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.

A Philosophical Debate

Thirty years ago, during the roaring 90s at Lands' End, there was a philosophical debate about investing in catalog mailings to housefile customers.

One camp said you should mail to a 10% variable profit level, because after accounting for fixed costs, you were approximating a break-even approach to mailing. This meant that a housefile mailing might be sent to 4,500,000 housefile customers.

Another camp viewed the world differently. They said you mailed to a -10% variable profit level, because after you converted customers to a purchase, those customers had higher long-term value, and consequently you would make money on the transaction on an annual basis.

Neither side had an actual Marketing Budget Experiment to prove or disprove the other side. It was an argument that could never be won, and as we've learned from politics, those are the arguments that our modern world is optimized for.

Today we have Marketing Budget Experiments.

Here, we invest more in catalog housefile marketing and we lose money in the process. The top table shows what happens if we do it for just one year. The bottom table shows what happens if we do it every year for five years.

In the top table, we see that the investment makes sense. We lose money in year one, then we make money each year thereafter, causing us to make money overall.

In the bottom table, we see that if we employ this strategy as a "best practice" (doing it every year), we lose money for four consecutive years before finally turning a profit. Overall, the brand loses nearly $1.5 million over five years.

The endless argument continues ...

You get to decide which choice makes the most sense.

But you should make that decision with full knowledge of what your p&l looks like (on a Variable Profit Level) with/without the tactic, right?

Click here for project pricing.

Two Channels With Very Different Investment Profiles

The top portion of the table below represents an increase in marketing spend of 10% within Paid Search. Tell me what you observe.

The bottom portion of the table represents an increase in marketing spend of 10% within Email Marketing. Tell me what you observe.

In Paid Search, two-thirds of the customers purchasing are new customers. Finding new customers is expensive ... so you lose $34.50 profit per order this year ... then make $60.73 in years 2/3/4/5. In total, you generate $26.23 profit over five years.

In Email Marketing, nearly all of the customers purchasing are existing customers. You cause your existing customers to become better customers! You generate $71.94 profit per existing customer in year one, then you make $85.43 in years 2/3/4/5. In total, you generate $157.37 profit over five years.

Now, I harp on new customer acquisition all the time, and for good reason.

But come on! If you can make 6x as much profit over five years by figuring out how to improve email marketing productivity by 5% (based on a 10% gain in spend), wouldn't you want to do that?

This is the kind of stuff that your garden-variety Marketing Budget Experiment unearths for you.

An Example

Yesterday we talked about a different method for financial brands to fund growth ... here is an example of what we were talking about (click here). 

These concepts require significant long-term value from acquired customers.

A common e-commerce brand with a 28% annual rebuy rate "might" be a candidate for this style of financial assistance, especially with 70% gross margins. This combination leads to healthy long-term customer value.

There's a reason so many of you took advantage of my Marketing Budget Experiments pilot program (actual program cost is outlined here) ... the most successful product launch I've ever had. Money is no longer cheap, artificial growth via the COVID-bump is long gone, and we really need to take an honest look at 2024 and beyond.

I'm not saying you should avoid self-funding your brand ... I'm saying you should have long-term goals and have access to whatever you need to achieve your long-term goals. That may or may not require outside assistance.

A Different Investment Method

Are you aware of what General Catalyst is doing? No? Click here to learn how they are funding your marketing efforts, then taking downstream orders/sales from the customers they help you acquire (HT to https://twitter.com/d_mccar).

Think about it this way. Here's our Marketing Budget Experiment, and in this case our brand is going to spend 25% more on Paid Social for one year. Here's the projected outcome of the Experiment.

In this example, you spend $1,773,219 of marketing expense (you spend money acquiring the customer, then in the first year you have marketing expenses associated with the newly acquired customer, resulting in a lot more total first-year marketing spend). You lose $785,458 in the first year. Yikes! You generate 14,614 customers ... meaning you lose $53.75 converting these customers. Once you lose that money, the customers begin paying you back.

• $15.48 in year two.
• $16.47 in year three.
• $14.83 in year four.
• $13.80 in year five.
• (presumably more in years six, seven, eight, etc.)
• You generate $60.59 profit in years two, three, four, and five.

Would you give up all profit on this customer for years 2/3/4/5 in order for a third party to allow you to acquire a customer you would not otherwise acquire? Or under different terms, would you give up two-thirds of your incremental sales gain in year one to pay for the incremental ad cost provided to you from a third party (plus interest)?

If the answer is "yes", how would this change how you approach growing your top-line?

Something to think about. You may adore this style of "investment", you may abhor this style of "investment". But you should think about it at minimum, right?

Ever Have This Happen?

Have you ever worked at a company? Yes! Ok.

Have you ever worked at a company where you had a really good department head? This woman knew her stuff inside-and-out, her employees respected her, her co-workers got along with her, and she got stuff done. She protected you from the lunatics you are frequently subjected to.

And then ... something happened. Some cauliflower head is given her job. This guy knows nothing. He adheres to industry phrases like "move fast and break things".

He breaks things.

He cannot get along with people.

He seems to take pleasure when demeaning other people.

He might be corrupt ... it's hard to tell because you have incomplete information, but it seems like he might make more money than just his salary.

He might have inappropriate relationships with other individuals.

HR has a file on him that they'd love to share but can't share.

We've all been through it.

The person doesn't last terribly long - maybe a few years (years that seem like a decade).

Then it takes a half-decade to fix everything broken by the menace ... if the business doesn't go bankrupt.

Our modern world seems more likely to embrace this scenario than "back in the day". Profit was too darn important back in the day.

Even when somebody burns everything down, somebody always comes in and fixes things. It might not be at the same company (it might happen at a competitor), but things do get fixed. There's a time and season for everything, and sometimes the end of something aligns with the appointment of a cauliflower head.

Your Advertising Budget

It's common to think of channels like paid search and paid social as ad channels. You spend money, you get customers, everybody claps their hands and moves on.

Have you looked at your ad budget for email marketing? It's comparatively tiny, and sales are disproportionately huge. It is common in my projects to see e-commerce brands generate 30% of annual variable profit solely from email marketing.

Have you ever taken your discounts/promotions, and allocated them as an "ad cost"? In other words, if you take 40% off of everything, do you have a line-item in your p&l for dollars "given away"? I assure you that if you've ever gone through this exercise you've been gobsmacked by what you learn.

For many of you reading this missive, the biggest line item expense in your p&l is all of the margin dollars you give away begging customers to purchase at 30% off or 40% off or 50% off. You'd think you'd spend more time on this topic if it was your biggest expense, amirite?