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MARKETING

Made to Order

In-depth analysis of a start-up catalog business.
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Starting a catalog business looks easy: no office, no storefront, no employees. But in a field of 9,000 competitors, will Kathleen Mahoney's get lost in the clutter?

It would be quite a wedding. The nuptials would take place in the stone chapel at the school from which the bride and groom had graduated. A reception for 400 guests would follow at the seaside home of the bride's parents. And from start to finish, the festivities would be imbued with Gatsby-esque elegance and style. Kathleen Mahoney, the bride herself, would see to that.

"I researched every aspect of it to the nth degree," she says, recalling the year of preparation. "I went haywire. I looked at 20 guest books, 20 bridesmaids' gifts, 20 different goblets, and so on. I wanted everything to be perfect."

Only the finest items would do, and finding them was frustrating. "There's a decentralized flow of information and goods in the wedding industry," Mahoney says. "There was no source for the upscale bride to find all the high-quality, tasteful wedding accessories she'd need." Her search took her to some 50 stores from Boston to San Francisco -- gift shops, bridal boutiques, stationery stores.

All of which got her thinking. And by the time Mahoney and Ozzie Ayscue were married, in June 1990, she had a new business on her hands. One-stop shopping for brides -- the idea seemed irresistible. "It made intuitive sense to me, from my own experience," says Mahoney, 31. "I did some research with friends, and it made sense to everyone."

With 2.5 million weddings a year in the United States, a huge and lucrative market beckoned. The most promising targets, Mahoney reasoned, were career women, brides age 26 and up. They'd have the discretionary income to purchase topflight wedding goods but not the time to hunt for them.

How best to capitalize on the opportunity? She had dismissed a retail store as too limiting -- hers was a national concept. A catalog, though, could put the products right at brides' fingertips. Mahoney was a catalog nut -- she loved them. She didn't know the first thing about publishing one, she admits, but she figured she could learn.

The timing was fortunate. Mahoney was at American Express in Manhattan, in the direct-mail travel business. Ayscue was working for a travel-industry start-up in San Francisco, where the couple had decided to settle. In late 1989 Mahoney left American Express and moved west, itching to take a crack at the catalog game.

* * *

It's no cakewalk to start a consumer catalog from scratch. Typically, retailers branch into mail order to augment established store-based operations. Other merchants tiptoe into the field by first advertising a few items in magazines. That's a cost-effective way of learning what sells while building a buyer file. Gradually, their product lines expand to fill full-blown catalogs. That's how Lands' End got started, for example.

One impediment to launching cold is capital. Catalogs inhale money. One might open a retail store for, say, $50,000, but that won't even get you off the ground in the catalog trade. It can easily cost $150,000 or more to get that first book in the mail, and follow-on editions are needed to build a buyer file. First come production costs for photography, copy writing, layout and design -- the "creative" end of the business. Then come costs for list rental, photographic color separation, printing, fulfillment, data processing, and postage. And even before that first order comes in, a start-up needs to stock most of the featured items.

Mind you, all that happens before you know if the phone will ever ring. What if all the recipients throw your catalog in the trash? By definition, a start-up has zero name recognition. And with an estimated 9,000 consumer catalogs in the country, mailing hundreds of millions of copies, it's easy to get lost in the clutter. Given that saturation, catalogs are creeping into ever smaller niches, staking out tiny franchises in hopes of survival.

Even so, most of them don't last long. Industry lore is replete with tales of first-timers who sank $1 million or more into a black hole before calling it quits. The market is ruthless in weeding out the glut. According to Leslie Mackenzie, publisher of The Directory of Mail Order Catalogs, between 1,000 and 1,500 of them fail or cease operations every year.

It is a business, analysts stress, in which you must get everything right. For instance, you might have terrific merchandise, a superb shipping operation, and a good mailing list. But you drop the ball on the creative -- the product photos and the copy don't quite click. In that case, says consultant Bill Nicolai, "you are toast. It's a very tricky business, but it's one where sharp entrepreneurs can find their way in."

As Mahoney mapped her plans, however, she felt confident. A private investor had promised her $1 million, for 30% of the company, plus a $500,000 loan. That would sustain the business for two years or more. The wedding niche, moreover, seemed solid. "I knew in my heart it was a good idea, so I didn't do much formal market research other than some demographics," she says.

