The fallacy behind “break-even point” strategy

We believe that there is a big fallacy buried in the strategy of companies that use direct mail.

Most direct mailers, especially catalogers, have a ‘house list’ of customers to whom they mail. This list is scored by one methodology or another, for example recency or RFM (Recency, Frequency, and Monetary value). These companies usually talk about “mailing down” the list to some point called the “break-even point.” By this they mean they have ordered their scored list with their best customers at the top and their worst customers at the bottom, and have identified a point on the list below which it is unprofitable to mail. “Unprofitable” typically means that the mailing cost to reach these lower ranking customers exceeds the gross margin dollars that the mailing generates.

Companies who confidently use this approach think they can’t lose money, that it is good business and safe practice to send out more and more catalogs as long as they stay above that sacred break-even point.

Wrong!

Forget for a moment that RFM scoring is notoriously inaccurate in the low and mid-level deciles where the ‘break-even point’ lies. If that’s the method you are married to, rather than more accurate loyalty scoring, then stick with it. To understand the fallacy, it really doesn’t matter what scoring method you use. The bigger problem lies in the customer selection, not in your scoring methodology.

What your goal should be

The goal of a marketing campaign is to generate margin dollars — gross profit, not just revenue. The more margin dollars collected, the more successful the campaign. As print mail costs rise, it becomes harder and harder to have a profitable campaign. The obvious alternative is email, but emailing everyone over and over again runs the risk of turning off your customers completely and having them click the unsubscribe link, losing this channel to reach them forever.

Picking who to contact is the key to success.

The break-even strategy is flawed because it doesn’t consider the purchase probabilities for individual customers at the time of the campaign. Marketers that use this strategy calculate aggregate sales, typically by deciles of the scoring metric used, and typically after a campaign is completed. They look at the revenue for each decile and then decide at which decile the gross margin dollars from those aggregated sales drop below the mailing cost. Then they cut off below that decile in the subsequent campaigns.

Instead, customers should be ranked according to their probability of purchasing the products being offered in the next period. Then calculate the predicted revenue from each individual customer to find the set of customers who will generate enough revenue to cover the communications cost. This yields a unique set of customers in the target list. It is the most accurate way to determine when revenue will exceed costs, and the best way to optimize a marketing budget. Building your target list beforehand using purchase probabilities generates more margin dollars than using the break-even point from a previous campaign to determine which customers to touch in a subsequent campaign.

Companies that use the break-even strategy are looking at the problem from the wrong direction. Instead of asking “How deep can I mail and still be profitable?” they should be asking “How profitable can I be with the money I’ve budgeted for the direct mail campaign?”

[My thanks to Bill Vorias of Loyalty Builders for challenging conversations on this topic.]

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