The Direct Mail Business – An Economic Analysis (written July, 2000)
For any industry to exist, it must be profitable. For any industry to exist, the sales revenue generated by the products it produces and sells must exceed the costs of producing and distributing these products to the ultimate consumer.
These first two sentences might at first sound like “high brow” comments which would be delivered at a symposium of Nobel Prize winning economists, but if you stop and think about it, these two sentences represent a very simple and obvious truth. Unfortunately, many people do not really think about this when investing their time and money in some sort of business venture.
In any industry, there are a few individual firms who are the most profitable producers. By most profitable producer, I mean that each sales dollar generated by the most profitable producer has the greatest percent of profit. The most profitable producer might have ten cents profit per sales dollar while lesser profitable producers might make only three or four cents on each sales dollar.
Why is it that some firms always seem to be more profitable than others and maintain this margin over time? Let me suggest that one reason is that the most profitable firms either consciously or unconsciously understand the price and cost structure of the markets in which they deal better than their competitors. By price, I mean the dollar amount they can get from customers when they sell their products. Cost means the amount the firm must pay to obtain the product from manufacturers to wholesalers.
Some firms seem to have a “knack” for taking advantage of situations where the sale price is maximized and the cost of the product is minimized. Take for example an auto dealer. In the spring, many customers “feel good” about the coming of spring, the end of winter. The warm weather is on the way. These conditions bring out a greater number of potential auto buyers who are serious buyers. Auto dealers frequently buy cars in volume in the spring from their Manufacturers, thereby getting a low cost per auto. With a large number of buyers in the market, the dealer can normally get a better price than would otherwise be the case.
Cars bought from the manufacturer (at a relatively low per car cost) are sold to the consumer at a relatively high price. Do you think this is not true? Well if it isn’t why, do you see so many big auto sales in the spring? In fact, in our area, some local dealers get together and rent the parking lot of a local arena. Over a three-day weekend sale, they have a huge inventory of cars at this big arena parking lot. One time, this group of dealers even rented the runway of a closed airport! Buy cars at a relatively low unit cost from the manufacturer, sell at a relatively high price to a big pool of buyers. Nothing wrong with this. All things taken into account, the buyers get a better price than might otherwise be the case. The volume purchase cost savings work their way into the final price. This is free enterprise at its best.
Another economic principle, which will play into what you do as a direct-mail participant, is the economic principle of continuing to sell products until the marginal revenue from the sales equals the marginal cost of production and distribution. What does this mean? When used in economics, the term marginal means extra. For every extra unit produced, the question is what is the addition revenue generated from the sale of that extra unit and what is the cost of producing and selling that unit. What you read next is a real life example of how this works out.
About twenty five miles east of my house is the home office of Kellogg’s cereals. Now let’s say that Kellogg’s has on factory, which produces corn flakes. For example purposes, let’s say that a box of cereal sells from the factory to the grocery store for two dollars. The cost of producing each box of cereal at plant #1 is $1.40. That gives a profit of $.60 per box. If plant #1 is going full speed 7 days per week and still cannot keep up with the demand for corn flakes, Kellogg’s would likely build a second plant. Since Kellogg’s customers and suppliers know that Kellogg is making $.60 per box on the cereal, they will put price pressure on Kellogg’s to get a piece of that $.60. The suppliers are attempting to increase their prices and the customers are attempting to pressure the cost down to something under $2.00 per box of corn flakes. With plant #2, the price and cost pressure might cut the profit margin to $.40 per box.
Now if plant #2 gets to a point where it is going full speed and Kellogg is still making $.40 per box, they have an incentive to build a third plant. However, the cost/price pressure could easily reduce the profit margin to $.20 per box of the output of plant #3. If plant #3 is going full speed and the profit per box is still $.20, Kellogg would have to decide on possibly building a fourth plant. On the potential fourth plant, Kellogg estimates that the price of each box of cereal to the grocery store will be $2.00, but the cost of production per box will also be $2.00. At this point, it is a toss-up as to building or not building the plant. As you can see, Kellogg will keep building corn flake plants until the sale price ($2.00 per box) equals the production cost ($2.00 per box).
The Kellogg example is in theory what happens in an economy. In real life, the costs and prices are constantly shifting, but the underlying concept of producing until marginal revenue equals marginal cost still holds. Now you might be saying “OK all of this is nice, but what does this have to do with me as a direct mail marketer?” Easy!