She presented her concept to Jeff Haggin, chairman of the MoreNow Corp., a catalog-production firm in Sausalito, Calif. Over the years MoreNow had handled the creative work for many prominent catalogers -- Smith & Hawken, Sierra Club, Playboy, and dozens more. Haggin knew the industry cold, and he thought Mahoney's idea had real merit.

That's all she needed to hear. And thus was born, in February 1990, the Wedding Fantastic Inc.

* * *

With that start date, the earliest Mahoney could mail her first catalog would be July. That wasn't optimal. The big wedding season is spring and summer, and she would miss most of it. But impatient to get something into the market, she plunged in, headquartered in her San Francisco apartment.

Ayscue pitched in and joined the company in July as copresident. Two years as an analyst with Morgan Stanley had given him strong number-crunching skills. He'd handle strategic planning, statistical analysis, and financial management, while Mahoney concentrated on merchandising and marketing. Working with list brokers, she identified between 3.5 million and 10 million rentable names that met her demographic profile. Industry wisdom has it that you must mail at least 100,000 books to get a reasonable response. To reach her target market, she rented 100,000 names from Bloomingdale's, Williams Sonoma, Victoria's Secret, Nieman-Marcus, and 16 other upscale catalogers. She also rented from bridal-magazine subscriber lists. "I wanted to reach not just brides but brides' mothers, aunts, and shower throwers," she says.

From each list she rented a "cell" of 5,000 names. As a rule, names rent for about a dime each for onetime use, with rates rising to 15¢ depending on the number of "selects." That is, a renter can request names based on such factors as the timing, frequency, and monetary value of the customers' catalog purchases. Mahoney shot for people who had ordered through the mail in the previous six months, a common select.

The use of competing cells is key. It allows a cataloger to see which lists work best, so that when more names are needed, one can mine deeper into the good ones. Essentially, a cataloger cold calls people in their mailboxes, and on average only 1.66% of the prospects respond. In other words, for every 100 catalogs mailed to rented names, better than 98 yield no sales. And those who do respond place smaller orders than established buyers.

To succeed, a mail-order operator must build a buyer file so that repeat customers represent a substantial percentage of total circulation. That can take several years. In Mahoney's model, the critical mass would be reached in 1994, when, she calculated, 12% of the 7 million people receiving her catalog would be buyers. That's the point at which her business would turn profitable. Her plan projected net sales that year of $12.5 million, with purchases averaging $95. That translates to more than 131,500 orders, enough that the company could amortize its costs over a far larger business base. General operating expenses, for example, would shrink from 41% of net sales in 1991 to 8% in 1994. Publicity expenses -- creative work, color separation, printing, list rental -- would drop from 89.5% of sales to 30%. And net income would rise from a 1991 loss of $837,000 to a positive $484,000. h

Economies of scale work their magic all over the place once catalogs grow large, but reaching the magic number of 236,000 was, and remains, an ambitious goal. By comparison, Gump's, an old-line San Francisco gift cataloger, has a buyer file of about 100,000 names.

Pressing on, Maoney contracted with MoreNow for production and arranged to have the book printed by Alden Press, a catalog specialty house in Elk Grove Village, Ill. Fulfillment -- everything from inventory storage to order taking to product packing -- was farmed out to a small San Francisco company. United Parcel Service would handle deliveries.

* * *

Time was short. to get the catalog out in July, all the merchandise had to be selected and turned over to MoreNow by April 1, to start photography. It was a crash project, but Mahoney made it. Just three weeks after she and Ayscue exchanged vows, 110,000 copies of the inaugural edition of The Wedding Fantastic hit the mail.

It was very classy, a glossy, beautifully designed 32-pager featuring pretty much everything an upscale bride would need except a gown and a groom. Most items were the fruits of Mahoney's research for her own nuptials. There was a personalized Limoges porcelain ring box ($125), an heirloom-quality moiré hatbox ($298), a lace picture frame ($85), and even a sterling-silver service for the wedding cake (knife and server, $95 each).

The other half of the equation called for putting wedding gifts right in the catalog, to make it a complete wedding resource. They included some of Mahoney's personal favorites, among them a sterling ice-cream scoop ($95), a Zen rock garden ($48), and a birdhouse shaped like a Victorian manor ($145) -- "mainstream products," she says, "but with a twist." In all, the catalog had 120 handpicked items.

