Public funds versus private endeavors: catalogs and conflict in Alaska.
Roberts, Wayne A., Jr.
INTRODUCTION
The Rural Alaska Community Action Program, or RurAL CAP, is a
leading nonprofit organization in Alaska whose mission is "to
protect and improve the quality of life for rural Alaskans through
education, training, direct services, advocacy and strengthening rural
people's ability to advocate for themselves." RurAL CAP began
in 1965 as a consequence of the 1964 Economic Opportunity Act. In
pursuing its mission it has started or otherwise managed well over a
dozen statewide programs, including Head Start, weatherization
assistance programs, information services, programs related to alcohol
abuse, AmeriCorps, and a program to provide legal assistance to
villages. By 1995 RurAL CAP's annual budget exceeded $8 million,
and it had over 200 employees.
As a nonprofit social agency the majority of RurAL CAP's funds
come from federal and state grants. However, RurAL CAP does obtain some
funds from Rural Electric Enterprises (REE), a profitable wholly-owned
subsidiary formed in 1987. REE grew out of an effort to import and sell
cost saving, efficient, affordable heating sources to rural native
Alaskans through rural product dealerships. The initial feasibility
analysis was funded by a grant from the Department of Energy, and was
initially supported by Community Service Block Grant funds. REE is a
profitable operation that wholesales various energy saving products,
including Toyostoves, to more than 60 dealers in the United States and
Canada.
THE AURORA CATALOG EXPERIENCE-PLANNING
In February 1992 the Board of Directors of RurAL CAP gave the
go-ahead to the staff to begin examining the feasibility of producing a
catalog that would feature products made by rural, native Alaskans. As
subsequently stated, the following were the goals/mission of the
project:
1. Develop income opportunities for Alaska natives that promote
increased self-sufficiency;
2. Develop wider markets for Alaska native arts, crafts and
products;
3. Create value for the subsistence way of life and distinct Alaska
native cultures by providing accurate education and information about
rural Alaska; and
4. To supply RurAL CAP with an unrestricted source of funds to help
support other programs and activities.
The executive director, accompanied by several board members,
traveled to nine villages to discuss the project and to buy
representative sample products. At this point it was made clear that
artisans would be paid what they asked for their products--there would
be no haggling or negotiations. Further, they were informed that goods
would be purchased when it was convenient for the artists and producers.
Rural residents showed overwhelming support for the project.
Throughout 1992 staff members began to become acquainted with the
catalog industry. Based on discussions with representatives from other
catalogs, such as the catalog operations of the World Wildlife Fund and
Robert Redford's Sundance catalog, RurAL CAP decided to hire an
experienced, highly recommended catalog consulting firm from San
Francisco to help in the analysis and planning of a catalog.
The decision was made to forego undertaking an in-depth feasibility
study. Rather, based on the success of catalogs such as The Hemmeter
Collection, Faith Mountain, and Sundance, it was decided to proceed
directly to a test market. The strategy was to develop a high quality,
distinctive catalog that would appeal to the socially conscious
consumer.
Expected costs associated with the first year's mailings in
1993 were much higher than expected revenues: catalog design costs,
consulting fees, and other start-up costs associated with this research
and development effort were understandable. A consultant's
feasibility study estimated that, based on industry experience, it would
take 2 or 3 years before the catalog achieved profitability. In the
business plan developed by another consultant, published in January of
1993, profitability was predicted in 1994.
In pursuing its strategy RurAL CAP relied on knowledgeable
consultants for overall planning, product selection, catalog copy,
mailing list evaluation and choice, promotion planning and execution,
and in projecting results. Fulfillment operations (order taking,
billing, packing and shipping, and information tracking) were to be
contracted out to other organizations, as is common in catalog
operations. RurAL CAP was responsible for the procurement of product and
overall approval of various aspects of the project. It was the intention
of RurAL CAP to bring responsibilities in-house, over time, as their
expertise improved.
The intention of RurAL CAP was to have three mailings of a 24 page
catalog during 1993; once on August 1, a second in late September, and a
third in November, which would include four pages of Christmas items.
