Editor’s Note: This post was originally published on Seattle 2.0, and imported to GeekWire as part of our acquisition of Seattle 2.0 and its archival content. For more background, see this post.
By Danielle Morrill
Being lean is about getting an efficient output in relation to your input, by managing to the constraints of your business.
What I’m interested in isn’t “how can I do a tradeshow for $1,000″,but “how can I make sure I get a really impressive ROI on $1,000″. More specifically, how do I generate high quality leads who are likelyto spend enough money on my products in the course of their lifetime asa customer to give me a 10x return (and often much better) on what I’vespent to acquire them.
For consumer products, if I am buying traffic this means I need tomake sure that is being paid for my customer acquisition down the line– converting a certain % of that funnel for a certain average lifetimevalue per customer. For bigger ticket items, usually falling into thedomain of B2B, I need to do the same but the up front expense is goingto be larger (and the lifetime customer value will also be much bigger).
What constraints are at work here?
- How much money to do you have to spending on customer acquisition?
- What is the *maximum plausible lifetime value* of a customer?
- What is the *maximum possible throughput* of your sales team?
Maximum Customer Lifetime Value
This is the maximum amount of money you can realistically expect a customer to spend.
If you are selling wheelbarrows (just bear with me here) thecustomer probably will only need one at a time, and if he continues togarden his entire life (highly unlikely) he will replace it every 7 to10 years from age 30 to age 70. There is also no guarantee he will buyfrom you twice because there are plenty of places to buy wheelbarrowsand brand loyalty is extremely low.
So let’s say the maximum number of wheelbarrows you can expect himto buy from you is 3. And they each cost $50. This means the maximumrevenue you’ll see from him is $150. Let’s say the wheelbarrows costyou $20 each, so the maximum profit you’ll see from him is $90. You canspend up to $90 marketing to him and still be cash flow positive – buthopefully you’ll spend much much less.
Selecting Marketing Channels
Imagine you are considering going to a tradeshow for mastergardeners, hoping to sell your wheelbarrows and build brand awarenessfor your business. You think you will stand out as one of the nicheretailers there, and the sales people for the event have offered youwhat sounds like a great deal. For just $10,000 you can have a booth onthe show floor for 3 days and mingle with an estimated 20,000 attendees.
You quickly realize that going to this tradeshow will be great, butyou’ll need some help to interface with all those people. You’ll alsoneed to find someone to work at your store (opportunity cost) whileyou’re gone. So you hire two hourly people to help you set up, present,and break down your booth. You also ask your best staffer as the shopto work overtime during the weekend. So for the 3 days you will bepaying an extra $1000 a day in personnel expenses. Additionally, you’llneed to spend about $1000 on signage, shipping, and other things tomake your booth professional and presentable. So your cost is up toabout $14,000 now.
There are 20,000 people attending, so you feel like you’re doing great. You’re only spending $0.70 per attendee!
Maximum Sales Throughput
Maximum sales throughput is the total number of sales you can physically make within your constraints.
Constraints include:
- How many people you have on hand to ring up customers
- How much inventory you have in stock
- How many conversations you can have in a given period of time
So you’re spending $14,000 to reach an audience of 20,000 people. Of course, you can’t expect that every single person is going to buy awheelbarrow, but you know that this is a relatively qualified group. You decide that with 2 hourly people to help you ring up customers andanswer questions you could probably sell a maximum of 1 wheelbarrowevery 5 minutes or 12 wheelbarrows an hour, and the tradeshow floor isopen for 10 hours each day so that is 120 wheelbarrows each day, for atotal of 360 people you can possible reach – or a conversion rate of1.8%.
Remember, we said your margin on a wheelbarrow was $30? This meansyour maximum possible profit with all the current constraints is$10,800. You’d be spending $14,000 to make $10,800… not such a greatidea.
Managing to Constraints
Before you give up on the idea entirely, you consider what you coulddo to reduce your cost or increase your sales throughput. You couldclose down the shop to avoid paying overtime, but then you’d miss outon potential sales there as well (remember that saying “don’t look forfish when you’ve already found fish”?). You could try to reduce yourstaff at the booth to reduce your cost, but then you might only be ableto sell 1 wheelbarrow every 10 minutes.
