20 Teams Competed For The Coveted Prize!!

At last week's VT/NH event, two-hundred participants divided into twenty teams battled through a five-year business simulation!

Why put people through this?

A quick story. When I worked at Lands' End, we had answers to questions. When I worked at Eddie Bauer - not many answers until 1999 - poor data. That didn't stop us from making decisions. As long as we made decisions we pushed the peanut forward.

Well, in our modern world, we have more data than ever - but I keep hearing that people don't know what to do - or I keep hearing that the "right" metrics aren't available.

Nonsense.

You are smart.

You know your business.

Maybe you just need permission to make decisions (and be allowed to make mistakes).

The point of the simulation was to demonstrate that smart business people don't need perfect metrics to make good decisions that result in positive outcomes. And in our simulation, the participants proved me right!!

Each team (approximately 10 professionals) chose a "CEO" to communicate the business plan each year. Each team had five minutes (which wasn't enough time ... and was not enough time by design) to review annual results and then develop a new business plan for the next year.

The teams could change a handful of tactics.

• Each team started with $200,000 cash. The could spend it all on advertising (offline and/or online), or they could choose to not spend the money.
• Each team had to allocate 10 staffers across offline marketing, online marketing, and mobile/social marketing.
• Price of Widgets, Price of Bidgets, Price of Tidgets. Widgets had a $30 cost of goods. Bidgets had a $20 cost of goods. Tidgets had a $10 cost of goods.
• Promotional Strategy: Teams could select the percentage off promotional level they wished to employ.
• Paid Shipping, Free Shipping with Hurdle, Free Shipping 24/7/365. Each team had to select their shipping strategy.

Each team selected a "one word" team name.

The teams developed strategies.

I furiously keyed-in twenty business plans within five minutes, sweat beading upon my balding head. If I was stressed ... then imagine how stressed each team was?

The winning team would maximize "company valuation" ... 0.25*Net Sales + 2*Earnings Before Taxes in year five. In other words, you could fail for four consecutive years and then win the whole thing in year five.

The results were in ... here are the results for each of the twenty teams following year one of the simulation.

Yeah, sure, click on the image, blow it up and study the strategies employed by each team.

"Widgwon" took the early lead, leveraging a strategy where marketing dollars skewed online, staff skewed offline, prices were average (compared to other participants) with the exception of Tidgets (which were cheaper than average) ... coupled with no promotions and free shipping with a hurdle.

"Dozen" brought up the rear ... after taking 50% off as an initial business strategy.

Ok, here's what I want you to pay attention to ... pay attention in subsequent runs how the "average" metrics iterate toward an overall optimal solution. With no metrics to demonstrate how advertising / staffing / pricing / % off / shipping impact company valuation, the teams were able to improve business performance. This is the point of the simulation ... you don't need great metrics ... you need great people making great decisions!!

Tomorrow, we'll study the adjustments that teams made!

And yes ... you go right ahead and name me a single popular industry conference where you get to spend two hours competing against other attendees in a business simulation ... I'll sit right here and wait while you name one ...

Year 1 Valuation

• Widgwon = $740,000.
• Loopy = $706,000.
• Pickaxe = $660,000.
• Name = $645,000.
• WBT = $631,000.

File Power and Ad Cost

Here's a fun one from the world of Retail.

I worked with a company that loved trying to convert online buyers to in-store buyers. Retail catalog after retail catalog after retail catalog - until that customer bought in a store. Then what? Way more retail catalogs!

Here was the scenario they created.

3x Online-Only Buyer.

• Rebuy Rate = 50%.
• Spend per Repurchaser = $280.
• Gross Margin = 50%.
• Operational Expense = 10%.
• Next Year's Ad Cost = $12.
• Next Year's Profit (File Power) = 0.50 * 280 * (0.50 - 0.10) - 12 = $44.00.

2x Online Buyer, 1x Retail Buyer.

