Manage by the ratios and the dollars will take care of themselves. And, keep in mind that dollars go into the bank, not percentages. Although there are many metrics to running a profitable catalog business, there isn’t one set of factors that works for all. For example, an apparel company might set a goal for their overall return rate of 22%, while a gift mailer would strive for less than 6%. The ideal metrics for any given company is one that leads to a profitable income statement. Key metrics can range from service levels to response levels to specific costs. Metrics are the main influences in the success of your business and all are essential. This month, we will discuss key ratio guidelines which will help to maximize profitability.
Benchmarking
It is important to understand the key ratios which are standard for your specific market. This will enable you to measure against these “realistic” standards. Set goals for each that will impact your bottom line. These goals can be set in a “what if” spreadsheet scenario. For example, if your cost-of-goods is currently at 50%, what would happen to your bottom line, if you were able to get this to 48%? This can be done for every line in your income statement. However, be cautious not to over estimate, or expect all of your goals to fall into place at once. In other words, be realistic about your expectations! As I like to say, “Under promise and over deliver”.
Direct Selling Expense (catalog design, production, printing, paper, bind-in order form, postage, lists, merge/purge, etc.) are a significant line item grouping on your income statement. For a consumer catalog company, this ratio typically ranges from 25% to 30% of net sales. For a business-to-business catalog company, this ratio is much lower ranging from 15% to 20%. As a general rule, the lower the gross profit ratio, the lower the selling expense to sales ratio. For example, if you are selling highly competitive, name brand products such as electronics, fishing gear, hunting equipment, etc., your gross profit margin will be low. And, your selling expense to sales ratio will also be lower than industry averages. While it would be nice to have it both ways, i.e., high gross profit margin ratio and low selling expense to sales ratio, this is generally not realistic.
So, what should key ratios be for a typical catalog company, both consumer and business-to-business? I would like to provide you with several key ratio guidelines but do keep in mind that these ratios will and do vary by catalog company. Again, the key to profitability is to manage these key ratios. If, for example, you decide to prospect more aggressively, you will increase your selling expense to sales ratio and doing so could result in a loss on your income statement. Yet, you might decide to accept a short-term loss on the bottom line for long-term growth and improved profitability. That’s fine. Just know the impact of the decisions you make on your income statement before you act.
| TYPICAL INCOME STATEMENT | ||
|---|---|---|
| B-TO-B | CONSUMER * | |
| Total Gross Merchandise Sales | 97.50% | 106.00% |
| Less: Returns & Allowances | -2.50% | -6.00% |
| Net Sales | 100.00% | 100.00% |
| Less: Cost-of-Goods | 48.00% | 46.00% |
| Gross Margin | 52.00% | 54.00% |
| Direct Selling Expenses: | ||
| Catalog design, layout and production | 1.50% | 2.50% |
| Print and Paper; Ink-Jet Address | 7.00% | 11.17% |
| Postage | 5.00% | 12.32% |
| List Rental | 1.00% | 1.88% |
| Merge/Purges | 0.75% | 0.40% |
| Order Form Bind-in w/Envelope | 0.55% | 0.66% |
| Other Marketing Expenses | 3.00% | 0.50% |
| Total – Direct Selling | 18.80% | 29.43% |
| Operating Expenses: | ||
| Total – G&A Expenses | 22.70% | 20.00% |
| Total S.G.& A. Expenses | 41.50% | 49.43% |
| Operating Income (loss) | 10.50% | 4.57% |
| Net List Rental Income | 0.50% | 1.00% |
| Income (loss) – EBIT | 11.00% | 5.57% |
| * Non-Apparel | ||
Format of Income Statement
It is important to format or to layout your income statement properly. Often times, the direct selling (catalog) expenses are included in the G&A (general and administrative) expenses. Direct selling expenses should be grouped together and separately on your income statement as shown in our example of a typical income statement. By grouping these expenses, it is much easier to manage this ratio.
