Q. I’ve been using direct mail (DM) to market my product. I sent out 500 pieces and had 17 people purchase my product. I think these results are good, but I’m not 100 percent certain. I’m contemplating borrowing money to expand my DM operation and mail to about 1 million people. Is there anything about which I should be concerned?
A. It sounds like you have an interesting opportunity. However, before going all in, we suggest that you focus on three things:
Breakeven – The first thing you need to understand is the close rate you need to breakeven. In your test, you had a close rate of 3.4% (17/500). For direct mail, that is typically very good. However, you still need to verify that, given the economics of your product, this close rate will make you profitable. We’ll define a couple of terms to help you with this calculation.
Close Rate – the number of closed sales divided by the number of pieces mailed
B/E Close Rate – is the Close Rate you need to breakeven on the mailing
Variable Mail Cost – the cost per piece mailed including postage, printing, etc. (these costs increase in proportion to the number of pieces mailed)
Fixed Cost – the cost of executing your direct mail campaign including creative development, campaign management, etc. (these costs do not change as a function of the number of pieces mailed)
Gross Margin – the money (in dollars) you make from each closed sale (the sales price minus your cost to deliver the product or service)
Pieces – the number of pieces of mail you drop
In a breakeven calculation, revenue must equal cost. Therefore, the breakeven equation is:
B/E Close Rate X Pieces X Gross Margin = Fixed Cost + (Pieces X Variable Cost)
Solving for the B/E Close Rate:
B/E Close Rate = ((Fixed Cost / Pieces) + Variable Cost) / Gross Margin
If the B/E Close Rate you calculate, is less than your actual close rate, you’ll make money. Notice that the B/E Close Rate declines as the number of pieces mailed increases. This is because when the number of pieces mailed increases you amortize the fixed cost of the campaign over more pieces of mail. Therefore, the fixed cost per piece is less. When calculating the breakeven, use the number of pieces that you would expect to be able to mail consistently after rollout (this will likely be more than the 500 you mailed in your test).
Source of names and mail frequency – To execute an ongoing direct mail marketing campaign, you’ll need a reliable source of names to mail. Make sure that you have access to enough names to make your program successful. You will need to test to determine the best cadence for mailing your prospect list. If you mail too frequently, close rates will decline to the point that the mail campaigns are unprofitable. If you mail too infrequently, you are missing opportunity. Test your way into the optimal mail frequency.
Sample size – To date you have tested a very small sample size, only 500 pieces mailed. With this sample size and response rates in the 3% range, you can be 95% confident that your actual close rate will be ± 1.5% of the result you got. Your observed close rate was 3.4%. That means you can be 95% confident that the close rate with your planned 1 million mail pieces will be between 1.9% and 4.9%.
If your breakeven close rate is below 1.9%, you are probably safe significantly expanding the size of your DM campaign. However, we think it would be prudent to test with a mail drop of 10,000 to 100,000 before rolling out to 1 million. With a mail drop of 10,000 pieces, you will be able to read close rate to within ±0.33% and with a mail drop of 100,000 pieces, your confidence interval will shrink to ±0.11%. We suggest testing at these levels before rolling out to 1 million people.
DM can be a profitable way to market certain products or services. It can also be an expensive waste of money. It sounds like you may have a promising opportunity. Using the three tips above will help you to make sure you come down on the right side of the ledger.