July 16, 2023

Channel Inflation

I talk about Merchandise Productivity all the time, and for good reason. You have no choice but to improve Merchandise Productivity to offset rising costs across the rest of your business.

Here's a p&l comparing normal conditions to one where Paid Search costs increase by 3% per year ... 3% next year, 6% the year after ... 15% after five years. If your goal is to keep conversions identical, your p&l suffers.

Over five years this brand gives up $4.3 million in profit to Google. Google will say they did nothing ... it's "competitive forces" that drove up the cost of the keywords. Google did cash the checks, by the way.

At some point, your CFO gets angry and asks you to "right size" your Paid Search program. She doesn't want Google making money. "Right Sizing" the program means you will experience a sales decline.

But a funny thing happens along the way.

To right-size year one, we have to cut spend by 9%.

In year two, it is -22%. In year three it is -46%. In year four it is -65% and in year five it is -65%.

But you cannot get the profit back ... eventually you lose enough customers and those customers are never there to generate the long-term profit you need to offset channel inflation. Eventually you are forced to spend much less, you make less profit, and your top-line eventually drops by 20%.

All because of a little bit of channel inflation.

Yeah, you'd want Marketing Budget Experiments at your disposal to understand these dynamics, right? Click here for pricing.

P.S.:  At the beginning of the article, I mentioned Merchandise Productivity. Merchandise Productivity covers up a bunch of vendor cost sins. The more things cost, the more you need merchandise productivity to offset increased costs.

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