Comparison website iSelect’s (ISU) half year results last month showed revenue falling 12% on the previous December half. For most companies lower revenue would mean sharply lower profits. Not for iSelect. Profit was up 79%. Why the disparity?
The difference obviously lies in lower costs, down 16% for the half year. But the breakdown of those cost savings is an important insight into iSelect’s business model, and any company that has to spend more money to attract each new customer.
What’s on TV?
Most of Myer’s (MYR) marketing costs are locked in well in advance. It commits to a TV campaign and spends a lot of money on in-store promotions. Once that money has been spent, each customer who buys something from them is bringing profit through the door.
iSelect does this sort of marketing too. A bland TV advertising campaign was a significant contributor to iSelect’s horrible 2018.
But much of its marketing spend is direct customer acquisition, like search engine marketing through Google. Return on money spent in these channels can be measured accurately. They know exactly what it costs to drive a potential customer to iSelect’s website, and how much revenue that customer generated for them.
The important point is that this number is variable. Some potential customers visit iSelect because they have used the service previously or heard about it from a friend. The company didn’t have to spend anything attracting these visitors. While we don’t know how many visits the company gets for ‘free’, about 30% of iSelect’s website visits come from visitors going directly to the site or typing iSelect into Google. It has been marketing to Australians since getting started in 2000, so there is a group of die-hard iSelectors coming back and spreading the word to their friends.
Not all marketing channels are created equal
Then there are attractive channels where returns on investment are extremely high. Maybe offering incentives to their existing database rewards iSelect with $10 of revenue for a dollar of marketing spend. That should be the first place to spend money. But that channel might only be able to attract a small number of visitors. Once exhausted, the company will need to move on to the next most effective channel. This will go on and on until it becomes uneconomic to spend that extra marketing dollar.
Unlike Myer, where each new sale brings in more profit, it’s possible for a new customer to cost iSelect more than they generate in revenue. Even one from the same source. A particularly prospective Google keyword might bring in visitors for a time. But when a competitor decides to pay more for the same keyword, it might no longer make sense for iSelect to pay the higher price. In an environment that changes so quickly it’s easy to be left with loss-making marketing spend.
In fact, we’re pretty sure that’s exactly what was happening. Last year iSelect’s return on marketing spend was just $2.82, barely enough to cover its costs. Management’s renewed focus on avoiding loss-making spend improved the number to $3.54 in the latest half.
Health insurance action all happens in the second half of the year. iSelect still needs to show it can maintain this marketing discipline and generate plenty of revenue. But less revenue is still better than loss-making revenue.
Ready to invest?
Click here for more information about investing with Forager.
Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.