Death Spiral: Channel Shift

There are two situations where channel shift leads to big problems.

1. Customers shift from an old technology (newspapers) to an newer technology (online), and in the process, trade customer dollars spent on old technology for dimes spent in the newer technology.
2. Rate of Adoption.  When customers, after controlling for age, are slow to shift to new technology (say mobile), pay close attention to customer counts.  When this happens, it can become ever more difficult to acquire customers.  As new channels emerge, customers tend to shift behavior, adopting the new channel over the old channel, making it harder and harder to acquire customers via the old channel.

Set up your dashboards to understand this phenomenon.

Death Spiral: New Customers vs. Loyalty

Here's an easy one.  Businesses locked in a Death Spiral are, for a myriad of reasons, unable to acquire enough newbies to offset the customers being lost.

• Example:  100,000 twelve-month buyers, 45% repurchase = 45,000 customers ... 25,000 reactivated customers ... 15,000 new buyers ... total buyer file next year = 85,000 customers.

This isn't a challenging query to run.  Just run it, monthly!!

Management is going to have a natural reaction ... they're going to suggest that if customers were just more "loyal" or more "engaged", you wouldn't have a problem.  Unfortunately, that's not true.  Repurchase Rates vary by +/- 10%, on average ... so if you did everything right on repurchase rate, you'd have the following situation.

• Example:  100,000 twelve-month buyers, 50% repurchase rate = 50,000 customers ... 25,000 reactivated customers ... 15,000 new buyers ... total buyer file next year = 90,000 customers.

In other words, new customers are a bigger indicator of a business in a Death Spiral than changes in customer loyalty is.

Run this query on a monthly basis, and communicate your findings to Management.  If you are in Management, demand that somebody run this query for you, you need to understand this relationship!

Death Spiral: Customer Age

Pay really close attention to the average age of your customer.

I mean this!

By and large, most businesses have a customer base that ages as time passes, it's just the way life works.  In other words, if you had a 45 year old customer in 2001, you probably have a 48 year old customer in 2011.

Businesses locked in a Death Spiral often have a rapidly aging customer base.  The 45 year old customer in 2001 becomes a 53 year old customer in 2011, and will become a 61 year old customer in 2021.

This is a simple metric that everybody can track, with a simple demographic overlay.  Spend a few pennies, and see if your customer base is aging at a disproportionate rate.  If it is, you know you may have a business that has future potential to be locked into a Death Spiral.

Death Spiral: Expenses

Pay close attention to the signals you receive from Management.

You're blessed when your Management team wants you to grow the business, and gives you marketing dollars to do just that.

It's a bit more stressful when somebody asks you to start minimizing expenses.

Businesses in a Death Spiral are constantly focusing on expense reduction.

If you can get your hands on a profit and loss statement, take a look at several expense lines, especially over the past three to four years.

• Marketing Dollars as a percentage of Net Sales.  If sales are decreasing while expenses are increasing, then Management is trying to spend their way out of a Death Spiral.
• Pick/Pack/Ship and Contact Center Expense as a percentage of Net Sales.  If sales are decreasing, and this expense line is the same percentage of Net Sales, then Management is actively trying to fly the plane out of a Death Spiral.  If sales are in decline, and this expense line is increasing as a percentage of Net Sales, you might want to question the Management Team about what they are thinking!
• Promotional Dollars as a percentage of Net Sales.  If this number is rocketing skyward, then your Management Team is trying to use promotions to fly the plane out of a Death Spiral.
• Gross Margin Percentage:  When this line is decreasing (was 62%, then 59%, then 54%, then 52% by year), it tells you that the business is spiraling out of control, that Management is actively trying to lower prices to move merchandise.
• Liquidations/Clearance:  You only sell a lot on clearance when your inventory team buys too much, or the customer buys too little merchandise.  Pay close attention to the this.

Carefully analyze your profit and loss statement, and look for these tell-tale signs of a Death Spiral.

Death Spiral: Product Death

Pay close attention to how fast merchandise "dies".

Now, in some businesses (i.e. Fashion), merchandise turns over quickly, that's the nature of the beast.

In many other businesses, a product should "live" for a reasonable amount of time, two or three or four years, and should generate a significant amount of sales as well.

This is an example of a business with a quick "product death".  Here, we look at 1,000 new products.

