Market Effectively to Profitable Customers
How Multichannel Retailers Can Achieve Strong Profits
Every Multichannel Retailer should be pursuing Three Prime Marketing Objectives. Each of the three is important. We believe the best way to view them is that Objectives 1 and 2 are really preludes: they are what a brand must do in order to generate the customers that make it possible to achieve Objective 3.
This article focuses on Objective 3: Achieve Strong Profits by Marketing Effectively to Profitable Customers. Let's dissect this crucial objective:
1. Achieve Strong Profits: The first section of Objective 3 is "achieve strong profits". What does "strong profits" mean, precisely? There are very successful companies that have small profit margins on high revenue. And, there are companies that have very high profit margins, some on high revenue. They are considered successful too. There are also a few companies that are growing at such a rapid rate that they are considered successful even though they are operating in the red. The point here is not to suggest any particular growth rate or margin goal. Rather, it is that every brand should ask two Big Questions, answer them truthfully, and set goals related to each question.
This suggests that every brand should have a "Strong Profits Goal" that is expressed in the following manner:
Strong Profits Goal Every month, Brand Name should have revenue at least NN% higher than the same month last year, and should exceed this minimum growth goal whenever doing so contributes to the long-term health of the brand. In addition, on a trailing 12-month basis, brand contribution to overhead and profit should be XX% of brand revenue or higher.
Every brand should adopt this precise goal, or some variation of it, with the percentages set appropriately for the brand in question. Then, the brand should track performance vs. each of the two percentages in the goal, looking back historically as far as is practical to establish a past pattern. But most importantly, the brand should establish strategies that lead to achievement of both percentages. When the brand fails to achieve one of the percentages, find out why and take corrective action quickly.
Relative to revenue growth, there is a simple rule: businesses need to grow. Stagnant revenue or extremely low revenue growth is troublesome. It is harder to attract strong talent to no-growth companies; harder to retain strong talent; harder to feel successful; harder to survive long-term. There is a corollary to the "businesses need to grow" rule: organic growth is important. Acquiring revenue growth can be good, but revenue growth that comes only from acquisition is not the same as organic growth. Acquired growth can be good for a business, but it does not speak directly to the health of a brand. If a multichannel retailing company has sufficient capital and management talent to be acquisitive, go for it. But seek organic growth too. How to pick the target organic growth rate? Not so easy. But it should be higher than the rate of inflation, and it should probably be equal to or higher than an industry average. Study the brand's markets, study competitors, study past brand results, study opportunities, and set the revenue growth goal accordingly.
Relative to contribution margin, there is another simple rule: contribution margin from marketing programs directed to customers of the brand must perform at an established minimum level. Professionals differ on the question of how to establish the minimum performance level. Our opinion is that a customer segment should produce a contribution margin at least equal to brand overhead and administrative costs as a percent of brand revenue. Some would set minimum performance higher. So long as the minimum isn't so high that it severely restricts volume we concur. Others would set minimum performance for a customer segment lower, even at a loss level. In most cases we believe doing so is unwise because the purpose of marketing to customers is to produce profit – not to tolerate losses in hopes of future profit. Customer segments that are modestly in the red can usually be moved into the black by adjusting contact strategy (investing in such segments less often), thereby converting them to contributors to the bottom line rather than loss generators.
Whichever philosophy is utilized to determine minimum acceptable performance of a customer segment, it is important to be clear on how "contribution margin" is calculated. For our purposes it is a simple formula:
( [ Brand Revenue ] – [ Marketing Cost ] – [ All Order & Inventory Related Costs ] ) / [ Brand Revenue ]
The "Achieve Strong Profits" portion of Objective 3 is crucial. However a brand answers the Big Questions, answer them. And pursue them. Be willing to stop customer marketing programs that are detrimental to the objective. This is a key underpinning of the strategies that will lead to brand profit optimization.
