The Cost to Acquire a New Buyer

by Stephen R. Lett

First Rule of Thumb: A catalog company cannot break even overall on the initial orders generated from prospects.

Catalogers must be willing to invest to acquire new buyers in order to grow or to at least maintain their 12-month buyer count. This month, I want to discuss the cost to acquire a new buyer and why it is important to investment-spend on prospecting. I want readers to understand why it is not likely to break even on the initial order.

I have catalogers tell me that they do not want to prospect below the incremental break-even point. That’s a nice goal, but it is not realistic. Today’s economics, (i.e., postage costs, paper prices, and so on) combined with lower response rates (an ongoing trend that results mostly from list fatigue) are the main reasons why catalog companies cannot break even on the initial order mailing to outside rented lists (including those from cooperative databases).

Typically, a few lists or database segments will break even or better. However, the universe size from these top-performing lists will not be large enough to generate the desired number of new buyers required to grow or to maintain file sizes. Therefore, in order to grow your 12-month buyer file, other lists and/or database segments that perform below breakeven will need to be part of your circulation plan. It is simply a fact of life and part of the cost of doing business today.

Not investing in growing your house file can have a negative effect on your business and future growth trend. At the same time, overspending to acquire a new buyer and trying to grow too fast can lead to financial ruin. It is the balance of mailings to your house file versus mailings to prospects that is important to your long-term success. The size and financial performance of your current house file is what really determines how much prospecting you can afford.

There are always customers who elect not to purchase again for a variety of reasons. They may not be pleased with your service, or they purchased based on a one-time need, or a specific promotion caused them to buy once. At a minimum, it is important to replace those customers who elect not to buy again with fresh buyers so that your 0-12 month file does not decline.

If you want to grow, the amount of prospecting you do needs to exceed your normal house file attrition rate. For example, let’s assume that 50% of a typical customer file will purchase again next year. This means that at a minimum, we need to replace the 50% who do not purchase so that the active house file does not decline. This includes a combination of adding new buyers and bringing the “older” buyers on our house file into the 0–12 month category. If we want to grow, the percentage of new-to-files has to be even higher than our normal attrition rate.

Second Rule of Thumb: The percentage of revenue growth will approximate the percentage increase in your 12-month buyer file.

Let’s take a look at how much a cataloger can afford to spend for a new buyer based on what we expect in return. Once again, I am talking about spending money — making an investment to acquire a new buyer. I feel a payback of one year (or less) is considered a reasonable investment payback period.

Some catalogers might say that they want to base the cost to acquire a new buyer on the expected lifetime value. While this is not an unreasonable approach, most prefer to take a shorter-term view. While it unrealistic to expect to prospect in total (on a cumulative basis) at or above the break-even point, it is reasonable to attempt to pay back that investment within one year. How much we can afford to spend for a new buyer assuming a one-year payback is calculated below.

    COST PER BUYER
INITIAL
MAILING
REPEAT
FACTOR
YR. 1
PAYBACK
Number of New Buyers 1,500 1,500
Quantity Mailed 100,000 15,000 115,000
Number of Times Mailed Annually 1 10 11
Response Rate 1.50% 5.98% 2.08%
Average Order Size $65.00 $67.00 $65.75
Number of Orders 1,500 898 2,398
Gross Sales $97,500 $60,143 $157,643
Less: Returns @ 5% $4,643 $3,000 $7,643
Net Sales $92,857 $57,143 $150,000
Less: Cost of Goods @ 47% $43,643 $26,857 $70,500
Less: Direct Selling @ $.60 $60,000 $7,500 $67,500
Less: Variable Fulfillment @ 8% $7,429 $4,571 $12,000
Net Cost ($18,214) $18,214 $0
Cost/Contribution Per New Buyer ($12.14) $20.29 $8.15
Note: Catalog cost in “Repeat” Column does not include the cost for the rented name; house mailing only.

 

We want to break even (or better) within one year. We accept the fact that we will lose money on the initial order. In our example based on a mailing to 100,000 prospects, this company lost $18,214. It cost $12.14 to acquire a new buyer. At a response rate of 1.5% 1,500 number buyers were acquired. If these 1,500 buyers are mailed 10 times during the next 12 months they will generate an estimated contribution to profit and overhead equal to the contribution loss from their initial purchase.

Therefore, if our goal is to break even after one year on the investment we make initially to acquire a new buyer, we can afford to invest up to $12.14 to acquire a new buyer in our example above.

As you can see, the year after the initial investment, our contribution to profit and overhead is a positive $8.15 per buyer. Obviously if we considered lifetime value, the contribution in years two, three, and beyond would be even greater. The point is, new buyers are the life blood of any catalog company and we need to be willing to investment spend initially to acquire them.

Let’s be sure we know what contribution to profit and overhead means. Contribution is the amount of money left over to contribute to overhead expenses after we deduct for customer returns, cost of goods sold, direct selling expenses (paper, printing, postage, list costs, and so forth), and variable order processing costs.

Our formula is as follows:

Gross Sales – Returns = Net Sales – Cost of Goods Sold – Direct Selling Expenses – Variable Order Processing Costs = Contribution

A positive contribution to profit and overhead exists when there are excess funds available after this formula has been applied. A negative contribution to profit and overhead occurs when there is a shortfall.

In order to know how many new buyers you need to generate a year, you need to know your house file attrition rate and desired growth factor as determined by management. For example, for the Acme Catalog Company, let’s assume their house file (buyers only) totals 164,286. Let’s also assume that 60% of this file will make a repeat purchase during the next 12 months. This means that 64,714, or 40%, of this file needs to be replaced simply to maintain the same file size (before any growth factor). See our chart below:

Size of Housefile 164,286
Attrition Rate 40.00%
Buyers to Replace 65,714
MAINTAIN SIZE OF FILE:
Circulation to Prospects 3,100,000
Average Response Rate 2.12%
Total New Buyers 65,714
GROW BY 10%:
Circulation to Prospects 3,614,292
Average Response Rate 2.00%
Total New Buyers 72,286

At an overall average response rate of 2.12%, Acme must mail to a total of 3.1 million prospect names in order to generate the 65,714 new buyers needed to maintain the file size. To grow by a factor of 10%, the company would need to mail 3.6 million catalogs to prospects. (This is based on a slightly lower overall response rate of 2.0% due to the increase in quantity.)

It costs money to acquire new buyers … the lifeblood of any catalog business. Think of prospecting as an investment in your future. Know how much prospecting you need to do base on the attrition rate of your house file. Add a growth factor on top of that if you desire. Balance your circulation to prospects versus the house file in order to protect your bottom line.


Stephen R. Lett is the President of Lett Direct, Inc., a catalog consulting firm specializing in circulation planning, forecasting and analysis since 1995. Mr. Lett spent the first 25 years of his career with leading catalog companies; both business-to-business and consumer. He is the author of a book, Strategic Catalog Marketing. He can be reached at 302-539-7257 or by email at steve@lettdirect.com.

About the Author: Jim Gibbs

Vice President of Sales & Marketing at The Dingley Press. Jim has been with Dingley since 2002 and lives in Maine near our Lisbon, Maine plant location.