Established catalogers know from experience how much inventory to carry. Start-ups don't know which items will be best-sellers and which will be dogs, and guessing wrong either way can be costly. "That's one of the hardest things we do," says Ayscue. "If you overstock, you are stuck with products. If you understock, you have to back-order and you might not make the sale." Going conservative, Mahoney went with a bare-bones inventory.

Competing not on price but on quality and uniqueness, she marked the products up 60% on average. On shipping and handling charges she aimed for break-even. The order form listed an 800 number and a fax number and allowed payment by check, money order, or credit card. On page three, a chatty "Dear brides" letter from Mahoney touted her commitment to top-quality goods and superb customer service, plus a full refund-exchange policy.

Getting that first book out was pricey. MoreNow's bill for the creative was $74,000 -- over $2,300 per page. Color separation added another $30,000. Alden charged 22¢ each for the 112,000 copies printed (there were some extras), and postage totaled $24,640. The combined in-the-mail cost came to $153,000, excluding list rental.

So handsome was the book that it won second prize that year in a new-catalog competition. "Even the most cynical of readers cannot help but be charmed by the catalog's sentimental approach to weddings," gushed trade journal Catalog Age.

The problem, however, was meager response, well below the 1.66% industry average for prospects. Response fell further when Mahoney "dropped" the second batch, 88,000, in September 1990, and further still when 127,000 went out in November. On the up side, however, the average order was $90, against an industry average of $61.

The new, updated spring edition hit the mail in three volleys, in February, March, and May of 1991. With 40 pages, it featured new items as well as top sellers from the first book. A total of 501,000 copies went out, half of them in May. With timing on the edition's side, the response rates climbed across the board. The new mailings generated sales of $917 per 1,000 catalogs, versus $547 for the first edition. Still, the response rate remained discouragingly below the industry standard, and the average order dipped to $81. "The wedding books were very narrowly targeted," Mahoney says now, "but we were taking a shotgun approach."

* * *

Needing something with broader appeal, she and Ayscue brought forth in September 1991 a brand-new catalog -- The Christmas Fantastic. Weddings were seasonal, so why not launch a sister publication for the hottest shopping time of the year?

Working again with MoreNow, they developed a 32-page version known in the trade as a "slim jim." By virtue of its dimensions, 6 inches by 11 inches, it was cheaper to print and mail. To give the new catalog a better product mix, Mahoney and her employee sidekick, Georgina Sanger, scoured gift shows all over the country and developed several exclusives with California artists.

As with the wedding catalog, the products in The Christmas Fantastic were eclectic and fairly expensive. The new book featured about 150 items, everything from personalized tree ornaments and stockings to a hand-painted "kitty privy" and a $795 "Grand Mr. President" desk set. There were books and CDs, festive party invitations, even a beer-brewing kit. Some old favorites encored -- the silver ice-cream scoop, the Victorian birdhouse, and the Zen rock garden.

The company sent out a test quantity of 112,000 catalogs in three mailings (early returns provide a "product read" that removes some inventory guesswork), and this time it hit pay dirt. The response rate topped the national norm, orders averaged $97, and sales per 1,000 catalogs mailed hit $1,584, beating the industry standard by $566.

So compelling were the overall economics that Mahoney and Ayscue retooled, shifting entirely away from the bridal market and into the gift business. There will be no new Wedding Fantastic this spring, although some of its products are featured in full-page ads in bridal magazines, and a leftover 10,000 copies are available for $3 each. Instead, they launched another new catalog -- The Celebration Fantastic -- and changed their name to the Fantastic Catalogue Co.

The newest book, a 32-page slim jim, is billed as a way to "celebrate life's special occasions with romance, whimsy and imagination!" While some core items remain -- the birdhouse, for one -- the new catalog is heavy on unusual gifts for Easter, Mother's Day, Father's Day, graduations, anniversaries, and new babies. Its 120 items include everything from a complete gourmet picnic hamper for six ($525) to donkey and elephant earrings for this election year ($34). Like Mahoney's other books, it strikes an upscale and upbeat tone. "We think now we are sending the right message to the right people," she says. "Our targeting is getting more refined."

* * *

If The Celebration Fantastic yields results comparable with the Christmas edition's, as Mahoney expects, she will have a strengthening, nonseasonal business and a more secure foothold in the $2-billion mail-order consumer gift market.