2. By Marketing Effectively: The second section of Objective 3 is "by marketing effectively". There are a lot of well-established good marketing practices that should continue. But there are also new, data driven approaches that can markedly improve the profitability of marketing campaigns to a brand's customers. Every brand should investigate and test these new approaches, which are discussed in more detail later in this article.
3. To Profitable Customers: The third and final section of Objective 3 is "to profitable customers". This topic is discussed thoroughly in the next section, and throughout this document.
Another way to view Objective 3 is that its components address three topics: what, how, and who. "Achieve Strong Profits" is what the brand is trying to accomplish. "By Marketing Effectively" describes how the brand will pursue the objective, by constantly evaluating and refining its techniques and methodologies. "To Profitable Customers" addresses the fact that not all customers are equal and that the brand's customer marketing budget needs to be spent marketing to customers that will actually produce a profit.
Optimizing Profits: Profitable Customers are the Key
What do we mean by "profitable customers"? Multichannel retailing industry professionals express a lot of different answers to this very important question. One answer would be "any customer segment that performs at breakeven or better is profitable". Others might say "24-Month Buyers in segments with a 10% or higher net profit as a percent of sales are the only segments that are profitable enough to help pay admin costs and leave something for the bottom line."
There are endless variations of precisely what "profitable customers" really means, but within every customer base profitability is stratified. Some customers are immensely profitable. Others produce good profits. Some are marginal, but profitable. Some are slightly unprofitable. Others are very unprofitable. How should a brand decide which of its customers are profitable enough to justify continued marketing investment? The general answer is to rank all customers and "draw the line" between which are worthy of continued investment and which are not.
Virtually all multichannel retailers have a methodology in place for ranking customers and deciding which ones to promote. They perform a ranking prior to each customer marketing campaign and then draw the line. The line, simply put, divides customers into two groups: those that will and those that will not be promoted in the upcoming customer marketing campaign. Improving this valid methodology can add margin points to the bottom line.
Such improvement involves three basic objectives: improve the ranking; classify all customers in their appropriate Customer Profitability Group; and implement sound strategy by Customer Profitability Group.
1. Improve the Ranking: in an ideal ranking, which is impossible to achieve, all of the customers who will buy as a result of an upcoming customer marketing campaign would be in Segment 1 of the ranking, the marketer would promote only Segment 1, the response rate would be 100%, and profits would be enormous. Sadly we don't know how to achieve this, and neither does anyone else. But what we can do is push more customers who will buy soon toward the top and more customers who will not buy soon toward the bottom.
Many companies perform statistical modeling, and most of them have methodologies in place not only to "find the top" but also to "find the bottom". However, it is also true that most modeling methodologies emphasize finding the top. Selection, not elimination, has been the primary goal: find the customers to whom we should market. Less attention has traditionally been paid to finding the bottom: identifying the customers whose performance will be so bad if promoted that no marketing budget should be allocated to them. Another worthy goal is to identify the customers whose performance is so marginal that they should be contacted less often.
The chart below depicts a Typical Ranking Distribution (what most predictive model curves look like) and a Target Ranking Distribution (what we strive to accomplish).
You will note that the Target Curve is an inverted S. Considerably more segments and therefore customers who will buy again soon have a very high ROI % and more segments (customers) are identified as very poor ROI %. In customer marketing the bottom of the ranking is in some respects the most important: if you can make the bottom progressively worse and worse by developing predictive methodologies that stress identification of non-buyers just as much as identification of buyers then the bottom segments get worse, and marketing budget previously devoted to them can be saved, pushing ROI higher and adding margin to the bottom line.
Wiland has invested heavily to create and enhance a proprietary modeling system that does just this: it stresses finding the bottom just as much as it stresses finding the top. This Polar Extremes Response Modeling system can save a brand a lot of money by improving the ranking of their customers (it works for prospect audiences too), thus facilitating customer marketing budget optimization, and increasing profits from customer marketing campaigns.
