"But Wait, There's More!" - The Economics of Direct Response Advertising
I have a client that's in an enviable position as the company re-launches the product Zap! in the Consumer Packaged Goods (CPG) space. Zap! restores porcelain, tub, fiberglass, grout, and more to its original condition, and I tried it on some grout by my front door and was amazed at the results. (See http://www.zap-restorer.com/ for more information about the product. A new website is coming soon with more info.) Most companies looking to launch struggle to get major retailers to pay attention to their product, but Zap! is different. First of all, multiple retailers contacted them about bringing back the product. Second, one of those retailers is Walmart, the behemoth of all retailers with over $400B in retail sales in 2010. Walmart plans to roll out Zap! in every one of its stores at the beginning of its next fiscal year in February, 2012.
That rollout presents challenges for the company. You see, in the CPG space people don’t buy a product unless they are aware of it. And being aware means exposure to advertising. How can a small company bring advertising to all the markets they need to in order to drive consumer demand? For Zap!, the answer lies in Direct Response (DR) advertising. Now of course, DR isn't for everyone, but the team and Zap! has extensive experience in the space, knows the industry service providers well, and has a product with the right kind of “wow factor” to make a good pitch on TV. In any case, the key to the economics is that with DR, costs of advertising are defrayed by product sales. We thought of it like this:
Net Media Cost = Gross Media Cost - DR Gross Margin
Given the expertise of the media buyer, Zap! is purchasing remaindered time at a low cost. That helps keep the Gross Media Cost low to begin with.
The real linkage becomes clear when you consider the effectiveness of the advertising. Since of course
DR Gross Margin = DR Revenue - DR COGS,
the trick is to determine what DR Revenue will be. Here’s where some industry jargon comes in. The measure of advertising effectiveness is Cost Per Order, or CPO.
CPO = Gross Media Cost / Orders
And of course,
DR Revenue = Orders x Average Price per Order
Finally, the best part of this for me was understanding the margins involved. For the business plan we showed a Gross Margin of 45%. The major costs involved were product (about 30%), and telemarketing and fulfillment (each about 10%). In doing research on the product’s DR history, there were times when product COGS were a mere 10% of revenue. DR is part science, given the copious amounts of data generated for each ad shown on TV, but also part art in how offers are developed and tweaked. (Here is another area of expertise for the Zap! team.)
In the final analysis, the product’s Average Order Size x Gross Margin = Gross Margin per Order. If that is above CPO, the company is printing money: the more ads they buy, the more money they make. Zap! has been there before and certainly could do it again. For planning purposes, the assumption was only that DR revenue reduced the costs of the sales & marketing advertising expenses.
If you’re interested in learning more about Zap!, please email me. You'll also get the amazing Potato Peeler Glove for just three payments of $19.95!