• Rebuy Rate = 53%.
• Spend per Repurchaser = $285.
• Gross Margin = 50%.
• Operational Expense = 10%.
• Next Year's Ad Cost = $18.
• Next Year's Profit (File Power) = 0.53 * 285 * (0.50 - 0.10) - 18 = $42.42.

Among the customers who converted to stores, spending increased (0.53*285 vs. 0.50*280 = +8%). That's the kind of number that the omnichannel experts love to hear!

But profitability declined by 4%. The Power of the Crossover File (#multichannel #omnichannel) was/is worse.

I know, I know, folks should #optimize ad spend for this customer ... well good. But how do you know you should optimize ad spend for this customer unless you compute File Power?

File Power and Extra Customers

In my projects, it is common to witness a company that becomes addicted to discounts/promotions. Vendors love this strategy, because it means that marketing technology is needed to "target" the discounts and "measure" the results.

Customers like discounts, too.

Your CFO does not like discounts.

We're all told that you use discounts/promos to improve customer quality. And when you measure metrics not called "profitability", you often find that you do improve customer quality.

File Power, however, deals with the future profitability of your customer file. When you train customers to purchase via discounts/promotions, you hurt future profitability.

See the graph above?

In one project that was the relationship between last year's gross margin percentage (after subtracting discounts/promos) and next year's gross margin percentage. What do you observe?

Yup - next year's gross margin percentage is worse when this year's gross margin percentage is bad.

So here's the challenge you face. Let's say that you could have gotten 10 customers to purchase at full price - but instead, you get 12 customers to purchase at 30% off.

Next year, we model File Power.

• 10 Full Price Customers.
• Probability of Buying Next Year = 40%.
• Amount Spent Next Year = $200.
• Next Year's Predicted Gross Margin = 60%.
• Next Year's Pick/Pack/Ship Expense = 10%.
• Next Year's Predicted Ad Cost = $15.
• Next Year's Predicted Profit = 0.40 * 200 * (0.60 - 0.10) - 15 = $25.00.
• Total File Power = 10 Customers * $25.00 Profit = $250.00.

Here's what File Power looks like for 12 customers purchasing at 30% off.

• 12 30% off Customers.
• Probability of Buying Next Year = 42%.
• Amount Spent Next Year = $205.
• Next Year's Predicted Gross Margin = 50%.
• Next Year's Pick/Pack/Ship Expense = 10%.
• Next Year's Predicted Ad Cost = $15.
• Next Year's Predicted Profit = 0.42 * 205 * (0.50 - 0.10) - 15 = $19.44.
• Total File Power = 12 Customers * $19.44 Profit = $233.28.

Do you see what happened?

• You increased buyers by 20% (from 10 to 12).
• You decreased future profit from $25.00 per customer to $19.44 (-22%).
• You decreased File Power from $250.00 to $233.28 (-7%).

You measure File Power, right?

In other words, you know whether your discounts/promotions increase the power of your customer file, or decrease the power of your customer file. Right?

In this case, the promotion needs to increase the number of buyers by about 30% to cover the loss in File Power caused by the promotion.

Please evaluate your marketing efforts via File Power.

File Power and Gross Margin

When we apply marketing discounts and promotions to gross margin dollars, we learn a lot about how we are managing our businesses, right?

Say business is not great. So instead of selling at full price, we sell at 30% off.

At Full Price:

• Average Order = $100.
• Cost of Goods Sold = 40%.
• Amount Customer Actually Pays = $100.
• Gross Margin Dollars = $100 - ($100 * 0.40) = $60.
• Gross Margin Percentage = $60 / $100 = 60%.

At 30% Off:

• Average Order = $130.
• Cost of Goods Sold = 40%.
• Amount Customer Actually Pays = $130 * (1 - 0.30) = $91.
• Gross Margin Dollars = $91 - ($130 * 0.40) = $39.
• Gross Margin Percentage = $39 / $91 = 43%.

