Modern Channel Index (MCI)

When applied to merchandise, the Modern Channel Index (MCI) teaches us an awful lot about how customers interact with merchandise.

Here's some data ... the x-axis depicts how "old" the average customer buying an item is, in years (1.00 = all new customers, 2.20 = average customer is 2.20 years old).

The y-axis measures the "MCI" or "Modern Channel Index" for the top 500 items. A value of 1.00 represents highly modern channels (like mobile) ... a value of 0.40 represents old-school channels (like your call center).

Tell me what the relationship indicates?

We learn that "older customers" tend to lean toward "older channels".

We learn that "newer customers" tend to lean toward "modern channels".

You might say to yourself, "duh".

But here's why this matters ... you have been taught to leverage an "omnichannel" strategy, where every item is featured in every channel. And you wonder why the thesis behaves in such a tepid manner, right? Well, certain items align with modern channels, while legacy items tend to align with legacy channels.

It turns out that each channel serves a "purpose" ... and possesses merchandise that uniquely defines the channel.

More on this tomorrow.

Two Key Merchandising Attributes

In recent projects there are two key merchandising attributes I analyze. I'm encouraging you to do the same.

Attribute #1:  "Age" of the customer buying the item.

• Let's say you sell widgets. Two customers purchased a widget in the past year. The first customer is brand new. The second customer has been on the file for five years. "Age" of the customer buying the item = (1.00 + 5.00) / 2 = 3.00. The average customer buying the item is "three years old".

Attribute #2:  "Modern" channel index (MCI).

• Say you sell four widgets. The first widget is purchased at your call center. The second widget is purchased via your website. The third widget is purchased via email marketing. The fourth widget is purchased via mobile. Assign a value to each channel. Assume call center purchases are "old school" and get a value of 0.00. Assume e-commerce purchases are "average" and get a value of 0.50. Assume e-mail purchases are more "modern" and get a value of 0.75. Assume mobile purchases are very modern and get a value of 1.00.
• The "Modern Channel Index" (MCI) is calculated as follows:  (0.00 + 0.50 + 0.75 + 1.00) / 4 = 0.5625.

Why would I do this?

We'll discuss "why" tomorrow!!

The Recurring Challenge

Since 2014, there has been a recurring challenge in my project work. Here's how events transpire over time.

1. A business has a sales decline.
2. Discounts / Promotions are offered. Sales rebound.
3. Sales decline.
4. Free Shipping is offered. Sales rebound.
5. Profit suffers.
6. To fix the profit issue, new merchandise is offered at higher prices and/or at the same prices with lower quality.
7. Customers say "no" to the changes to new merchandise.
8. Sales decline.
9. Even more Discounts / Promotions are offered.

This is the time when new customers are needed the most ... new customers who do not have the baggage of 1/2/3/4/5/6/7/8/9 above.

Of course, Google + Facebook + (in catalog marketing, catalog co-ops) have locked-down new customer acquisition, making it terribly expensive to find new customers.

Since I've run across this problem 50ish times in the past four years, I'm familiar with what comes next.

• How do we get out of this mess?

I've only witnessed two strategies that work.

1. Innovative new merchandise that customers must have.
2. Innovative low-cost / no-cost customer acquisition programs that bypass Google / Facebook and other expensive sources.

And when (1) / (2) are offered to the Professional, there is a predictable response.

• There has to be another way. Isn't there a channel that delivers customers at low cost at "scale"?

If there were a channel that delivered customers at low cost at "scale" you'd be using it. And once you used it, everybody would use it. And once everybody used it, somebody would monetize the channel so that it wouldn't be a low cost channel anymore.

We're coming to a very unique inflection point in e-commerce. For more than twenty years, there was always hope in e-commerce ... sales grew and grew (usually cannibalized from other channels, but that's ok because lots of people made a career out of cannibalizing sales that would have already happened). The "hope" of e-commerce is ending. Amazon won. 

From here on out, it's hard work.

We've trained a generation of marketers to avoid hard work ... and yes, I realize that comment sounds "crabby" ... you have to work very hard to hustle Google and Facebook and retargeters and affiliates, no doubt about it. I'm talking about a different type of "hard work" ... the hard work traditionally performed by true marketers and gifted merchants.

1. Innovative new merchandise that customers must have.
2. Innovative low-cost / no-cost customer acquisition programs that bypass Google / Facebook and other expensive sources.

You are ready to deal with this challenge!

And if you aren't ready to deal with this challenge, it may be time to sell.

But I think you are ready to deal with this challenge!

Raise Prices on New Items

I spent the past three days explaining how marketers nuke businesses with discounts, promotions, and free shipping. As a marketer you likely disagree with me ... the merchants messed up or Amazon took your lunch money or whatever and you are simply responding to adjacent issues. You may be right. Of course, if the only tools in your toolbox are discounts, promotions, and free shipping ... well, then you are stuck. Brilliant marketers with low-cost / no-cost marketing programs have a lot more they can do to grow the business.

So the next thing that happens is that the CFO goes after the merchandising team to boost gross margins. You can't raise prices on existing items, so new merchandise takes the stage. Two things happen.

1. Prices increase. If a comparable new item used to sell for $35.00 with a $17.50 cost of goods, then the new item sells for $42.50 with a $17.50 cost of goods, boosting gross margins up to $25.00 instead of $17.50. Problem solved!
2. Quality decreases. On some widgets, the item is still $35.00 but the quality is worse, yielding a cost of goods of $15.00 and gross margins of $20.00 per item.

The strategy rolls out.

It takes a year to truly see what is happening ... but the early returns are not promising.

