Marketsmith, Inc. - Article From Newsletter

At Marketsmith, we have found that often companies do not look at the relationship between price bands and response rates. That relationship has a direct impact on the short term bottom line and the long term health of the company. We have seen response rates fall significantly in nine out of ten cases when the average price increased.

Faced by challenges from rising costs for both operations and advertising, catalogers are looking for immediate solutions and they have come up with two which appear to work in the short run:

1.	Increase promotions and/or lower their prices in the hope that will attract more customers (lift response rate) and grow the top line.
2.	Raise prices across the board or in significant merchandise areas with the goal of increasing the top line revenue.

The fallacy in both of these solutions is that growing the top line without a strategy will not necessarily improve results. What we found over and over again is a company struggling with a decreasing response rate is glad to see an increased average order to offset the decline in customer file or orders. But this logic is flawed and has created long term detrimental affects on many models. While companies focus on fragmenting and then cutting circulation in an effort to offset deterioration of house and prospecting response rate, the boat sets sail in another direction with the merchandise price bands being driven up by another governing body. The disconnect of this action puts many models in jeopardy and many companies lose because of the practice.

Merchandising and Marketing must talk to each other and not develop strategy without input from each other. As noted above, price points are tied directly to response rates. The key to understanding this relationship is that the numbers of products offered in each grouping drives the way a consumer or prospect makes a decision. Price points are part of the Brand DNA and how customers perceive the products and their value. Evaluating price bands, that is the number of products within price groupings, is part of the actual science of estimating response rate. There should be no change in pricing strategy without doing the math, projecting performance and testing the hypotheses in the real world. The analysis must also consider the consequences three to five years out.

Here are two examples that show the impact of a change in average price point offered and the shift in price bands:

A company offered a significant reduction on a large portion of its merchandise for a specific mailing in 2007. In 2006, there were no promotions for that mailing. Not only did contribution drop by a huge proportion, nearly 60% for the housefile, 83% overall, every other metric also decreased, except for circulation. In addition to decreasing performance for this book, we would argue that the promotional effort made consumers rethink the catalog, its merchandise and its value ratio to customers. This may seem like an extreme example and many will think that the results should have been a higher response rate and an increased demand. It may make sense to accept a decrease in prospecting results if it can build up the housefile. But if contribution goes down for the housefile, the company is shooting itself in the foot.

2007
	Circ	Adj Orders	RR%	Avg Order	Adj Demand	Ctrb	Ctrb/ Ord	Ctrb %
Total Main Mail:	4,750,000	107,317	2.26%	$51.26	$5,501,544	$90,469	$.84	1.64%
Total House:	3,752,816	91,951	2.45%	$49.33	$4,536,356	$254,592	$2.77	5.61%
2006
	Circ	Adj Orders	RR%	Avg Order	Adj Demand	Ctrb	Ctrb/ Ord	Ctrb %
Total Main Mail:	4,321,893	113,492	2.63%	$57.59	$6,535,650	$521,766	$4.60	7.98%
Total House:	3,428,337	98,769	2.88%	$57.35	$5,664,438	$626,804	$6.35	11.07%
2007 vs 2007
Total Main Mail:	10%	-5%	-14%	-11%	-16%	-83%	-82%	-79%
Total House:	9%	-7%	-15%	-14%	-20%	-59%	-56%	-49%

In this next example we show that the company drove the average order up over a period of time which hurt revenue, the bottom line, response rates and the housefile size, as can be seen in the table immediately following. The chart below shows that, additionally, the cost to acquire was driven up.

In this case, we can see that the company hit its sweet spot in FY 2007. The business model could handle the increase in average order (which we take as a proxy for pricing); the 12 month file increased, contribution increased, overall and per order; although the response rate was down 10%. But the business could not sustain the pricing increases, showing a precipitous drop in contribution and another drop in response rate which we can see began to affect the 12 month file.


	12 Month File	Demand	Response	AVO	Contribution	Contribution/ Order
FY 2008	904,600	$51,136,862	1.81%	$97	$4,692,386	$8.87
FY 2007	924,600	$57,467,268	1.90%	$94	$9,144,997	$14.92
FY 2006	856,500	$57,843,051	2.10%	$89	$9,012,808	$13.91
2008 vs.2007	-2%	-11%	-5%	3%	-49%	-41%
2007 vs.2006	8%	-1%	-10%	5%	1%	7%
2008 vs.2006	6%	-12%	-14%	8%	-48%	-36%

As the average order went up every year, so did the cost to acquire a customer, eroding the contribution. The available universe from which to acquire customers under this fiscal scenario has decreased significantly since there are fewer customers who are willing to pay higher prices

Pricing strategy matters. When looking at your business you need to go through a thorough evaluation of the following areas to make sure that the Brand is not forcing the merchandise to make up for challenges found in other cost centers.

1.	Manage your SKU's per catalog and category with a refined and definitive science.
2.	The science is knowing the percent change you can make without affecting your expected outcomes—the Marketsmith rule of thumb is no change greater than 5% in density or price point bands.
3.	Understand your three closest competitors and make sure that your prices for the exact merchandise are within 10% including shipping and handling.
4.	If you exchange and/or have list rental relationships with companies that sell the same products, make sure your relationship is beneficial to your Brand, providing a substantial return through the combination of contribution from the other mailer’s names and list rental income.
5.	Make sure you have a fluid handle on blocking in your co-ops.

The merchandise game has gotten difficult for catalogers. Manufacturers can not easily afford to invest in new merchandise expansion which limits product availability and/or increases the cost to expand a merchandise line. In either case risk increases dramatically. Add to the mix the entrance from the Big Box retailers as a first to market, which also puts a squeeze on the new product availability. Manufacturing from China is becoming unpopular with consumers.

The need to chase higher margin product is driving up the average price offered. As we have seen, in the end this strategy is causing decay in the response rate which makes the business smaller and the cycle continues. Catalogers spend much time and effort considering their merchandise mix with a goal of delivering product which is relevant to their consumers. While this focus is critical to the success of the business, making certain that the pricing strategy fits with consumers' expectations and brand perceptions is equally, if not more important to ensure the long term health of the business.