Advertisements in publications touting the catalog and specific products
were planned. The merchandise mix was to include some native and some
non-native products in several categories, including jewelry, native
dress, candles, food, artwork and other sundry items. In addition, short
articles about Alaska and Alaska natives were to be included. If the
results were encouraging, the intention was to expand the catalog
operation to four mailings in 1994. A continued reliance on consultants
in 1994 again was expected to result in high costs.
Internally one employee, the Economic Development Manager, spent
the majority of her time on the catalog project. Other employees
contributed according to their areas of expertise as time allowed. Some
of this was quite extensive. After the first year's mailings a
marketing specialist who had retail experience, as well as experience as
an assistant buyer for Nordstroms, was hired to assist in the
procurement and management of inventory. Shortly afterwards the Economic
Development Manager had to leave Alaska because of a job offer for her
husband, and the marketing specialist was thrust into that slot. Another
woman was hired to assist her, and the two of them devoted all their
energies to the project. One interesting practice was a weekly, one hour
catalog project meeting that involved various RurAL CAP program managers
and talented professionals, including the internal CPA and the Executive
Director. The purpose was to brainstorm and to discuss problems and
issues.
THE FUNDING CONTROVERSY
Initially the funds for planning the catalog operation, including
travel, personnel time, sample acquisition, and consulting fees, were
obtained by borrowing funds from child care, alcohol and abuse programs,
and from the planning and research component of a Community Services
Block Grant. The intention, of course, was that funds borrowed from
programs would be returned.
In December of 1992 RurAL CAP requested an amendment of $190,000 to
its current year Federal Community Services Block Grant (CSBG),
administered through the State of Alaska's Department of Community
and Regional Affairs (DCRA), to fund the catalog project. The request
was denied, however, on the grounds that the proposed catalog was
controversial and had not gone through the required application process
and had not been part of the required public hearing.
The controversy regarding the project was largely the result of the
president and founder, as well as the investors, of The Great Alaska
Catalog. As a privately funded firm, The Great Alaska Catalog had been
struggling for several years to build up its business to where it would
be a viable, ongoing concern. The business required a lot of hard work,
a lot of risk taking, and a lot of uncertainty. To find that a new
competing operation was now in the arena was bad enough, but to find one
that was run on lots of public grant money that did not have to be
repaid was galling. How could a private firm, accountable to
shareholders and lenders, compete against an organization that did not
have to turn a profit, and could easily hire high-paid consultants and
others?
The market for Alaskan products was not perceived to be overly
large or expandable, and so the two catalog operations were perceived to
be in direct competition for a fixed number of customers. Both were
targeting the same customers with the same product mix through the same
channels.
Not only were the two organizations competing for the same
customers, they were also competing for supplies. Both featured a
variety of native and non-native Alaskan goods. Supplies, particularly
native products, were limited--there were only so many talented artists
producing so many sellable products. The Great Alaska Catalog people
argued that RurAL CAP's efforts, particularly RurAL CAP's
policy of accepting whatever prices the natives wanted, were affecting
their ability to obtain products from the small number of sellable
artists. A museum buyer found that none of RurAL CAP's artists were
unknown and without a current market for their products.
The Great Alaska Catalog people argued that RurAL CAP, to the
extent they should be allowed to compete at all, should be restricted to
promoting and selling rurally produced products from unknown artists in
the bush.
An official complaint against the Department of Community and
Regional Affairs was filed by the president of The Great Alaska Catalog
with the Office of the Ombudsman on April 12, 1993, prior to the first
mailing, contending that:
"(1) The catalog has not been supported by an adequate
departmental review for compliance with federal requirements that funded
activities must have a measurable and potentially major impact on the
causes of poverty in the community or those areas of the community where
poverty is a particularly acute problem.
(2) DCRA's approval of federal funds for this project is in
conflict with Alaska's stated encouragement of private enterprise
and the development of small businesses to provide needed goods and
services whenever possible."
RurAL CAP and its supporters felt RurAL CAP had the right to help
develop markets for their constituents, had a mission that went beyond
making a profit (although they certainly intended to do that), and were
entitled to the funds. They also argued that using non-native products
and well-known native artists was a legitimate way to build a successful
catalog operation. RurAL CAP also contended that they were, in fact,
selling little-known artists, and further, that other talented,
enthusiastic natives were gearing up.