But as they say, that's a big if. Having virtually abandoned the wedding niche, she is stepping into a gift sector already sated with some 630 catalog companies, many of them large and resource rich. The Fantastic Catalogue Co. has to establish itself fast. "We need to become the household name, the completely trusted brand name for this whole celebration segment," Mahoney says.

To do that she feels she has to expand quickly. She'd like to circulate a million copies of The Christmas Fantastic this fall to aggressively build her buyer file from its current 15,000 names. But with the initial financing of $1.5 million fast depleting, that hinges on raising $1.25 million or so by summer. And another $1 million will be needed in 1993 to move The Celebration Fantastic beyond the test phase.

As the company expands and Mahoney increasingly understands exactly who her customer is, she has begun to focus on servicing that customer better. Toward that end she brought the company's fulfillment operations in-house early this year, a move that will require more employees and might produce as-yet-unseen complications.

Then there are also problems looming for the whole catalog industry: the always worrisome possibility of postal-service and UPS price hikes and a U.S. Supreme Court case that could require catalogers to pay sales tax to states other than the one in which they are based. That would create a paperwork nightmare and chip away at catalog sales overall.

To try to raise the cash all these plans and contingencies will require, Ayscue is probing the venture-capital market. Meanwhile, central to the whole operation is the idea that there is an expanding, loyal, and non-price-sensitive market for innovative gift merchandise. That's a tall order in recessionary times, but one Mahoney is sure she can fill.


EXECUTIVE SUMMARY

THE COMPANY

The Fantastic Catalog Co., San Francisco

Concept: Build a one-stop-shopping mail-order company offering top-quality wedding goods and gifts for brides and guests. After disappointing results, switched to distinctive, celebration-oriented gift catalogs, one for Christmas and one for such springtime occasions as graduations and Mother's Day

Projections: A loss in 1992 of $884,000 on net sales of $3.05 million. Reach profitability in 1994 with sales of $12.5 million. By 1996, when catalog circulation reaches 11.5 million, attain a pretax income of $2.08 million on sales of $24.3 million.

Hurdles: Building a substantial house file of buyers -- 236,000 needed by 1994; establishing a brand-name identity and customer loyalty strong enough to withstand heavy competition in the mail-order gift business, possibly including copycat catalogs by large retailers; raising $1.25 million this year and $1 million in 1993 to finance operations

THE FOUNDER

Kathleen Mahoney

Age: 31

Family: Married; no children

Personal funds invested: $20,000

Equity held: 70%, together with husband and co president, Ozzie Ayscue

Salary: $60,000

Workweek: 60 to 80 hours

Education: B.A., political science, Princeton University; M.B.A., Stanford Graduate School of Business

Other companies started: None

Last job held: Product manager at American Express Travel Related Services Inc.


FINANCIALS

The Fantastic Catalogue Co. Projected Operating Statement for All Catalogs

($ in Thousands) 1991 1992 1993 1994 1995 1996

Net Sales $890 $3,054 $8,265 $12,498 $17,723 $24,271

Cost Of Goods Sold $445 $1,493 $3,937 $5,801 $8,008 $10,718

Gross Profit $445 $1,561 $4,328 $6,697 $9,715 $13,553

Gross margin 50.0% 51.1% 52.4% 53.6% 54.8% 55.8%

Expenses

Publicity $796 $1,410 $3,023 $3,711 $5,012 $6,241

Fulfillment $111 $436 $1,000 $1,445 $2,020 $2,755

General operations $364 $572 $842 $1,039 $1,377 $1,709

Operating Income (Loss) ($826) ($857) ($537) $502 $1,306 $2,848

Net Income ($837) ($884) ($559) $484 $1,318 $2,082

Net margin (94.1%) (28.9%) (6.8%) 3.9% 7.4% 8.6%

Total catalog circulation (in thousands) 789 2,262 5,498 7,124 9,064 11,459

Growth versus previous year 213.6% 186.7% 143.1% 29.6% 27.2% 26.4%

Previous buyers as percentage of total circulation 3.6% 4.1% 6.4% 12.0% 16.2% 20.1%

Average order (in dollars) 86 94 94 95 96 96


WHAT THE EXPERTS SAY

CONSULTANT

BILL NICOLAI

President of Nicolai and Associates Inc., a catalog consulting firm in Seattle

I don't question Kathleen Mahoney's original assertion that there is a market for a wedding catalog. Problem is -- and Mahoney seems to be finding this out -- there's no easy way to reach that market. I don't know which database you could use to isolate professional, upscale women who are about to get married.

