Understanding Allowable Cost Per Order

No matter what the branch of marketing a firm is in or where that branch fits on the continuum, every successful marketer knows that there is a finite amount that an organization can afford to spend on each customer to promote its product or service. We call this the “Allowable Cost Per Order” or ACPO.

This amount can be determined through a calculation based on a mix of the revenue the marketer expects to receive for each product unit sold multiplied by the number of units the marketer expects to sell, less all the costs of the manufacturing or production of the product and its distribution. Stated as a formula, this can be expressed as:

ACPO=Total Revenue – all expenses including profit and/or contribution.

This formula can be applied to a single or multiple sale, a subscription, a club or any sales sequence to consumers or businesses.

If the marketer’s promotional efforts are very successful and sell more than originally contemplated, the organization benefits on the bottom line by being able to amortize promotional spend over a greater number of sales, thus reducing the amount of promotional money that must be allocated to each sale. Conversely, if sales to not achieve the desired level, each unit of merchandise is burdened with a greater marketing cost than had been anticipated and is reflected in lower profits or unexpected losses. A recent article in The Economist drew attention to this: “Last year…GM’s (General Motors) profit per vehicle was a scant $350—providing a wafer-thin profit margin of 1-2%. With manufacturing costs these days cut to the bone, the only way for carmakers to raise their margins is to lower their marketing and warranty costs.” [Emphasis added].

Even with the benefit of highly sophisticated models, “image” advertisers are subject to a high degree of risk. This risk reduces the closer we get to individual or one-to-one relationships with our customers. We can see them much more clearly, and they are many times more accountable than when we are marketing to the average consumer or even selected consumer segments. All marketers share a common objective, to obtain an actual cost per order lower than our allowable cost per order.

The concept of ACPO works at every stage of the marketing continuum. Although it is least applicable to image advertising, it still plays a positive and profitable role. But it becomes an increasingly powerful tool when applied to sales promotion, direct marketing and CRM.

The critical economic factor is always how much we can afford in marketing spend to make the sale, transform the prospect into a customer and retain the customer’s loyalty.

How much we can afford to do each of these things depends on a number of factors. Some are more obvious than others. There is the revenue we expect to receive. From this must be deducted the cost of the product we intend to sell, the cost of any sales incentives, the cost of handling and delivering the order, of collecting the money and much more. There is also the attrition rate of customers when the product is delivered and paid for over time and there is the cost of maintaining the customer relationship.

Finally, and importantly, there is the profit or contribution we plan to make. What can we afford to spend for promotion is what’s left after all these costs are deducted from the revenue.

This is the Allowable Cost per Order. It is arguably the most important economic factor in marketing and the one that most profoundly affects the profits on the bottom line. It informs every aspect of the marketing economics and media strategy. If you can’t calculate the ACPO you are, so to speak, flying blind, an activity not known to contribute to getting you where you wish to go or even surviving the journey.

A Single-Product Example

Calculating the ACPO for different types of products and promotions depends upon the marketer having sufficient data and tools to develop appropriate models. To better understand the drivers that condition the ACPO calculation, it would be useful to look at a sale of a single product.

The simplest sale is a single sale to a single person. Its economic requirements are rudimentary and every merchant who stays in business uses them in one form or another as second nature whether or not he includes direct marketing in his marketing armory. While this examples assumes this sale is made at a distance—what is usually called a “mail-order” or direct marketing sale-most of the criteria are the same if the product is delivered at the retail level.

Before direct marketers discovered the many advantages of acquiring a “customer” instead of simply making a “sale,” this was the most common form of responsive offer. It is still used frequently. It allows the user to input the important data and delivers the results including sensitivities (defined by the user) to aid planning.

The marketer needs the following information:

*The revenue value of an individual unit.

*How many units the person will buy.

*The total product cost per unit.

*The revenue from postage and shipping chargebacks if any.

*The cost of sales or other taxes.

*The total costs of fulfillment including distribution, handling, credit card charges, etc., if the product is to be delivered rather than sold at the retail.

*An assumption for bad pay.

*An assumption for product returns.

*The costs of any premiums or incentives to be given including shipping them if separate from the product shipment.

*Any miscellaneous expenses.

*The desired profit or contribution.

From these inputs we can compute the “Net Margin before Promotion.” Using an estimated total promotion cost per thousand, both the number of orders necessary to recoup the promotion expenses and the percentage response needed to get them are simple to derive.

In our example, we look at a single product with a unit price of $60,00 and a unit product cost of $15.00. There is also a “Postage Charge Back for Package,” which is additional revenue to help cover the costs of postage or other distribution. The model contemplates the sale of two units of the same product to a single buyer. What we see when all the operational costs have been deducted is $29.22 (Net Margin before Promotion). The question is: How much marketing can we buy for $29.22 or put another way, what level of response do we need to attain the 15% profit or contribution margin that is our objective?

Using this model, we see that we would need a 2.74% response to meet the target. If experience teaches that this is unrealistically high, then the additional cost of making the sale will eat into the profit or contribution margin and may negate the project, sending its proponents “back to the drawing board.”

To evaluate the effect of different response percentages, we also calculate sensitivities. The percentage in this case is 20%.

Let’s say the target percentage response is 1.71% and reducing it by 20% gives us a percentage response of 1.37%. This allows us to do easy “what ifs”: what if, for example, the response percentage was only 1.10%? How would this effect the profit? As can be seen, it would fall from the desired 15% or $18.53 to only 1.69% or $2.09.

Obviously, changing the promotion cost per thousand people promoted from $500 to, say, $800 would also substantially impact the results. The response needed for breakeven (including the desired 15% profit or contribution) has increased to 2.74%.

From Accountable Marketing, The Economics of Data-Driven Marketing 1st edition by ROSENWALD. Copyright 2004. Reprinted with permission of south-Western, a division of Thomson Learning: www.thomsonrights.com. Fax 800-730-2215. Copies are available online at: http://www.racombooks.com.