In early to mid-1993 the Department of Community and Regional
Affairs brought together both groups to try to come to a reasonable
compromise. At that less-than-cordial meeting RurAL CAP's planning
manager rejected any joint undertaking, since, to paraphrase her, far
too much money had already been invested in their current operations.
Both sides lined up supporters and argued their points. No less
than 3 State Representatives and 1 State Senator actively supported the
stance of The Great Alaska Catalog. RurAL CAP had support from at least
1 State Senator and various native organizations and native leaders. A
petition was circulated during native community and village functions,
and garnered well over 200 signatures in support of RurAL CAP's
Aurora Catalog project. Legislative hearings on the issue were held in
November 1994.
The Department of Community and Regional Affairs was, of course,
very concerned about this. Early in 1993 the Commissioner sought advice
from the Alaska State Attorney General's office. In March, 1994,
approximately 1 year later, the Attorney General's office simply
responded that there was no legal prohibition against using CSBG money
to fund a for-profit venture. This clearly wasn't enough to decide
one way or the other whether to continue funding this project.
While the controversy raged, DCRA did provide almost $600,000 to
RurAL CAP for the project during 1993 and 1994. The pressure to suspend
future financing was intense, but so was the pressure to continue the
financing.
It was finally decided to see whether the project could be
self-sustaining, or whether it would always have to be subsidized with
public and grant money. No one in the Department was excited about
continually funding a losing proposition that did, indeed, compete
against private sector operations. Therefore, a consultant was hired to
see if the project warranted the investment of money from a private
sector perspective. In other words, would private investors invest in a
project characterized by the risk and returns that had been experienced
so far?
THE AURORA CATALOG--THE MARKETPLACE EXPERIENCE
RurAL CAP developed a beautiful catalog. In fact, it won an award
at the Direct Marketing Association conference as the best new catalog
of the year. There was no question it was beautiful, and that it
portrayed Alaska and Alaska natives in a favorable light.
At least partially because of funding difficulties there were two,
rather than three, mailings of a 24 page catalog in 1993; one in
mid-September and another in early November. The catalog and select
products were advertised in consumer magazines, and the catalog and
seven products were highlighted in an insert that accompanied mileage
statements for 168,000 Alaska Airlines' frequent flier customers
During 1994 print advertising and similar activities were not
undertaken. Instead, RurAL CAP opted for investing in more catalogs.
Again, there were only two mailings. Table 1 provides income statements
for 1993 and 1994, along with circulation numbers, the number of orders,
and the average order size for the two years.
Table 2 provides information regarding the sales/book (as the
sales/catalog is referred to in the industry), response rates, and
average order sizes for 1993 and 1994 for various types of customer
lists.
In order to appreciate these results it is necessary to understand
industry terms and the way in which a catalog operation builds a
profitable operation. Building a profitable catalog business is
contingent upon building a sizable House Buyer File. The House Buyer
File consists of customers who have purchased a catalog's products.
These are people or organizations that have clearly demonstrated an
interest in a catalog's products. Customers in this file buy more
frequently than average, and usually spend more. A more general list is
referred to as the House File, which generally includes the names of
people who have contacted the catalog company for one reason or another,
and may include as past purchasers (here past purchasers are reflected
only in the House Buyers File). In Table 2 the House File contains the
names of people who contacted RurAL CAP in 1993 and were mailed a
catalog in 1994. House Files are built through advertising the catalog,
advertising select products
from the catalog, and by sending catalogs or other promotional
materials to lists owned by others (referred to as outside runs or
outside tests).
Typically catalog operations 'rent' lists of people from
other catalogs, magazines, and other sources. Results from rented lists
are listed in Table 2 as Outside Tests and Outside Runs. The cost/rented
name for the Aurora catalog operation was $.14/name. Rented names
normally can be used once/contract. If the recipient does not respond to
the mailing, the name is lost. However, if a recipient contacts the
organization that rented the name for any reason, that name and address
is added to the House File, and the organization can use it as it
pleases. It can even rent that name to others for their use. Catalog
operations will rent a relatively large number of small lists when
searching for lucrative lists. They may, for example, rent 20 different
lists of 5000 names (e.g., 5000 names from Good Housekeeping, 5000 names
from Outside Magazine). When the catalog operation, through these
outside tests, which essentially is a type of reconnaissance
prospecting, finds a list where the response rate and sales/book is
high, they will commit to renting much larger lists of names, and the
names associated with these lists are termed outside runs. Costs
associated with outside runs are similar to prospecting and development
costs: the primary purpose is to locate customers who can be added to
the House Buyers File or the House File. Usually the costs of finding
customers through the use of rented mailing lists are expected to exceed
the net revenue from initial purchases. Therefore losses in the initial
years of a catalog are expected.