The secret to measuring File Power lies in modeling future gross margin percentages.

In my projects, there is a strong correlation between historical gross margin percentage and future gross margin percentage. If a customer generated a historically low gross margin percentage, the customer tends to generate a low future gross margin percentage ... and vice versa.

What does this mean? It means that when we offer 30% off, we lower future File Power because we push customers into lower future gross margin percentages.

Of course, File Power is a function of future profitability and future customer counts. If discounts/promotions generate incremental additional customers, then File Power can actually increase.

More on the topic tomorrow, ok?

File Power

Dig deep into Google Analytics, and you'll find very little about the important concept known as "File Power".

What is "File Power"?

File Power is the amount of future profit to be generated in the next twelve months from customers who purchased within the past twelve months.

Now, there's no right/wrong way to measure File Power. But there are key tenants that one should follow.

1. Model the probability of a customer purchasing again in the future.
2. Model how much a customer is likely to spend if the customer purchases again in the future.
3. Model gross margin generated by future transactions.
4. Model future ad cost and operational expenses.

In many ways, "File Power" is lifetime value extended to the entire twelve-month buyer file. Lifetime Value is used for advertising/targeting purposes ... File Power is used to communicate to Management whether existing strategies are leading to future success.

Let the topic sink in today ... we'll pick the subject back up tomorrow, ok?

Oh, Look At This One!

Check out this item. Tell me what you see.

We have a highly seasonal product that took a year to get rolling (2015) ... and then the item began the process of slow erosion.

Also notice that the merchandising team did the item no favors in early 2016, not advertising/offering the item in April, hurting demand.

So the question is this ... do you run this item in 2017? If the item is advertised properly, one might expect demand to drop-off by another 30%.

In other words ... how long do you hang in there with declining demand until you decide to kill the item?

It's almost like you need a rule of thumb or something, right?

Top 10 Problems I Observe In My Projects: #1

Problem #10 = New Items Are Too Expensive
Problem #9 = Discounts Drive Down Price Of Existing Winners
Problem #8 = Relying On 1-2 Customer Acquisition Channels
Problem #7 = Has To Be Right
Problem #6 = Seasonal Misalignment
Problem #5 = Email Clicks And Online Clicks Not Linked To Purchase Database
Problem #4 = Not Killing Existing Products
Problem #3 = Too Few New Customers
Problem #2 = Not Enough New Products
Problem #1 = Company Culture

I took a job at Eddie Bauer, back in December 1995. The marketing department was about half as big as the department I left at Lands' End. At Lands' End, we had a Director and a bunch of Managers. At Eddie Bauer, we had an EVP of Marketing and an SVP of Marketing and a DVP of Marketing and a couple of Directors and a bunch of Managers and a handful of Analysts.

At Lands' End, things "moved" ... decisions were made. I may have disagreed with the decisions, but there was progress.

At Eddie Bauer, there was one individual - a Manager, with considerable experience. And when decisions had to be made, this person got to "weigh in". Example - we were installing a new customer database. I wanted to pass customer intelligence to retail employees (this was 1997) ... new customer vs. existing customer, customer quality (loyal, lapsed), customer return rate (60% or 0%), that kind of thing. I made a fateful comment.

• "We could recognize the customer as being new or loyal and then personalize the message or discount structure based on customer history."

Mind you - we offered different promotions to different customers online and in catalogs ... all the time.

The Manager looked at the room, face turning red, and with anger announced the following:

• "That smacks of DISCRIMINATION. That's not who we are."

Well of course that was who we were ... we did it in catalogs/online all the time.

Heads nodded up and down, and my proposal to make retail point-of-sale systems "smart" died on the vine.

Then I noticed that when this person appeared in meetings, this person stalled progress. Whatever the progress was, this person said no. And the employees all got in line and did what this person told the room to do ... VPs did what this person wanted to do ... co-workers in other departments did what this person wanted to do.

