Strategy-Hurdling to Profitability (1,147 words)

By Stephen Lett

Your catalog is like a piece of beachfront real estate: every square inch of space is valuable. And every square inch of space should be considered selling space—from the front cover to the back cover.

On every page, every product must pay its way for the space it occupies. Some catalogers like to use a traditional "square inch analysis," fairly common in the industry. I prefer a somewhat different method to measure the performance of any given product, which is based on the calculation of a "hurdle rate" —the amount of sales a product needs to bring in, given its space allotment on a page, to be profitable. Let's look at how to determine the hurdle rate and proper mark-ups in your catalog, in order to evaluate the success of the merchandise at the SKU level.

Product Selection First

I like to leave the actual product selection up to merchandising experts. The professional merchandisers have a real knack for knowing which items will sell best. After all, selecting products is a real art. My focus is on the analysis of the merchandise. What products sold? What didn't sell? How many pages should the catalog be? How much space should an item have? These are all important questions, which must be answered in order to maximize the earnings potential.

I have always subscribed to the "one-third, one-third, one-third" rule as it relates to merchandise in a catalog. This means that one-third of the items in a catalog will be the real winners—the best sellers. One-third will perform so-so, and the other third will be non-sellers. If you rank your sales by item, you will probably find this to be true for you, too. It is not brain surgery to realize that some items will sell better than others, and every item is not going to pass the hurdle rate. Obviously, the goal is to know what items to drop, how to adjust the selling space for the marginal items, and how to select more top selling items.

Another point has to do with changing out your merchandise from one printing to another. Rule: You should change 25 percent to 30 percent of your merchandise every printing.

What Price Profitability?

Let's start by defining gross margin vs. markup. I hear these terms used interchangeably much too often. If your cost for a particular item is $50.00 and you plan to sell that item for $100.00, your gross margin is 50 percent and your markup is 100 percent. A 50 percent gross margin represents a 100 percent mark-up. Gross margin and markup are not the same.

Hurdle Formula

Step 1: Total catalog cost / gross margin = dollar amount of sales needed to break even

Step 2: Break-even point per catalog / Number of pages = Break-even point per page

Step 3: Dollar amount of sales needed per page X Percent of page occupied = Dollar amount needed for particular item (Hurdle Rate)

Step 4: gross sales of item / hurdle rate = performance of item

Often, I see a cataloger leaving extra margin on the table. That's because catalogers tend to price based on a formula, such as "two times cost." I believe that prices should be set based on the "perceived" value of a particular item. Remember, the price/value relationship is the perceived value of a product at a given price. When prices are set based on the perceived value of an item, the price is generally set higher, which increases the gross margin and helps improve the bottom line.

Let's assume you print four times annually; spring, summer, fall and holiday. If you print four times a year, you most likely mail 12 times a year. For each printing, you are probably mailing three times; in other words, one seasonal drop with two re-mails every season.

Leaping The Hurdle

For each and every item in the catalog, you can determine a "hurdle rate" to measure the performance of the product. For example, a hurdle rate of 100 percent represents the break-even point. Any item doing less than 100 percent is below break-even. Any item generating above 100 percent is performing better than break-even. Here is how the hurdle rate is determined.

Let's assume your catalog cost in the mail is $.8222 and your gross margin is 50 percent, giving you a break-even point of $1.644 per catalog mailed ($.8222 divided by .50).

Assuming the catalog includes 24 pages, your break-even point is $.0685 per page per catalog mailed. Please keep in mind that this example represents a simplified version of the calculation. Customer returns and direct order processing costs should also be included.

Now, let's assume you mail 525,000, 24-page catalogs. You first need to calculate a hurdle rate as follows:

$.0685 x 24 pages = $1.644 per catalog

$1.644 x 525,000 = $863,310 in sales required

to break even.

$863,310 divided by 24 pages = $35,962 per

page needed to break even.

Let's assume you have an item that occupies one quarter of a page and $9,500 of gross sales. For an item to occupy 25 percent of a page, it must do $8,991 ($35,962 x .25) in gross sales to meet the hurdle rate.

If the item generated $9,500 in gross sales, the item did 1.057 percent of the hurdle rate ($9,500 divided by $8,991)—in this case, above break-even. On the other hand, if the item generated $8,000 in gross sales, it did 88.9 percent of the hurdle rate—below break-even.

By calculating the hurdle rate, it is easy to separate the winners from the losers in your catalog. Obviously, the higher the percentage, the stronger the item.

The products with a low hurdle rate will obviously need to be helped or discontinued. Hurdle rates between 90 and 99 percent deserve close attention. For those items, you might be able to improve the results by simply adjusting the amount of selling space, combining an item with another item, or by doing something similar. You will want to do everything possible to push these products over the hurdle rate next time.

Meanwhile, don't ignore basic merchandising requirements. For example, are you offering an adequate selection of merchandise—in both depth and breadth—to your customers? In general, you should be offering a minimum of 250 to 300 distinct products. If your product selection is too narrow, consumer interest will decline, and your response rates will drop over time.

By calculating a hurdle rate, you will be able to analyze your merchandising results most effectively. This is a never ending process. It's basic. It's necessary. And, it is important to the success of any catalog. Go for it!

Stephen R. Lett is president of Lett Direct Inc., a catalog consulting firm specializing in circulation planning, forecasting and analysis. He can be reached at (317) 844-8228 or through his Web site www.lettdirect.com.