In Table 2 there are two other lists: Catalog Requests consist of
the results from sending the catalog to those who have asked for one
during the current year's operation, and Multi-Buyers, which
consists of the names of those that have purchased more than once.
Finally, note that the lists are all mutually exclusive: if a
person's name is added to the Multi-Buyer list, for example, it is
deleted from the House Buyers list. No name appears on more than one
list.
The results from the Aurora Catalog were discouraging. While much
of what the RurAL CAP consultants predicted would happen in 1993 did
occur, at least with regard to market reaction, and much of it was
better than expected, the 1994 results were very disappointing. In
looking for explanations, a number of problems and potential causes were
cited, including the following:
1. Poor performance by the fulfillment houses. Because of
complaints and a lack of confidence in the fulfillment house used in the
first year, a different organization was used the second year. But
several people, including the RurAL CAP consultants, felt that
information capture, and performance, of the second fulfillment house
was suspect. One RurAL CAP consultant said she heard that 24 out of 200
orders were not entered, recorded, or fulfilled by the second
organization. As a result, plans were made to bring fulfillment
operations in-house, even though this was expected to drive up costs
considerably.
2. Suspension of advertising and promotion for the catalog during
1994. RurAL CAP decided they wanted to put all money into catalogs and
mailings, rather than spend any money on promoting the catalog through
advertisements, or promotions such as what was done with Alaska
Airlines.
On hindsight, it was felt that those activities could have been
important.
3. Not all catalogs were delivered by the U.S. Post Office. There
were no efforts to control for this possibility, such as sending
catalogs to employees.
4. Prices were high. The margins were too narrow, some thought, to
support a catalog operation.
While not a reason for the poor performance, clearly RurAL CAP
employees, particularly the Executive Director, were discouraged and
frustrated by the intense and continuing effort that had to be devoted
to obtaining and justifying funds. It distracted her and the other
employees from focusing on doing a good job.
The Department of Community and Regional Affairs consultant decided
to project the income statement out to 1997 based on different
combinations of factors from the 1993 and 1994 experience. In all cases
the results indicated that the cash flows would be large and negative.
Table 3 contains some representative pro forma income statements.
Another tack was to compute the break-even point for this operation
based on the 1994 experience. Table 4 provides some of what was computed
based on a detailed analysis of RurAL CAP figures (some numbers are not
directly derivable from Table 1). The analysis is incomplete, though, in
that it does not take into account printing and mailing costs. The
average printing and mailing cost per name in the House File (those
people who either had purchased from RurAL CAP before, or requested a
catalog) was $.38. The average cost/name on rented lists was $.14
higher, or $.52 each. This reflects the charge of using someone
else's mailing list on a one-time basis. (As stated above, once the
customer has contacted the organization seeking a response that name can
be transferred to the House File list, where it may be used without an
additional charge.)
DISCUSSION QUESTIONS
1. Do you believe it made sense to forego a detailed feasibility
study and instead actually put together a catalog operation, complete
with products, contracts with fulfillment houses, etc.? What are the
dangers of pursuing such a strategy? What are the benefits? Under what
conditions does acting, rather than analysis, make sense? Under what
conditions do analysis, prior to acting, make sense?
2. Are there other ways RurAL CAP could achieve the objectives and
goals set out for the catalog? In other words, what other marketing
strategies could be considered as competitors to a catalog operation? Do
you believe that a catalog is the best means for achieving the
identified goals?
3. RurAL CAP decided to target individual, upscale, socially
conscious consumers. What other target groups could have been chosen or
considered?
4. Examine the results for 1993 and 1994 (Tables 1 and 2). Do the
results bode well for the catalog operation? What conclusions can you,
as an analyst, draw from these data? Does your examination of the pro
formas in Table 3 support your expectations?