I'd sit there and think to myself ... "This person has worked at this company for 25 years and has never been promoted above Manager and the company chooses to listen to this person instead of people who are actually paid to make decisions?"

This kind of behavior is flummoxing to a 30 year old.

More than twenty years later, this kind of behavior is not only common, but is behavior that should be studied at a University level.

Each company has an unofficial "Keeper of the Culture" ... in fact, each company has numerous "Keepers of the Culture" ... scattered across many departments. These individuals protect what has always been done. Their decisions save the company millions of dollars, preventing new employees from implementing risky initiatives.

Their decisions prevent the company from moving forward as well.

In 1998 at Eddie Bauer, I became the Director of Circulation/Analytics. I wanted all discounts/promotions removed - gone!

One of my Managers turned out to be a "Keeper of the Culture". I told my Manager to remove all discounts/promotions. He refused. "Oh, that's not what we do here." I told him to do it. He countered. "Sr. Management won't like this one bit. You're new to to the job, you have to learn how we do things." I reminded the employee that he reported to me. He sat silent. This should have been a sign that trouble was brewing. And when the SVP of Marketing told me to run the discounts/promotions, I again said no, sharing test results showing how unprofitable discounts/promotions were.

When the Manager brought the fiscal plan into my office with discounts/promotions, I reminded the Manager to remove them. He refused.

I then figured out what motivated this employee. This manager loved "the process" ... the process of applying the promotions and doing the math. So I made his life a bit easier ... I offered to do all the work and bypass him altogether ... he could author whatever plan he wanted but the rest of the company would follow my plan, and because I was his boss the company would have no choice but to work off of my plan.

The Manager was cut-off from his co-workers, from interacting with the rest of the company.

Later that week, the discounts/promotions disappeared.

Often, the "Keeper of the Culture" thrives on power. I've found that the "Keeper of the Culture" doesn't have a lot of org-chart power, even if s/he is a VP ... but has a lot of human power. A long history with the company. Knowledge of company processes. Good relationships with a handful of people who have power. A desire to change only when change comes from the person who keeps the culture.

Our job is to identify the real factors that motivate the person who keeps the culture. Take those factors away, and the person will change.

At Nordstrom, one of the "Keepers of the Culture" wanted all things to flow through her. And because she worked in the Information Technology department, all things had to flow through her. She didn't want change happening unless she initiated change. So whenever my team had new ideas or new ways of doing things, we allowed this person to get all the credit. This tactic enraged my team ... "she has nothing to do with this, why does she get the credit?".

By giving the "Keeper of the Culture" public credit for our work, the "Keeper of the Culture" implemented our agenda. She was happy. The company moved forward. And those who "mattered" knew where the ideas were coming from.

Find a way to take the power away from those who keep the culture.

Why do I bring this up?

Because when interact with you ... the most common refrain is this ... "Somebody will not let me do what I want to do, and that person is dumb and stupid." Sometimes the person is an Executive. Sometimes the person is a "Keeper of the Culture". Either way, the person is holding up the progress you want to make.

In the past decade, it has been my observation that we've lost the ability to manage our co-workers. Our data-driven approaches focus on metrics, not people. We work with outside vendors more than we work with in-house co-workers. We've lost our ability to convince people to change. When we lose the ability to argue with co-workers for change, we give power to the "Keeper of the Culture".

Out on Twitter, a follower asked why retailers won't change. "Isn't it obvious as retailers go bankrupt that they need to change? Why are they so stupid?"

Retailers (and catalogers) aren't stupid. Instead, both industries have ceded authority to the "Keeper of the Culture" (which amazingly can be members of the vendor community - yes, true story - they keep the culture of the industry intact for their benefit). When this individual (or team) has too much power, new ideas die and innovative employees leave the company, leaving a disproportionate skew toward those who are "Keepers of the Culture".

This is the number one problem I observe in my travels and interactions with you. Until we get good at shifting the power structure within our companies, nothing will change.

Thoughts?