When I left gainful employment as a magazine staff editor and set out on my own in 1979 with a B.A. in English and history, I was the quintessential, clueless first-time entrepreneur. Suffice it to say that my first two years as a small business start-up rookie were quite humbling.
What I needed was a simple tool to help me navigate the swamps of a typical start-up. So I studied measurable advertising from the direct marketing industry and fine-tuned it for my own use. This served as virtual red and green stoplights on my route to daylight.
First, of course, I had to find and develop the product, around which I could build a successful business. That was a marathon of its own. Once I had the product, I applied measurable advertising, and the results of each ad pointed me in the direction I needed to go next.
In year three my company grew rapidly, while staying very profitable -- about 20% pretax profits, in a retail apparel company. In year eleven I sold the company and walked away a free man, with time aplenty to help raise my children, consult, and follow new interests.
Besides a good product line, the key to financial freedom was measurable, targeted advertising. Used properly, it became a virtual bank for growth. When an ad or direct mailing succeeded, it paid its cost and delivered a profit. Doing this on a larger and larger scale self-financed rapid growth of both revenues and profits, and provided freedom from outside investors.
Too many small business owners view advertising as a necessary evil. It's just something you have to do, they subconsciously say to themselves. So they spend -- too much or too little -- and hope for the best. Little do they know that they are missing a powerful growth catalyst.
All they, or any entrepreneur, needs is measurement -- so that they can avoid flying blind with their checkbooks, and wasting precious capital and time on ads that don't pan out.
Fortunately there's a tried-and-true methodology that anyone can follow. All you need is discipline and accurate record keeping. Here's the skinny:
Whether your existing or proposed business is a restaurant, small manufacturer, technology service company, sporting goods retailer, landscaping business or day care center, measurable advertising works the same. All you need to know is your gross profit margin on the product or service you are advertising, the amount you spend on each ad or promotion, and your break-even point expressed in revenue per ad, and unit sales per ad. Here's the blueprint:
Take the net cost of your advertisement and divide it by your gross profit margin for the product(s) or services offered. This gives you your break-even point for that ad, expressed in revenue. Example: If the ad costs $1,000, and your average per-product gross profit margin is 50% (.50), then $1,000/.50 = $2,000. That is, you need $2,000 in revenue derived from that ad to break even.
Now, let's add a share of advertising art production costs, which might be $1,000, but which can be allocated over five runs, and hence cost $200 per run. So now the ad costs $1,200, and divided by the 50% profit margin, the break-even point in revenue attributed to that ad becomes $2,400.
The secret is key coding each ad. Let's say you run a magazine or direct mail ad with a "Department 101" code by the phone number and address, or a traceable link at your web address. All sales tied to "Department 101" are later tallied manually or by a linked spreadsheet to see if you topped your break-even point of $2,400. If not, try a different product or headline to see if revenues will move upwards. Or try a higher-margin product or service, and negotiating for a lower ad cost, both of which will lower your break-even point.
Let's say you strike a deal for an ad cost of $900 for the same-sized ad, you tweak the ad with a new headline that you hope will pull better, and experiment with a different product or service with a higher profit margin -- 63 percent in this example. Your break-even analysis now looks like this: $900 + $200 = $1,100/.63 = $1,746.
Now let's allocate the $1,000 ad development cost over 10, rather than five, ad placements, and increase your gross per-product profit margin to .66 (66 percent). Hence the allocation for creative development is $100 per ad. Now the ad total cost is $900 + $100 = $1,000, and the break-even point is $1,000/.66 = $1,515. Any sales over $1,515 for that ad are pure profit (minus the proportionate cost of goods, of course).
Perhaps you can run this promotion in larger media or larger electronic audience segments, more often, thus increasing your profit per ad run, and positive cash flow. There are no limits once you have a handle on measurable results. Losing ads are quite simply a red light; winning ads are a green light to run them again.
As you lower your ad costs and increase profit margins, your break-even point will steadily decline to a more and more comfortable level. (Comfortable, because they are predictably producing positive cash flow.)
Once you have a run a few ads in print media, by direct mail, by email or on the Internet, you will get some data on response. If your response ranges from $300-$800 per ad, and the lowest you can get your break-even point is $1,400, then you are on a dead-end road and need to cut your losses ASAP.
If your ad responses range from $1,500-$1,700, and you see a way to reduce your break-even point to $900 and your margin on the advertised product is, in this example, 66 percent or more, then you may have a runaway train of an ad in the making. The more you advertise well-conceived ads in large circulation, statistically reliable media, the more gross profit you can accumulate.
This discussion is based on one-dimensional advertising -- a process that does, or does not, make you profits based on one ad, or one mailing, or one Internet ad and the resultant sets of responses. This is a wonderfully simple concept if your product or service, media opportunities, and profit margins are favorable.
If they are not, then you need to go to the two-step method. Here you calculate the value of a new customer, and then acquire that customer -- via several ad contacts -- at a loss that is less than the value of a new customer. That is, if, for example, you can acquire a new customer at a loss, or cost, of $50 or less, and you have determined that a new customer's lifetime value to you is $150, then the $50 loss is, in effect, self-financing over time. If you have an adequate credit line, you can keep turning the advertising crank, knowing that the profits of the customers acquired at a loss will more than pay for the cost of acquiring them over the long run. That's what Lands End and a few others did in the halcyon days of direct marketing in the 1980's. But, that's a story for another time...
Frank Farwell is founder and past president of the WinterSilks catalog. His book, Chicken Lips, Wheeler-Dealer, and the Beady-Eyed M.B.A.: An Entrepreneur's Wild Adventures on the New Silk Road, was nominated by its publisher for the Financial Times/Goldman Sachs Best Business Book of the Year Award. It is sold in most English-speaking countries, at Amazon.com, and www.wiley.com.