5. Complete the break-even analysis begun in Table 4. In doing so,
assume only 2 categories of lists: outside runs (rented names), and
House Buyer File names. Further, assume 9 outside run names need to be
used for every House Buyer File name (this is necessary to replace House
Buyer File customers who cease to be interested in the catalog's
products). Finally, assume the average sales/book for House Buyer names
is $4.14, while the average for rented lists is $1.00. The $4.14 figure
represents the sales/book for 1994 for those sent to names in the House
Buyers File. The $1.00 figure is admittedly on the high side for the
rented names, but will suffice for this exercise.
6. A useful analysis is to compute the customer acquisition cost,
and the contribution from each customer over the customer's
lifetime. These numbers can be used to generate customer lifetime
values. When answering the following ignore all taxes.
a. How much money will The Aurora Catalog lose or make on a mailing
to 1000 rented names? How much per acquired customer? Consistent with
The Aurora Catalog's experience, assume i) the marginal cost of
renting names and mailing a catalog to each person is $.52, ii) the
response rate is .9%, iii) the average order size is $76, and iv) the
contribution margin is 31.04%.
b. Once a person becomes a customer costs go down and response
rates and sales/book go up. Compute how much money RurAL CAP will make
or lose, on average, the next time they send customers acquired from the
initial list of 1000 a catalog, assuming i) the cost of sending a
catalog to each customer is $.38 (note the cost is lower because the
names are not rented), ii) the response rate is 4% (that is, there is a
4% chance each customer will buy), and iii) the average order size is
$102. Further, assume that the contribution margin remains 31.04%. These
figures, of course reflect The Aurora Catalog's experience.
Determine how much RurAL CAP will net on this mailing, as well as how
much they will net per acquired customer.
c. If we assume that the 4% response rate will be good for 2.5
years (5 mailings), and that the average order size remains at $102,
compute the net present value of renting a list of 1000 names using a
discount rate of 5%/half year. Under the assumptions implied in this
analysis, is renting names a good investment strategy for The Aurora
Catalog?
7. In addition to the quantitative analyses relating to RurAL
CAP's experience, what else would you want to know before making a
judgment as to whether this catalog has a chance of becoming profitable?
If you were part of RurAL CAP's management team, what would you
recommend?
8. When do you think public money should be used to support
for-profit forays by nonprofits? Should DCRA continue to support the
catalog? Under what conditions? If you were the Commissioner of the
Department of Community and Regional Affairs what would you recommend?
Wayne A. Roberts, Jr., Southern Utah University
Table 1 Income statements and other data, 1993 and 1994
1993
Dollars % of Net
Rev.
REVENUES- Merchandise Sales $204,786.00 111.53%
Less Returns and Allowances $21,164.00 11.53%
TOTAL NET REVENUES $183,622.00 100.00%
COST OF GOODS
Product purchases $107,183.00 58.37%
In-Bound Freight $829.95 0.45%
TOTAL COST OF GOODS $108,012.95 58.82%
GROSS MARGIN $75,609.05 41.18%
EXPENSES
Direct Marketing Expense $184,891.00 100.69%
Operations Expense $41,683.79 22.70%
Administrative $229,655.26 125.07%
TOTAL $456,230.05 248.46%
Income (loss) from Operations ($380,621.00) -207.29%
List Rental Income $0.00 0.00%
Net Income from Operations ($380,621.00) -207.29%
GRANT FUNDING $361,450.00
NET REVENUE FROM OPERATIONS & GRANTS ($19,171.00)
Circulation 187,846.00
Number of Orders 2,096.00
Average Order Size $87.61
1994
Dollars % of Net
Rev.
