Direct Marketing, Mail Order, and E-commerce News from the National Mail Order Association


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HOW TO DETERMINE YOUR BREAKEVEN POINT
by STEPHEN R. LETT

In order to prospect for new buyers cost effectively, any catalog company needs to know what their breakeven point is.  I like to express breakeven on a per catalog mailed basis.  In other words, how much gross (or net) revenue do I need to generate per catalog mailed in order to hit my desired breakeven target?  This becomes my stake in the ground. All outside lists and house file segments should be evaluated and measured against this breakeven criteria. 

There are two different breakeven points that can be used. An incremental (sometimes called variable) breakeven and a fully absorbed breakeven point.   Mailings to prospects should be evaluated using an incremental breakeven point analysis.  The fully absorbed breakeven point can be used to determine the effectiveness of mailings to your house file. The difference between these two breakeven points is that the incremental or variable breakeven does not include any fixed overhead expenses in the calculation whereas the fully absorbed breakeven calculation does.  Why are two breakeven points needed? Can the initial mailings to prospects reach the variable break-even point? What should be included in our calculation?  These are all questions to be answered in this article.

Most catalogers cannot prospect above breakeven on the initial mailing to outside names. Profitability comes over time from repeat business, i.e., the customer’s life-time-value.   For this reason, I feel it is important to use two different breakeven points in order to evaluate mailings to prospects vs. mailings to the house file.  All mailings, regardless of whom they go to, cannot be considered incremental.  It is the house file – your proven customers – that needs to cover your overhead expenses.  Again, prospects cannot be expected to cover overhead expenses but these expenses are real and need to be absorbed somehow.  This is why start-up catalogs see red ink!  They do not have a proven customer list to pay the rent, light bill, salaries, etc.  It takes a few years of prospecting at a bottom line loss in order to have a sufficient number of proven customers on the house file to begin to absorb the overhead expenses of the firm.

An incremental breakeven point is defined as: 

Net Sales minus Cost-of-Good Sold minus Direct Selling Expenses minus variable
order processing costs = Incremental BEP

A fully absorbed breakeven point is calculated the same way as the incremental break-even point with one significant exception.  All fixed overhead expenses should also be included as part of your total costs. Our focus this month is on the value of the incremental breakeven point.  We will take a look at the line item expenses that need to be included in our costs later in this article.

In a perfect world, the desired goal is to prospect above the incremental break-even point.  By doing this, the gross profit dollars generated from your prospect mailings would equal (or exceed) the amount of money spent on mailings (including your variable order processing costs) to prospects.  Caution:  Few catalogs can mail above the incremental breakeven point. While some lists will perform above the incremental break-even point, it is not likely that your overall mailing results will be above this point.  This would mean that it would cost nothing out-of-pocket to acquire a new buyer, which again is most unlikely.  The cost to print and mail catalogs today, and lower industry response rates overall, makes it very difficult to prospect above breakeven and still grow your business.  By limiting the amount of prospecting you do to those outside lists that are above the incremental breakeven point will obviously limit your growth.  The lists, which do perform at or above the incremental breakeven point, will be few.  Typically, these are the lists with limited universes available for rollout or continuation.  Again, an investment will be required to grow your buyer file.

Too much prospecting will result in a bottom line loss on your income statement. Limiting the amount of prospecting you do is not good either. This will stifle your growth.  Maintaining the proper balance between mailings to current customers and to prospects is key to good circulation planning.  The size and performance of your house file and knowing how long it takes to recover your investment from acquiring a new buyer will help you know how much prospecting you can afford to do.

For every mailing campaign, I like to prepare a Proforma contribution statement similar to the example on the next page. This is not an income statement because overhead expenses have not been included. This report has two purposes. The first purpose is to determine the revenue per catalog needed to achieve breakeven. Secondly, this report is used to determine the amount of contribution dollars any given mailing campaign will generate towards profit and overhead at 100% complete.

Lets take a look at The Acme Catalog Company (for example only) Proforma Contribution Statement.  Our example is based on a 64-page gift catalog business with an average order size of $62.  If we want to print a total of 1,357,104 catalogs (per our bottom-up circulation plan), here is what we need to know in order to calculate the incremental breakeven point:

1.      Direct Selling Expenses – Cost per Catalog of $.585 as shown.

2.      Returns and Allowances Ratio – Shown at 6% of net sales.

3.      Cost of Goods Ratio – Shown at 45% of net sales.

4.      Variable Cost to Process an Order – Shown at $5.00 per order or 8.55% of net sales.

 Based on quotes we have received in our example, we know it will cost $793,814 to print the desired number of catalogs.  When we divide this number by the gross margin percentage less the variable order processing cost ratio we get the net sales figure we need to achieve breakeven (refer to the column headed BEP ANALYSIS). Our formula looks like this:

Direct Selling Expenses / 

(Gross margin percentage – variable order processing ratio) =

Net Sales

Next, we determine our returns and allowance figure by multiplying net sales by our returns ratio of 6.0% in our example. This gives us the gross revenue needed to achieve breakeven.  The Acme Catalog Company needs to generate net sales of $1.26 per catalog printed and mailed in order to break even.  On a gross revenue basis, Acme needs $1.33 per book.

Our circulation plan tells us that we can expect this mailing campaign to generate $2,795,635 in net sales, which amounts to $2.06 per catalog.  Our direct selling expenses remain the same at $793,814 as does our cost-of-goods and returns and allowances ratios. This mailing campaign is forecast to produce $504,804 or 18.06% contribution to profit and overhead.

Will this mailing to customers and prospects be profitable?  It will by profitable as long as Acme’s overhead expenses do not exceed the amount of contribution this mailing is expected to generate.  When we consider the contribution expected from list rental income and the net gain from shipping and handling revenue, The Acme Catalog Company is expected to show a nice bottom line!

Behind any Proforma contribution statement is a detailed and well thought out catalog circulation plan. We don’t start with the Proforma but rather we end with it. Before beginning any mailing campaign, it is critical to know your breakeven point. Knowing how much revenue per catalog you need to achieve breakeven is critical to your success.  Not knowing this is like being lost at sea!  It is imperative to prepare a bottom-up forecast, which determines your expected sales against your incremental breakeven. You may need to adjust your circulation in order to maximize your contribution to profit and overhead.  The more prospecting you do, the less contribution. It is also not advisable to under prospect.  Squeezing every dollar of contribution you can from your mailing will reduce the number of buyers you add to your file.  A decision such as this would represent short-term thinking, which could hurt the business long-term.  Remember, maintaining the proper balance between mailings to the house file and mailings to prospects is the right strategy for good circulation planning. 

Stephen R. Lett is President of Lett Direct, Inc., a catalog consulting firm specializing in circulation planning, forecasting and analysis.  Mr. Lett spent the first 25 years of his career with leading catalog companies; both business-to-business and consumer.   He can be reached at 317-844-8228 or through the Web site: www.lettdirect.com 

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