what I was asking.

Key competitor Macy's has an ad-to-sales ratio of around 6%. Their business is less healthy.

Many e-commerce brands have ad-to-sales ratios between 5% and 15%. They spend a lot of money on Search and Facebook. Many e-commerce brands "hack" their way to sales not by spending ad dollars but by optimizing the online experience coupled with word-of-mouth from social/mobile endeavors.

The best catalog brands have ad-to-sales ratios between 10% and 20%. Lands' End, currently struggling, has an ad-to-sales ratio of around 14%.

The worst catalog brands have ad-to-sales ratios between 25% and 40%. Yes, I said 40%. I see it happen all the time. You cannot tell a cataloger with a 40% ad-to-sales ratio to mail fewer catalogs ... the reason the ratio is 40% is because the staff LOVE to mail catalogs ... they get more satisfaction from putting a catalog together than they get from generating profit.

Ad-To-Sales Ratios are dependent upon Gross Margin percentages. If Gross Margins are north of 60%, you can absorb an Ad-To-Sales Ratio around 30%. If you are Best Buy, no such luck ... your Gross Margins might be +/- 25%. An Ad-To-Sales Ratio of 30% would bankrupt Best Buy. So your Ad-To-Sales Ratio must be sufficiently lower than your Gross Margin percentage.

Having said all of that, the most profitable brands I work, after accounting for business model and gross margin structure, have Ad-To-Sales Ratios that are low. Customers love the merchandise these brands sell, and consequently, they do not need to be advertised to in order to buy something.

In fact, the following sentence could be repeated after every blog post I write.
  • The most successful brands I work with earn customers who love the merchandise sold by the brand, and as a result, these brands do not need to advertise to generate sales."