REVENUES- Merchandise Sales $284,770.02 104.85%
Less Returns and Allowances $13,184.05 4.85%
TOTAL NET REVENUES $271,585.97 100.00%
COST OF GOODS
Product purchases $129,506.00 47.69%
In-Bound Freight $3,709.00 1.37%
TOTAL COST OF GOODS $133,215.00 49.05%
GROSS MARGIN $138,370.97 50.95%
EXPENSES
Direct Marketing Expense $239,182.00 88.07%
Operations Expense $34,983.00 12.88%
Administrative $206,255.00 75.94%
TOTAL $480,420.00 176.89%
Income (loss) from Operations ($342,049.03) -125.95%
List Rental Income $359.81 0.13%
Net Income from Operations ($341,689.22) -125.81%
GRANT FUNDING $360,874.00
NET REVENUE FROM OPERATIONS & GRANTS $19,184.78
Circulation 374,886
Number of Orders 3,452
Average Order Size $78.67
Table 2: Sales-book, response rates, and average order sizes 1993-
1994
Sales/Book Response Rates Average Order Sizes
1993 1994 1993 1994 1993 1994
Catalog Requests $0.88 $0.82 1.29% 1.13% $67.79 $73.07
Outside Tests $1.06 $0.53 1.10% 0.71% $96.09 $74.25
Outside Runs $0.92 $0.66 0.95% 0.87% $96.89 $75.66
Multi-Buyers $2.83 $1.66 2.35% 2.06% $120.54 $80.61
House File * $0.76 1.01% $74.95
House Buyers $3.31 $4.14 0.82% 4.06% $403.50 $101.82
Overall $1.03 $0.71 1.06% 0.92% $87.61 $78.67
* Those who formerly requested a catalog
Table 3: Representative pro forma income statements, 1995-1997
1995
REVENUES- Merchandise Sales $920,586.29
Less Returns and Allowances $95,170.45
TOTAL NET REVENUES $825,415.84
COST OF GOODS
Product purchases $393,640.82
In-Bound Freight $3,714.37
TOTAL COST OF GOODS $397,355.19
GROSS MARGIN $428,060.66
EXPENSES
Direct Marketing Expense $535,196.00
Operations Expense $137,141.09
Administrative $231,041.73
TOTAL $903,378.82
Income(loss) from Operations $(475,318.16)
PROPOSED GRANT FUNDING:
Grant 1 $400,000.00
Grant 2 $100,000.00
CSBG Grant $250,000.00
TOTAL GRANT MONEY $750,000.00
NET REVENUES FROM OPERATIONS AND GRANTS: $274,681.84
1996
REVENUES- Merchandise Sales $2,556,277.37
Less Returns and Allowances $264,268.61
TOTAL NET REVENUES $2,292,008.76
COST OF GOODS
Product purchases $1,093,058.98
In-Bound Freight $10,314.04
TOTAL COST OF GOODS $1,103,373.02
GROSS MARGIN $1,188,635.74
EXPENSES
Direct Marketing Expense $1,269,197.00
Operations Expense $297,925.56
Administrative $261,840.18
TOTAL $1,828,962.75
Income(loss) from Operations $(640,327.01)
PROPOSED GRANT FUNDING:
Grant 1 $400,000.00
Grant 2 $100,000.00
CSBG Grant $250,000.00
TOTAL GRANT MONEY $750,000.00
NET REVENUES FROM OPERATIONS AND GRANTS: $109,672.99
1997
REVENUES- Merchandise Sales $5,271,485.63
Less Returns and Allowances $544,967.54
TOTAL NET REVENUES $4,726,518.10
COST OF GOODS
Product purchases $2,254,076.48
In-Bound Freight $21,269.33
TOTAL COST OF GOODS $2,275,345.81
GROSS MARGIN $2,451,172.28
EXPENSES
Direct Marketing Expense $2,046,376.00
Operations Expense $515,781.32
Administrative $331,870.95
TOTAL $2,894,028.27
Income(loss) from Operations $(442,855.99)
PROPOSED GRANT FUNDING:
Grant 1 $400,000.00
Grant 2 $100,000.00
CSBG Grant $250,000.00
TOTAL GRANT MONEY $750,000.00
NET REVENUES FROM OPERATIONS AND GRANTS: $307,144.01
Table 4: Breakeven analysis data based on 1994 experience
FIXED COSTS:
Marketing Expenses $47,260.00
General and Administrative $191,257.00
TOTAL $238,517.00
Contribution Margin as a Percentage of Gross Merchandise Sales Before
Catalog Variable Expenses *:
Gross sales 100.00%
Returns and allowances -4.63%
COGS -46.78%
Excess S&H charge -12.28%
Variable Administrative Expense -5.27%
Adjusted Gross Margin 31.04%
* In Table 1 total net revenues is equal to 100%.