And since all the profits in this business come from selling to repeat buyers, the point is to build a customer base and maintain it. But if you theoretically get married only once, here by definition is a catalog that you can shop from only once. In effect, you have to turn over your entire customer base every year. That's another serious problem.

The Christmas Fantastic catalog seems like a marginal success, but I don't think Mahoney will be able to repeat it with The Celebration Fantastic. The gift business falls off drastically at all times of the year other than Christmas.

COMPETITOR
BARBARA A. TODD

Founder of Orchids Only, which she built to a seven-figure mail-order house before selling it, in 1989. Currently president of the Good Catalog Co., a new venture based in Portland, Oreg.

In 1992 Mahoney and Ayscue are predicting an increase in circulation of 187% as well as an increase in sales per circulation of 22¢. There's no way both can happen. In the catalog business, as your circulation increases, your response rate falls because the quality of your rented names deteriorates. And as the names on Mahoney's list get older, they'll be generating less revenue.

But even assuming Mahoney and Ayscue just maintain their sales per circulation at their current $1.13, and they decrease expenses as much as they can, I calculate they'd make $308,000 by 1994 -- well below what they project. Those aren't numbers that make venture capitalists jump for joy. To get the $1.25 million the founders need this year and the $1 million they need next year, they'll have to give up a good deal of equity. They'd be lucky to wind up with 10% of the company.

Looking to 1996, they see repeat buyers as being 20% of overall circulation and are predicting net income of 8.6% of sales. That doesn't jibe, either. For an established catalog to get that kind of return, it would need a buyer file closer to 80% of circulation.

Finally, their cost of goods looks high for a mail-order company. Right now they are at 48.9% of sales, but you really need costs well below 40% to make it.

FINANCIER
HOWARD WOLFE

Partner in New Enterprise Associates, a large venture-capital firm based in Baltimore. Member of the board of J. Peterman Co., a three-year-old, $30-million catalog company based in Lexington, Ky.

I quibble with Mahoney's early premise. I'm not sure brides consider shopping for all their accessories such a nuisance. I think that's part of the overall wedding experience. Maybe the items are hard to find, but she targeted a yuppie audience. Yuppies already know where the best stores are.

Be that as it may, the company now seems to be more in the general gift sector, where there is a great deal of competition. In the catalog business you don't have geographic barriers to entry, as you do in regular retailing. Every catalog in your niche has equal access to every prospect's mailbox. And with the incredible proliferation of catalogs, consumers' mailboxes are overwhelmed. By definition, the size of the targeted markets shrinks considerably. Every one of the 630 or so gift catalogs will claim to be distinctive, but because of the clutter in this arena it's hard to set yourself apart. I question whether Mahoney's catalogs have been able to do that so far.

OBSERVER
KATIE MULDOON

President and CEO of the Muldoon Agency, an ad agency and catalog-production firm in New York City

They expect an average order this year of $94. That's very high, and in the beginning that's not a great sign. Generally speaking, a high average order indicates less overall response. Less response means proportionately fewer existing customers on your list, which you don't want, because existing customers always outperform prospects.

Again and again focus groups show that most customers will test out a new catalog by making small purchases to gauge quality and service. But if you offer mostly high-ticket items, as Mahoney's catalogs do, there are few trial purchases that can be made. And this is the wrong time to be offering expensive items, anyway. The catalogs that are doing well are the high-value, low-price ones -- J. Crew is still doing phenomenally well. High-ticket catalogs, even some that were stars several years ago, are doing poorly.

What's more, I think Mahoney is trying to grow too fast. According to Catalog Age, most catalogers start more slowly -- 43% have sales under $1 million, 19% have sales between $1 million and $2.9 million, and 22% have sales between $3 million and $9.9 million. It really is a good business for an entrepreneur, if it's run tightly and grown slowly. Mahoney seems to have done neither. If she had been a little less ambitious, perhaps she could have first taken out ads in magazines, then printed catalogs in proportion to the response. It would have taken longer to build her list, but she probably would have made money instead of losing so much so fast.

Last updated: May 1, 1992




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