About this time your wife walks in, and askes youwhere you think people are going to store these wheelbarrows all dayafter they buy them. Are they going to go put them in their cars, orwheel them around with them? She thinks this could be a major barrierto making a buying decision.
You’re so demoralized now, and are thinking that working out themath for this tradeshow is costing you much more time than its worth. You decide to have a glass of wine and think it over later.
Keeping the Goal in Mind
Going back to the beginning of this post what was the goal? Toefficiently sell wheelbarrows, but having our input multiply 10x orbetter upon a sale.
Two constraints:
- It is too expensive to sell wheelbarrows at a rate of 1 per 7 minutes
- Customers are unlikely to buy because they don’t have a place to store wheelbarrows
You jump up so fast you nearly spill what’s left of your wine! You’ll use the interne! People can walk up to self-service kiosks (alaptop and a monitor) to place their wheelbarrow orders.
You’ll keep one person on hand for helping you field questions, andyou’ll send the other hourly worker to the store instead of yourstaffer so that you don’t have to pay overtime. You’ll borrow thecomputer equipment from a friend in return for a couple wheelbarrows,and now your cost for the event is down to $12,000. This is still morethan the $10,800 you were planning to make but now that you have 2self-service check out stands you can twice as much at a time and haveeffectively doubled your conversion rate. Additionally, you aren’tconstrained by inventory on hand so you decide to offer a promotionalprice for customers who purchase two or more wheelbarrows.
- Make 1 sale every 3.5 minutes
- 25% of customers take up the offer and buy 2 wheelbarrows for $90 (a $10 discount)
So you’ll now make 514 sales, and 25% (129) of those sales will befor the 2 wheelbarrow promotion. We also said that the customerlifetime value involves three purchases, so now we have 514 newcustomers who could potentially yield another $25,700 over the courseof the next 40 years, if the retention funnel were to convert 100%(unlikely) and the wheelbarrow company stays in business.
- 129 sales @ $90 each for 2 ($50 margin) = $6,450
- 385 sales @ $50 for 1 ($30 margin) = $11,550
- Total of $18,000 earned, for a cost of $12,000 over the course of 3 days ($2,000 per day, or $200 per hour)
- Potential lifetime customer value increased by $642.50 per year (if converted at 100%)
Should You Sell Wheelbarrows at the Tradeshow?
I’m no expert on wheelbarrows, but I’ve been to a lot of tradeshows,and I know that people aren’t there to shop. There are still somepretty dubious assumptions in this plan, and maximum sales throughput should not be confused with product demand. It’s kind of when you launch a new website and say, “we’ve bought 20servers so we can handles millions of visits without going down”. Thisisn’t Field of Dreams, where “if you build it he will come“.
Here’s how you want to look at it: making $2000 a day is the bestcase scenario. You probably won’t capture all of that, and looking atthis scenario I’d actually be shocked if he came away happy with thisevent based on the goal of selling wheelbarrows.
Does Your Goal Fit the Channel?
Personally, I dislike events as a marketing channel for one simple reason: measuring return on investment is nearly impossible.
Why? Because events, such as tradeshows, are not for making direct sales, they are for building brand awarenessto seed future sales. That is the real constraint at work here, and inorder to manage to this constraint you have to embrace the nature ofthe event. If you’re looking to measure success in the number ofwheelbarrows sold, direct marketing channels, online marketing, or evenhaving an event at your store are probably all better options. On theother hand, if you want to convince this community of master gardenersthat your company and brand are the most aligned with their value,s,you could be laying the groundwork for more sales in the future.
So this is the premise behind lean. Your business is constrained,and if you manage to these constraints you can set proper goals basedon context and maximize how much output you can expect to receive fromany input into the system you have put in place. By checking thepremises you’ve used to determine which actions to take, and embracingthe reality of the constraints your business faces, you can save a lotof wasted time and money.