Every brand should constantly strive to improve its customer ranking methods. Improving the ranking is where Wiland can help most. Almost without exception, Wiland Customer Modeling Services put more money on our client's bottom line – and we consistently outperform competitors in even handed head-to-head tests. We enjoy this very high success level for several reasons:
- We Pursue the Right Goal: Our goal is for our client to increase their bottom line. This means that the costs for our customer ranking services must be significantly less than the added profit they deliver to our client.
- We Don't Attempt to Replace a Proven Customer Ranking System that Works: Many marketers are happy with their current customer ranking system. Further, they are reluctant to change it because they know it delivers profit and they can't risk weakening the bottom line. We respect such points of view. If the current system is poor then we will replace it. On the other hand, if a brand's current customer ranking method is good we will strive to improve it by simply subdividing current customer subsets so they can be tracked. Or, we can produce our score and provide it to the client's internal modeling team for them to use in conjunction with other data.
- We Want to Prove It: We know our track record and we are proud of it. We are happy to participate in even handed tests vs. any other customer ranking methodology.
- We Improve the Bottom Line: Everyone wants more money on the bottom line. We deliver on this very fundamental goal.
- We Consider the Top Line Too: Sometimes a client is wasting so much money marketing to unprofitable customers that the net effect of our customer ranking services is a significantly better bottom line despite a small reduction in revenue. But more often we are able to not only improve the bottom line but also slightly increase revenue from customers by finding desirable customers to promote that our client was not previously able to identify.
The heart of our customer ranking methodology is our Comprehensive Customer Model. This predictive model studies at least three past customer marketing campaigns and differentiates customers who bought again from those that did not. We find the characteristics of the repeat buyers. Customers with many favorable characteristics move to the top of the ranking. Customers devoid of favorable characteristics fall to the bottom. The ranking produced by our Comprehensive Customer Model beats other methods for two simple reasons:
- Superior Approach: our proprietary methodology, developed and refined specifically for direct marketing over a period of many years, is good data science. It has been tested and refined, tested and refined again, many times.
- More and Better Data: we have more data that is relevant. We have the client's data, which the client also has, so we can use it in our Comprehensive Customer Model™. We also have billions of transactions from other multichannel retailers. Beyond multichannel retail, we know what our client's customers buy in stores, what they read, how much they read, whether they are a charitable donor, how much they give, whether they are an active traveler, what kind of lodging they prefer, and more. Plus, we know their demographic and psychographic characteristics. Simply put, our data arsenal, which we do not sell to anyone (we have very strict privacy policies) is unsurpassed. And we use it only for the benefit of our clients. We provide our services only to brands that participate in our data cooperative. And, unlike some, we don't sell client data to 3rd parties. The result is that our clients that use our customer ranking services enjoy higher profits and often higher revenue too.
2. Classify all customers in their appropriate Customer Profitability Group: Most multichannel retailers classify customers into just two groups prior to each marketing campaign: those that will be contacted in the campaign and those that will not be contacted. Instead, customers should be classified into Customer Profitability Groups. A brand may vary the percentages in the table below, but a methodology such as this may improve the thought process on this crucial topic:
The point of Customer Profitability Groups is not to argue for the profit margin ranges given as examples in the above table. Rather, the point is that customers should be divided into logical groups so that each group can receive different marketing treatment, as appropriate.
3. Implement sound strategy by Customer Profitability Group: The very best (most profitable) customers may be contacted in literally every marketing campaign. Less profitable customers and unprofitable customers can receive special treatment. Often the best answer will be one or more of Wiland's optimization services that improve the ranking and identify weak, unprofitable customers that are not worth the brand investing more to market to them. Wiland's Optimized Customer Reactivation Loop and our Customer Lifecycle and Segmentation Modeling are excellent alternatives. However it is accomplished, every brand should take steps to further segment low margin and avoid the Customer Profitability Loss Groups. There are many methods. Wiland's services are among the very best. However it is accomplished almost every multichannel retailing brand needs to devote more attention to customer ranking, customer classification, and strategy by group. Proper attention to this topic can improve a brand's bottom line swiftly because it can end the waste of marketing expenditure on unprofitable customers.
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