January 06, 2013

Dear Catalog CEOs: Full Price

Dear Catalog CEOs:

I just ran a query for one of your peers ... well, not a query, but a model.  I'll simplify the model for you, so that we can all understand the message behind the model.

I analyzed first-time buyers in the past twelve months, modeling the amount of future demand these customers will generate.  There were only two dependent variables.

  • Dependent Variable = Demand Spent Next Year (2012).
  • Independent Variable = Demand Spent Last Year (2011).
  • Independent Variable = 1/0 Indicator ... Did Last Year's Purchase Include A Discount/Promotion Code ... 1 = Yes, 0 = No.
Here's the outcome of the model (again, this is over-simplified to make a point):
  • Future Demand = $28 + $0.220 * (Demand Spent Last Year) + $8.00 * (Did Customer Purchase Include A Discount / Promotion Code).
This company mails about 12 catalogs a year to this audience.  This company converts 45% of demand to profit.  This company produces catalogs that cost $0.50 each.  This company spends an average of $2 per customer on online marketing.  

This company utilizes 20% off promotions. 
  • 10% of future demand among customers not historically using a discount/promo code are discount focused.
  • 20% of future demand among customers who historically used a discount/promo code are discount focused.
We now have enough information to determine the future impact of discounts/promotions on this audience.  Let's assume that each customer spent $150 last year.
  • Full Price Customer Future Demand = $28 + 0.220*150 = $61.00.
  • Discount Customer Future Demand = $28 + 0.220*150 + $8 = $69.00.
So far, the discount customer is "worth more", in terms of demand ... 13% more.
  • Full Price Customer Profit = $61.00*0.45 - $61.00*0.10*0.20 - 12*$0.50 - $2.50 = $17.73.
  • Discount Customer Profit = $69.00*0.45 - $69.00*0.25*0.20 - 12*$0.50 - $2.50 = $19.10.
Oh oh.

On the surface, with all of your KPI-infused dashboards, you're increasing customer value by 13%.  Google Analytics tells you how successful you appear.  Great!  Except you're not successful.  You cut future profitability by 7%.

By the way .... this is a common outcome.  In fact, the outcome often looks worse than this.

Of course, you have to do the math to know this.

And almost nobody does the math.

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