Portfolio theory is quite useful in making personal and/or business investment decisions. The basic premise is that if you spread your investment dollars wisely over a variety of investment types and industries, you will mitigate much of the risk that you would incur by investing in a single stock or industry. For many years the catalog industry was a single industry investor – we rented and exchanged lists with other catalog companies and mailed those prospects a version of our catalog.
And guess what? It worked for a very long time; our businesses grew and we made a lot of money. Fast forward to 2015, and the “single industry” approach to investing in new customers is no longer working for most direct marketing companies. The increased cost of mailing, decreasing productivity from cooperative databases and the disappearance of many catalog brands have all contributed to this dilemma. What we need today to succeed is a real portfolio approach to customer acquisition. What we see instead from many companies is a reactive response to higher mailing costs, where we cut back on prospecting circulation and hope to make it up with online programs.
Unfortunately, “hope” is too often the operative word here. We reduce an investment in one “industry” without truly understanding whether opportunities exist in other “industries” to continue to grow our portfolios. Portfolio investing requires not just diversification, but also a true understanding of the cost of various investments and their corresponding return on investment potential.
In direct marketing, we call this “cost of customer acquisition” and “lifetime value,” and to successfully grow, we must understand how these metrics differ by channel and offer. For example, here is a company with the following metrics for their acquisition channels:
|
Channel |
New Customers |
Cost of Acquisition |
Lifetime Value |
|
Catalog |
5,000 |
$30.00 |
$80.00 |
|
Paid Search |
4,000 |
$15.00 |
$35.00 |
|
|
2,500 |
$12.00 |
$30.00 |
|
Re-Targeting |
1,500 |
$9.00 |
$20.00 |
|
Amazon Store |
1,500 |
$5.00 |
$12.00 |
Clearly it costs at least twice as much to acquire a new customer via catalog prospecting than in any of the online channels. If you stop the analysis here, you might decide to eliminate catalog prospecting entirely and acquire those 5,000 customers via other online programs at a reduced cost. Assuming that both paid search and email marketing are scalable enough to accomplish that, you save money in the short term and experience no immediate house file erosion.
But, as time goes by, what happens to your business?
- Assuming those new customers are equally acquired through email and paid search, you forfeit $262,500 in future profits,
- Assuming that lifetime value is driven primarily by retention rate (which in my experience, it is), your 12-month file begins to erode, driving down house file catalog and email circulation over time,
- Your business shrinks, putting tremendous pressure on your fixed cost structure.
Lest you confuse this as an appeal to keep mailing catalogs, please understand that I ran a business where we reduced catalog circulation by 35% over a 5-year period and maintained double digit sales growth and dramatically increased profits. I am completely channel agnostic, and in the above example, the exact same argument can be made against moving email prospecting investment to ramping up your Amazon store. Unless you understand both the cost of acquisition and corresponding lifetime value of a channel, you can easily shrink your business by trading off high LTV channel prospects for low LTV new customers.
Managing a portfolio approach customer acquisition program requires a thorough understanding of the following variables:
- The cost of acquiring a new customer through a specific channel,
- The corresponding lifetime value of customers acquired through that channel,
- The scalability (growth potential) of the channel.
Lacking knowledge of any of these three elements might cause you to unintentionally begin a downward spiral for your business.