Merchandise Productivity Forecast
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
New F	0	200	0	0	0	0
New D	0	200	0	0	0	0
New C	0	200	0	0	0	0
New B	0	200	0	0	0	0
New A	0	200	0	0	0	0
LY F	0	0	200	0	0	0
LY D	0	0	200	0	0	0
LY C	0	0	200	0	0	0
LY B	0	0	200	0	0	0
LY A	0	0	200	0	0	0
Existing F	0	0	0	236	110	28
Existing D	0	0	0	208	21	4
Existing C	0	0	0	212	29	6
Existing B	0	0	0	158	36	9
Existing A	0	0	0	23	19	12
Items	0	1,000	1,000	837	215	60
Demand	$0	$18,458,695	$6,675,725	$3,634,327	$2,237,493	$1,289,102
$/Item		$18,459	$6,676	$4,341	$10,400	$21,610
Item Chg.			0.0%	-16.3%	-74.3%	-72.3%
Demand Chg.			-63.8%	-45.6%	-38.4%	-42.4%
$/Item Chg.			-63.8%	-35.0%	139.6%	107.8%

This is a problem.  New items generate the majority of sales in year one, then rapidly decline over the next four years, to the point where barely any sales are left by year five.


In cases where a business is in a Death Spiral, products have an unusually rapid rate of decay, with few items generating high sales volumes.  Each business needs a healthy number of items generating large sales volumes.  Think about The Sharper Image several years ago, they had that ionizer problem, and because that item carried a disproportionate level of total net sales, the business was in big trouble.


When you introduce a thousand items, you need a reasonable number of items to achieve success within 1-2 years.  If this doesn't happen, then existing products are required to carry a disproportionate load, and that is a recipe for a true Death Spiral.

Death Spiral: New Products

If you read Twitter or Trade Journals or Leading Bloggers, you read a lot of content about how to engage customers, how to use technology to grow sales (mobile, social, ecommerce), you know, all of the stuff that you've all tried over the past fifteen years.  Hopefully, sales increased at a rate faster than inflation.

Now, this may come as a surprise to some of you.  I hope you are sitting, because I am about to share something interesting with you.


When a customer buys from your business, what is the customer buying?

• Answer:  Merchandise (for some, Services)!

That's right, the customer is buying merchandise.

So wouldn't it make sense if we take a little of the time we spend analyzing customers, and reallocate it, focusing instead on merchandise?

It turns out that new products are critically, critically important to most of our businesses.

Businesses in a Death Spiral sometimes fail to invest in new products.

So, if you suspect that your business is not investing in new products, run a little five year simulation, analyzing how products evolve and change over time.  Here's an example:

Merchandise Productivity Forecast
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
New F	261	261	261	261	261	261
New D	810	810	810	810	810	810
New C	1,371	1,371	1,371	1,371	1,371	1,371
New B	1,248	1,248	1,248	1,248	1,248	1,248
New A	174	174	174	174	174	174
LY F	795	261	261	261	261	261
LY D	873	810	810	810	810	810
LY C	1,161	1,371	1,371	1,371	1,371	1,371
LY B	1,257	1,248	1,248	1,248	1,248	1,248
LY A	168	174	174	174	174	174
Existing F	999	1,626	1,697	1,626	1,604	1,596
Existing D	555	939	851	836	833	832
Existing C	789	936	730	705	700	698
Existing B	909	819	690	660	653	650
Existing A	354	312	282	262	250	243
Items	11,724	12,360	11,979	11,818	11,767	11,746
Demand	$107,436,827	$99,760,685	$95,912,962	$93,673,513	$92,400,613	$91,694,053
$/Item	$9,164	$8,071	$8,007	$7,926	$7,853	$7,806
Item Chg.		5.4%	-3.1%	-1.3%	-0.4%	-0.2%
Demand Chg.		-7.1%	-3.9%	-2.3%	-1.4%	-0.8%
$/Item Chg.		-11.9%	-0.8%	-1.0%	-0.9%	-0.6%

I like to look at brand new products, products introduced last year, and products introduced prior to last year.  Then I grade each product ... A/B/C/D/F ... just like when you were in school, based on sales levels (high sales per item to low sales per item).


Many companies have a challenging sales hurdle for new items to overcome ... the new item has to achieve a certain level of sales, or it will be discontinued.  As a result, if a company develops 100 new items per year, only a handful will achieve high sales potential.


Now, if you kill new product development, then you're stuck in a situation where you'll kill the number of successful products in future years.


In the above example, sales are forecast to decrease, all things being equal, because there aren't enough new products in the product pipeline.


Here's a scenario where new product development is increased by 20%.