Shipping & Handling Income and Expense
A common question that is often asked has to do with how shipping & handling income and expense should be handled on the income statement. Most often, shipping income is posted to the revenue line, i.e., sales. This is legitimate revenue line item that is part of gross sales. The actual cost to ship the order to the customer is a fulfillment expense and normally an operational or G&A line item. Shipping and handling rate charts are normally set (and adjusted) by the Marketing Department which is another justification for having this important line item on the top line on the income statement.
What to measure? How to reach your goals?
Cancellations are primarily caused by back orders. Cancellations (and backorders) also affect your revenue per catalog. In general, cancellations run 1% to 3% of sales. If you track the peaks of your cancellations (as an aging from the date of order), they generally occur when the 30 day and 60 day back order notices are received by the customer. Allowing enough lead time from order to need, using back up suppliers where necessary, developing strong inventory control/forecasting and maintaining accurate and current stock information for the telemarketing team all play a significant role in managing back order cancels.
Customer Return Rates have an enormous impact on your bottom line. Not only is a return costly to process ($8.00 to $10.00), it can dramatically reduce your gross demand (and your revenue per catalog mailed). In general, return rates range from a low of 1% to a high of 25% depending on your business. If return rates are an issue for your company, be sure to analyze what is being returned and why. To reach your return rate goals quickly, address the high volume, high return rate items first. If there is a top selling item that is returning at a high level, you should have the supplier fix what is causing the returns. You can also take an active role in reducing order processing errors. By conducting random checks on orders and measuring accuracy of the pickers, packers and other key personnel, you can identify problems before they escalate.
Cost of Goods should range from 45% to 55% and of course the lower the better. There may be room to reduce your cost of goods percent by raising the retail, but you have to be very careful to remain competitive and keep an eye on the perceived price/value of each item. Reducing your cost is generally a less risky approach to managing cost of goods. Negotiate with the supplier at every stage of the life of each item in your catalog. Run the numbers for each item and know what you can pay to make the item profitable. In addition, consider quotes from alternate suppliers.
Fulfillment Expenses and the cost to process an order can also range dramatically depending on your market and order volume. In general, the cost to process an order ranges from $7 to $15 and is heavily influenced by labor and freight costs. With all of the peaks and valleys of the catalog business, efficient staffing is a major challenge. Accurate order forecasting and flexibility are necessary. For some companies, no matter how well they forecast and staff, the economy of scale doesn’t work in their favor and they cannot impact their fulfillment costs. If you find that this is the case, consider outsourcing which can be a desirable alternative.
Catalog Cost and Direct Selling Expenses… a BIG line item on the P&L
There are many ways to reduce your direct selling expenses. Some things to consider:
- Test different paper grades and weights to see if you can use a less expensive paper without negatively impacting results. If you find a paper that is less expensive and lighter, you will save on postage as well.
- Annually bid out the production of your catalog with other printers and consider a slight adjustment to the trim size.
- Test an order form that is printed as a page in the book vs. a bound separate form.
- Look at the efficiency of your book size (physical size and page count) and make-up. Are you getting the most out of the way you are running your press forms?
Pre Tax Profit / EBIT for most catalogers is to achieve a 5% to 10% pre tax profit (measured as a percent of net sales). Since this is the final measure of a successful business, it is the common goal (regardless of market) that ultimately is the measure of how well all of your other metrics have played out. Although 5% to 10% is the general target for pre-tax profit, the actual dollars you are able to generate pre-tax, is just as important. You find that you have a pre-tax percentage that is lower than the prior year, but your actual pre-tax dollar increased. So, when working with “what if” scenarios, keep a percent range and total dollar goal in mind. Again, remember that you put dollars in the bank; not percentages! Note; when in start-up mode, don’t expect to reach this level until at least year 3 to 5 years, best case.
The road to profitability has many pot-holes along the way. It can be, and often is, a bumpy ride. Take it slow. Keep an eye on the ratios and the dollars will take care of themselves. Manage by the ratios and watch your profits increase!