December 05, 2007

Controlled vs. Uncontrolled Advertising Expense

"Back in the day", understanding customer profitability was easy, straightforward.

If you were a cataloger, you segmented customers on January 1. You summed what that segment purchased, you summed how much you spent marketing to that customer, and you calculated profit.

All of your catalog expenditures were "controlled". You decided if you mailed the customer or not. Only in instances of catalog requests did the customer participate in the cost structure of your marketing program.

Times sure have changed.

Here are two segments of customers, one a pure "catalog" segment, one a "multichannel", i.e. catalog+online segment. What looks different, when you analyze these two segments?

Catalog Multichannel
Demand $70.00 $77.00
Profit Factor 35.0% 35.0%
Profit Pre-Marketing $24.50 $26.95
Catalog Expense $15.00 $10.00
E-Mail Expense $0.10 $0.10
Search/PPC/Affiliate Expense $0.20 $9.00
Variable Profit $9.20 $7.85

Here's one of those situations where "multichannel customers are the best customers, they just aren't the most profitable customers".

Uncontrolled advertising expense causes this situation.

Customers who shop the online channel use paid search, shopping comparison sites and affiliates (along with catalogs and other online marketing channels) to facilitate their shopping experience.

As we know, paid search, shopping comparison sites, and affiliates aren't free.

While the marketer controls the ad budget across these activities, the marketer seldom controls "who" uses these marketing channels.

Therefore, "best" customers, those who used to be highly profitable, can become "less profitable", when the customer uses marketing channels that add incremental expense.

An important first step is to understand this phenomenon across your customer base.
  1. Sum annual demand, by segment. Segments are created on January 1, and customers stay in this segment for the entire year.
  2. Sum "controlled marketing expenses" by segment in your database on an annual basis.
  3. Sum "uncontrolled marketing expenses", those expenses driven by the customer, by segment in your database on an annual basis.
  4. Calculate profit by segment on an annual basis.
  5. If uncontrolled marketing expenses drive customer segment profitability down, test a different allocation of controlled marketing expenses.

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