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4/1/2020

 

Sales are down!

We have to cut costs!

Whoa, stop that train of thought for a sec…

 

Sometimes people believe things that aren’t true, such as believing that bulls (which are colorblind) hate the color red.  There are many reasons that smart people believe things that aren’t actually true, such as the confirmation bias, where people will often unknowingly go to great lengths to find evidence to support what they already believe.

It’s scary to go through a downturn, and it may mean unpleasant decisions like cutting valued staff or other resources.  In the face of declined revenues and increased stress, the idea of not cutting and potentially even increasing costs does not make sense to the vast majority of people, including marketers.  But if marketing is driving sales, what do you think will happen when you cut it?  Consider this question – do you no longer believe that your marketing is driving sales?

 

What’s the right next step for your brand?

Follow the exercise below to find out.

 

Step 1 – identify all of your costs

Your company’s profit and loss statement should reveal all of this information.  Use your recent average performance.  Perhaps all of 2019.

 

Step 2 – categorize your costs into three types

  1. Variable costs that happen with each order
  2. Variable costs that actually drive sales (ad spend for example)
  3. Fixed overhead – often referred to as selling, general and administrative (S, G and A)

 

Step 3 – build your profitability calculator

Report your sales and then setup your costs just like in the profitability calculator below:

 

 

Step 4 – identify the takeaways

  • Each time you made $1 in sales, you incurred $.66 in costs to fulfill the order and had $.34 left to pay for marketing and overhead
  • Each time you made $1 in sales, you paid $.79 to fulfill the order and pay for marketing to get the order, and then had $.21 left to pay for fixed costs (S, % & A), and contribute to profit
  • For every dollar you invested in marketing, you generated $8 in sales

 

Step 5 – now that we have things setup, we can run scenario models to see what will happen

 

Let’s start by looking at what would happen if we increased or decreased the marketing investment, with a simple assumption that your marketing effectiveness has not changed.  You still generate $8 in sales from each $1 invested.

See the results below?

What that tells me is that you haven’t been spending enough on marketing!  And, if you cut spend, you’re going to be in serious trouble and far more likely to have to lay people off.

 

Okay, that exercise was simple but maybe not entirely realistic.  After all, your ad performance is probably down, right? 

Your ROAS (return on ad spend) and broader ROMS (return on marketing spend) is probably down in this environment because it’s likely that many of you have seen lower conversion rates.   Let’s look at how to account for that.

 

New reality

Up to now, we based everything on your marketing performance historically.  But if the profitability of your marketing investment has come down, then you aren’t getting as much in sales per dollar invested in marketing.  You have a new reality.

We’ve run the math in the “New Reality” column below to calculate where you stand now.  That is quite simply what we have to work with. This assumes you don’t cut ad spend.

 

Ouch – profit dropped from $415k to $98k.

Time to cut marketing right?

No!

 

What should you do? 

Ok, we’re finally in a position to answer that question.

Remember that exercise where we looked at what would happen if you increased or decreased ad spend?  Now it’s time to run that calculation using your “New Reality” math. Remember, we just learned that company profit dropped from $415k to $98k.  We should probably be freaking out, right?

Here we’ve run 3 scenarios:

  • Lower ad spend
  • Higher ad spend
  • Much higher ad spend

Do take special note of the fact that as we increase marketing spend, we project a diminishing ROMS. Generally as brands scale marketing spend, they get a lower return as a higher % of the target audience is representative of prospects that are new to the brand.  The best way to estimate this is to ask the resource who manages this marketing/advertising spend to provide a projection of ROMS if you scale to higher spend levels.

Findings:

  • Lowering ad spend by $125k will kill the remaining profit and create a loss of $52k
  • Increasing ad spend by $125k will increase profit from $98k to $184k
  • Increasing ad spend by $375k will increase profit from $98k to $378k

You may point out that this brand used to spend $625k on ads to make $415k in net profit, and now they have to spend ~$850k on ads to make $378k.  They’re still making $378k!  This sure beats not making money and laying off staff.

  

Why the Investment Decision is Difficult

Ecommerce organizations faced with this challenge often look to the finance or marketing organization to inform the “what do we do” decision.  We are very much generalizing here and do not intend to imply that everyone fits in this category, but generally we find a couple reasons why it’s quite challenging for companies to get to the right decision for themselves on the right response to a downturn.

  • Finance departments– as a former CPA and CFO myself, I can tell you that I used to review marketing budgets and did not understand attribution and how ads scale and drive sales. I knew there was a connection, but it was difficult to have confidence that if $x was invested, $y would be generated.
  • Marketing departments – marketing personnel rarely have access to the Profit and Loss statement of the company. And while they generally understand how ads scale, it’s difficult to align them to real results if they can’t see the actual P&L and are limited to working with Google Analytics or ad platform reports.

Choosing to invest at higher levels during an economic downturn requires a certain amount of confidence about the math.  Given the common environmental challenges described above, this can be difficult.  Additionally, not everyone knows how to run the analysis we walked through, it takes an understanding of variable and fixed costs as well as how ads scale.  However, if you follow the steps we’ve laid out, you’ll get where you need to be.

 

Other Factors

Our analysis focused on how you might evaluate your response to an economic downturn, but it did neglect two other factors that might influence your decision.

 

First, realize that competitors are likely changing their game

Here’s the auction insights from Google Ads for one of our clients, where Amazon had historically held a 40%+ market share, but in March decided to exit the auction completely.  Amazon has left ads on a massive scale during the COVID-19 crisis. This has yielded a dramatic reduction to cost per click and improvement to ROMS.  Other brands may exit the auctions as well.  Things change, make sure you’re on top of it, and aware how it may improve or hurt your ROMS.  You may need to re-run your optimal spend analysis.

 

 

Second, be aware of the long-term impacts of pulling back

In Google Ads, a large percentage of your competitors are using automated bidding methods.  When you pull out of an auction, they capitalize by raising bids in auctions you used to participate in.  It will now be more difficult and expensive for you to return to the auction.

Also cutting spend on ads by lowering bids results in lower ad positions and that can hurt quality score.  This may not be a big deal, but worth considering if the pullback will be sharp.  We do generally find the bigger issue to be that when you cede ad positions, someone else steps in, and getting them back out is more expensive than if you had stayed put.

 

If you’ve made it this far, you might be having an internal reaction and thinking about how your environment is unique.  Maybe you have questions.  Feel free to shoot me an email at tom@conversionpath.com and I’d be happy to help.

 

Thanks for reading.

 

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