Let’s say that you have a mailing list of 10,000 people. Break the list down to ten groups of 1,000 each. If you mail an offer to the whole 10,000, you might get an average response of 15 to 20 out of each group of 1,000. Now let’s jump that mailing list to 100,000. You might still get 10 to 15 responses per thousand. But here is the kicker – the cost to reach each individual listed on the 100,000 list is less per individual than each of the list of 10,000. So what is happening is that this “law of marginal revenue equaling marginal cost” is being knocked on its head! As a large volume mailer, your per letter costs are declining as you increase the size of your mailings and yet the chances of getting a response in any group of 1,000 are about equal. The likelihood of getting a “sale” remains the same as your marginal (or extra) cost drop. By sending out big mailings, you become the smart business firm by taking advantage of the favorable price/cost structure of the industry.
Let’s take some real numbers from a real printing and mailing service, CME Mailing Express, Inc. These numbers are actually going to be higher than the final cost because they do not reflect the bonus circulation and 10% price discount which CME offers. They do however provide a good starting point. On a 10,000 piece cooperative mailing, the charge for one side is $187 for the list of names, printing, stuffing, postage, handling, and the delivery to the Post Office – the works! The unit cost is 1.87 cents per letter – and remember with bonuses and discounts, the final price is actually lower. On a 15,000 piece mailing, the total cost of “the works” is $251. Extra cost for the extra 5,000 pieces is $251-$187 = $64. The price per piece for the extra 5,000 is 1.28 cents. Jump to 20,000, the extra cost is $307 – $251 = $56. The per piece cost for the extra 5,000 from 15,000 to 20,000 is 1.12 cents. Do you see how the marginal cost is dropping, not going up as with the corn flakes?
Until eight months ago, CME mailing services were complete strangers to me. But after talking with him several times and using his service for some 100,000+ mailings, I have developed a great deal of respect for the way they do business. But you should make your own evaluation of CME. Do some research. You might want to start with a call to the Better Business Bureau. I think you will be favorably impressed. What are some of the other benefits of large mailings?
In Multi-Level/Direct Marketing, your chances of financial success are greatly increased by having other big mailers in your downline. How do you maximize the likelihood of finding other big mailers? Please read on. CME offers mailings of 10,000 to 100,000 (actually these workout to 12,500 to 125,000 when the bonus is added.) Now think of these 12,500 and 125,000 piece mailings as two cities of 12,500 and 125,000 population. In a city of 125,000, you are far more likely to find a variety of services which you would rarely find in any city of only 12,500. A city of 125,000 would be far more likely to have a hospital with a wide range of high level medical services (heart specialist, brain surgeons, nuclear medicine clinics, etc…), a symphony orchestra or an auto repair shop specializing in expensive sports cars than a city of 12,500. In fact, very few cities of 12,500 would have any of these things.
By mailing to 125,000 rather than 12,500, you would be far more likely to “hit” another big mailer than with only 12,500. Like anything in business, nothing is guaranteed. The likelihood however of finding the big mailer improves with the size of your mailings. Now you might say “Ok, all of this is nice, but $1,100 or so for a big mailing is a lot of money.” Very true. But consider this. In starting any new business, the start up costs can be considerable. Buying a computer, getting the software you need, having a computer specialist set up the software, legal fees, accounting fees, etc., which happen to one degree or another in all new businesses could easily cost over $4,000 or $5,000. This $4,000 or $5,000 would not do one thing to get you a customer for whatever it is you are selling. With CME, about $4,400 could get your product advertised in cooperative mailings to 500,000 people. Think about it.
Am I recommending that you borrow large sums of money to pay for large mailings? No! But do keep in mind that any successful business will very likely require a definite “up-front” financial commitment. Be realistic about the time it will take to start making a decent income from any business. It is not uncommon for a new business to take three years or more to “breakeven”. Keep in mind that direct mail selling however is about the only business where you can invest very little time of your own. You can deal through organizations such as CME Inc. by simply “buying in” to the name lists, printing services, envelope stuffing’s and bulk mail postage rates they handle.
Study and understand the economics of the direct mail business. Learn the cost/profit/operating structure of business. Above all, study, learn and think! On one final note, do you think that all direct mail is a “scam” and there is no profit in it? Well if so why do organizations such as Reader’s Digest of magazine publishing, L.L. Bean in the outdoor hunting and equipment business, and Harriet Carter and The Country Store of the “off beat” housewares and gifts industry mail, mail and keep mailing? One last thing to check. If you are really serious about this, find a copy of the September 6, 1999 Forbes Magazine. Read the article on pages 280 and 281. The article has nothing to do with direct mail, but a perceptive reader will see the possibilities of direct mail after reading about Mr. Dunlap and the Francis L. Suter.
The author of this article is Cy Mallinson, 1311 Manor St, Kalamazoo, MI 49006-2143, Fax 616-342-2242. His article has been inspired by our own Larry Costello, President of All-American Print & Mail, 2200 Wilson Blvd #102-57, Arlington, VA 22201.