Merchandise Productivity Forecast
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
New F	261	313	313	313	313	313
New D	810	972	972	972	972	972
New C	1,371	1,645	1,645	1,645	1,645	1,645
New B	1,248	1,498	1,498	1,498	1,498	1,498
New A	174	209	209	209	209	209
LY F	795	261	313	313	313	313
LY D	873	810	972	972	972	972
LY C	1,161	1,371	1,645	1,645	1,645	1,645
LY B	1,257	1,248	1,498	1,498	1,498	1,498
LY A	168	174	209	209	209	209
Existing F	999	1,626	1,697	1,843	1,894	1,904
Existing D	555	939	851	985	995	996
Existing C	789	936	730	821	833	835
Existing B	909	819	690	758	773	776
Existing A	354	312	282	277	278	279
Items	11,724	13,133	13,524	13,958	14,046	14,064
Demand	$107,436,827	$108,098,217	$108,277,042	$108,442,216	$108,657,216	$108,805,629
$/Item	$9,164	$8,231	$8,006	$7,769	$7,736	$7,737
Item Chg.		12.0%	3.0%	3.2%	0.6%	0.1%
Demand Chg.		0.6%	0.2%	0.2%	0.2%	0.1%
$/Item Chg.		-10.2%	-2.7%	-3.0%	-0.4%	0.0%

Interesting, isn't it?


If this company increases new product development by 20%, then the business is able to stabilize at about $108 million per year.  This business has to add 700 new products per year, every year, for the next five years, in order to stabilize.


Also notice that in year five, there are 279 outstanding existing items in the new scenario, vs. 243 outstanding existing items in the current forecast.  In other words, we add 700 new items per year, every year, and after five years, only 36 items qualify for elite status.


Merchandise success is a lot like the NFL, where you draft seven players and you sign twenty free agents, and you end up with one Pro Bowl player among the twenty-seven candidates.


Businesses stuck in a Death Spiral frequently fail to invest in new products, causing long-term health problems that take even longer to overcome.

Death Spiral: Core Business

When the core portion of a business is faltering, Management frequently tries to prop-up the business by extending into new product lines, and new channels.

Here's what a health situation looks like (sales in millions):

	Bus 1	Bus 2	Bus 3	Bus 4	Total	% Chg.
2011	$34.1	$13.1	$5.4	$1.6	$54.2	7.1%
2010	$33.4	$11.5	$4.6	$1.1	$50.6	6.5%
2009	$32.3	$11.1	$3.3	$0.8	$47.5	9.4%
2008	$30.7	$10.8	$1.9		$43.4	8.8%
2007	$29.3	$10.6			$39.9

In this case, the core business unit (business one) continues to grow, in spite of growth in other business units.  The healthiest businesses are able to pull this one off.

Most businesses, however, are not able to pull this off.  In response to stagnating sales in the largest business units, additional channels/businesses are added, and the results look something like this:

	Bus 1	Bus 2	Bus 3	Bus 4	Total	% Chg.
2011	$27.0	$8.8	$5.4	$1.6	$42.8	0.9%
2010	$27.8	$8.9	$4.6	$1.1	$42.4	1.7%
2009	$28.5	$9.1	$3.3	$0.8	$41.7	3.5%
2008	$28.7	$9.7	$1.9		$40.3	1.0%
2007	$29.3	$10.6			$39.9

This is classic ... decreases in the primary business units being offset by increases in new business units.  In total, the business is barely growing, and when you run a p&l on something like this, you're not going to be thrilled with the outcome.  This outcome can be correlated with a business that is entering the death spiral.


Now, if you have a product line that is in decline, and you are able to grow new product lines while the old product line dies (iPad vs. the classic iPod), then you have this situation, one that isn't bad:

	Bus 1	Bus 2	Bus 3	Bus 4	Total	% Chg.
2011	$9.7	$13.1	$20.7	$1.6	$45.1	5.4%
2010	$16.4	$11.5	$13.8	$1.1	$42.8	8.6%
2009	$21.2	$11.1	$6.3	$0.8	$39.4	3.7%
2008	$25.3	$10.8	$1.9		$38.0	-4.8%
2007	$29.3	$10.6			$39.9

This business responded to a challenge in 2007, and is now growing in total in 2010 - 2011.  The existing product line (business one) is in sharp decline, and is being replaced by sales in business three.


The middle scenario is the one we pay close attention to, when evaluating whether a business is in a death spiral.  Individual products or business lines are frequently in a death spiral, requiring new business lines to grow the total pie.