• Net items, which represent 25% of company volume, are selling 20% worse than prior year (due to higher price points).
• Total sales are down 5% as a consequence.
• The CFO is even more angry.
• The marketer responds by moving to 40% off (on all items, even the items that are still selling at an acceptable level), further nuking the brand in the process.

Tomorrow I'll discuss why I just spent four days on this topic, ok?

Free Shipping + 30% Off ... That's A Deal!!!

Here's our situation from yesterday.

• Three items at $35.00 = $105.00 demand.
• 30% off = $31.50 discount.
• Net Sales = $105.00 - $31.50 = $73.50.
• Cost of goods for three items at $17.50 = $52.50.
• Gross Margin Dollars = $73.50 - $52.50 = $21.00.
• Shipping Revenue = $10.00.
• Shipping Expense = $8.00.
• Net Shipping Revenue = $2.00.
• Total Profit from the Order = $21.00 + $2.00 = $23.00.
• Order Increase = 1.50.
• Total Profit = $23.00 * 1.50 = $34.50.
• Profit at Full Price = $54.50.

This is the point in the script where the CFO enters the picture ... she's not happy that profit never recovered. Sales aren't increasing enough, either. The Board (or the Owner) are upset.

What does the marketer recommend?

Free Shipping on Orders > $100!!!

So now we have 30% off plus free shipping. Somebody in marketing jumps up and down ... "we're competitive" ... they can't wait to measure conversion rates in real time. And conversion rates improve. 

Our situation changes ... we get a 20% bump in orders, so that's a good thing. But ...

• Three items at $35.00 = $105.00 demand.
• 30% off = $31.50 discount.
• Net Sales = $105.00 - $31.50 = $73.50.
• Cost of goods for three items at $17.50 = $52.50.
• Gross Margin Dollars = $73.50 - $52.50 = $21.00.
• Shipping Revenue = $10.00 (for half the orders, $0 for the rest) = $5.00
• Shipping Expense = $8.00.
• Net Shipping Revenue = -$3.00.
• Total Profit from the Order = $21.00 - $3.00 = $18.00.
• Order Increase = 1.50 * 1.20 = 1.80.
• Total Profit = $18.00 * 1.80 = $32.40.
• Profit at Full Price = $54.50.

We're losing more money now than before.

Order volume is up 80%.

Profit per order is down by 67%.

Total profit is down.

The customer has been trained to love discounts/promotions ... when you don't run discounts/promotions orders fall off of a cliff.

Now your CFO is really corked off.

To achieve more profit, the CFO asks the merchandising team to develop new items with better gross margins. We'll explore that issue tomorrow.

30% Off!!!

Here's what a typical order looked like (from yesterday):

• Three items at $35.00 = $105.00 net sales.
• Cost of goods for three items at $17.50 = $52.50.
• Gross Margin Dollars = $105.00 - $52.50 = $52.50.
• Shipping Revenue = $10.00.
• Shipping Expense = $8.00.
• Net Shipping Revenue = $2.00.
• Total Profit from the Order = $52.50 + $2.00 = $54.50.

At some point the widget business becomes "competitive" or "Amazon enters the space" or the merchandising team messes up and it's harder to sell widgets. A valuable marketing team has several tricks up their sleeve ... a typical marketing team says "30% off"!!!

Are customers surprised and delighted? 

Well, you get more orders, that's for sure.

But the dynamics of your business have been changed.

• Three items at $35.00 = $105.00 demand.
• 30% off = $31.50 discount.
• Net Sales = $105.00 - $31.50 = $73.50.
• Cost of goods for three items at $17.50 = $52.50.
• Gross Margin Dollars = $73.50 - $52.50 = $21.00.
• Shipping Revenue = $10.00.
• Shipping Expense = $8.00.
• Net Shipping Revenue = $2.00.
• Total Profit from the Order = $21.00 + $2.00 = $23.00.

You used to generate $54.50 variable profit per order.

You now generate $23.00 variable profit per order.

But order volume increases by 50% ... customers love your (albeit highly discounted) brand once again. Isn't that all that matters?

Well, here's the situation:

• You used to generate 1.00 orders at $54.50 profit per order = $54.50.
• You now generate 1.50 orders at $23.00 profit per order = $34.50.

Worse, you've trained your customer to expect 30% off.

Tomorrow we take a look at free shipping ... another favorite in the marketer playbook.

Generating Profit

This week we are going to talk about some of the dynamics surrounding generating profit. I know, I know, this is going to bore the living daylights out of many of you ... for those who are likely to be bored silly, read this little ditty about an old-school gaming organization who needed 11 years before being willing to "change" (click here) and then ask yourself if your organization would take that long to change.

Ok, let's pretend you sell widgets. The average price of a widget is $35.00. The gross margin of that widget is $17.50 (about 50%), yielding a cost of goods of $17.50 each. That's the business you are in. When a customer orders, the customer typically purchases three widgets, for an AOV of $105.00.

When the customer purchases, the customer pays $10.00 for shipping and handling. The cost to ship the merchandise is $8.00.

Make sense?

So here are the dynamics of a typical order.

• Three items at $35.00 = $105.00 net sales.
• Cost of goods for three items at $17.50 = $52.50.
• Gross Margin Dollars = $105.00 - $52.50 = $52.50.
• Shipping Revenue = $10.00.
• Shipping Expense = $8.00.
• Net Shipping Revenue = $2.00.
• Total Profit from the Order = $52.50 + $2.00 = $54.50.

Tomorrow we'll take a look at what happens when the marketing team thinks 30% off is a good idea.