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					Chapter


15        Marketing Cost and
            Profitability Analysis
                     Business prophets tell us what
                     should happen – but business
                     profits tell us what did happen.

                               Earl Wilson
Agenda

   Chapter 15: Marketing Cost and Profitability
    Analysis
   Case 15-1: Seal-Rite Envelope Company (B)
Marketing Cost Analysis

   Detailed study of a firm’s marketing costs
   Differs in purpose and scope from accounting
    ledger data:
     Mktg cost analysis is used more for planning and
      control of future operations
     Groups cost items differently

   Requires using good accounting ledger data

    An analysis of expenses as recorded in a
    company's accounting ledgers is better than no
    cost analysis at all. What specific policies or
    operating plans may stem from an analysis of
    ledger expenses alone?
    (see next slide)
Income and Expense Statement, 2002, Colorado
       Ski Company ($000) (Fig. 15-2)
         Net sales                             $27,000
         Less cost of goods sold                18,900
         Gross margin                            8,100
         Less operating expenses:
                                      $3,240
          Sales salaries and commissions
          Sales force travel             372
          Supplies and telephone         178
          Media space                    870
          Advertising salaries           218
          Property taxes                 120
          Heat and light                 168
          Insurance                       84
          Administrative salaries        930
          Other expenses                 120
         Total operating expenses                 6,300
        Net profit                              $ 1,800
Explain the similarities and differences between marketing
cost analysis and production cost accounting.
   Comparison           Marketing Cost                 Production Cost
   Factors              Analysis                       Accounting
   Bases for computing Marketing unit; territory       Unit of product
   costs               customer group, order size,
                       as well as product
                        More Complex                   Relatively Simple

   Source of cost       Salespeople in the field       Machines and closely supervised
   incurred                                            workers
                        Less Exact                     More Precise

   Cost-volume          Volume is a function of cost   Cost is a function of volume
   relationship         V = (f)C                       C = f(V)

                        Difficult to Measure           Relatively Easy to Measure
Types of Marketing Cost Analysis

1.   As they appear in ledger accounts and
     income statements
2.   After they are grouped into functional
     (activity) categories
3.   After they have been allocated to marketing
     units (territories, products, customer groups)
Marketing Cost Analysis


    Breakdown by Activities
     Expense Distribution Sheet, Colorado Ski
           Company, 2002 (Fig. 15-3)
          (showing allocation of ledger expense items to activity categories)

                                               Activity Cost Categories
                                Personal           Warehousing       Order
Ledger expenses         Totals   SellingAdvertising and Shipping Processing Administration
                   $3,240,000$3,240,000
Sales salaries/commis                         —              —      —                 —
Sales force travel    372,000   372,000       —              —      —                 —
Supplies & telephone 178,000     43,200 22,200           40,900 43,500            28,200
Media space           870,000        — 870,000               —      —                 —
Advertising salaries  218,000        — 218,000               —      —                 —
Property taxes        120,000    10,000 14,500           66,000 14,000            15,500
Heat and light        168,000    15,300 17,400          100,500 16,200            18,600
Insurance              84,000    12,000    4,200         46,300 14,000             7,500
Administ. salaries    930,000   144,000 62,000          168,000 126,000          430,000
Other expenses        120,000    10,500 11,700           58,300 26,300            13,200
  Totals           $6,300,000 3,847,0001,220,000        480,000 240,000          513,000
Marketing Cost Analysis


    Breakdown by Activities and Territories
              Allocation of Activity Costs to Sales Regions,
                       Col Ski Co. 2002 (Fig. 15-4)
                    Personal                              Warehousing Order
Activity            Selling        Advertisingand ShippingProcessing Administration
                                   Allocation Scheme
Allocation                                    No.
                    Direct expenseNo. of pages of orders No. of invoice Equally among
 basis               to each region of ads     shipped     lines         regions
Total activity
 cost                $3,847,000    $1,220,00 $480,000       $240,000      $513,000
No. of
 allocation units    —             61 pages   9,600 orders 120,000 lines 3 regions
Cost per
 allocation unit     —            $20,000/pg.$50 per order $2 per line   $171,000/reg.
     Allocation of Activity Costs to Sales Regions,
              Col Ski Co. 2002 (Fig. 15-4)




                Pers. Sell Adv.           Ware/Ship Order Proc. Admin
 Region                                  Allocation of Costs
           units    —         21 pages      3,800 orders 39,500 lines    one
 Eastern
           cost $1,070,000   $420,000        $190,000     $79,000     $171,000
           units    —         11 pages      2,500 orders 28,000 lines    one
Midwestern
           cost $747,000     $220,000        $125,000     $56,000     $171,000
           units    —         29 pages      3,300 orders 52,500 lines    one
 Western
           cost $2,030,000   $580,000        $165,000     $105,000    $171,000
Income and Expense Statement, by Sales Region,
      Col Ski Co. 2002 ($000) (Fig. 15-5)
                                               Total Eastern Midwestern Western
 Net sales                                  $27,000 $9,000      $4,500 $13,500
 Less cost of goods sold                      18,900   6,300      3,150   9,450
 Gross margin                                  8,100   2,700      1,350   4,050
 Less operating expenses:
     Personal selling                          3,847    1,070        802     1,975
     Advertising                               1,220      420        220       580
     Warehousing/shipping                        480      190        125       165
     Order processing                            240       79         56       105
     Administration                              513      171        171       171
 Total operating expenses                      6,300    1,930      1,374     2,996
 Net profit (loss)                           $ 1,800   $ 770       ($24)   $ 1,054
 Net profit (loss) as percentage of sales     6.70%    8.60%    (0.53%)     7.80%
        Methods Used to Allocate Indirect Costs
                     (Fig. 15-6)
           Method                                           Evaluation

Divide cost equally among territories or       Easy to do, but inaccurate and usually unfair
whatever market segments are being             to some market segments.
analyzed.
Allocate costs in proportion to sales          Underlying philosophy: apply cost burden
volume obtained from each territory (or        where it can best be borne. That is, charge a
product or customer group).                    high-volume market segment with a large
                                               share of the indirect cost. This method is
                                               simple and easy to do, but may be very
                                               inaccurate. Tells very little about a segment’

Allocate indirect costs in same proportion     Again, easy to do but can be inaccurate and
as the total direct costs. Thus if product A   misleading. Falsely assumes a close
accounted for 25 percent of the total          relationship between direct and indirect
direct costs, then A would also be             expenses.
charged with 25 percent of the indirect
expenses.
AN ETHICAL DILEMMA
Is it ethical to allocate indirect expenses to territories on the
basis of where these costs can best be carried?
   Particularly where the indirect expenses are allocated in proportion to the
    sale volume or gross margin generated by each territory?

   Any of the widely used bases for allocating indirect expenses has
    weaknesses. Unfortunately, there is no perfect basis.
   Becomes an ethical question if the compensation plan for the sales reps or
    the territory managers is based in part on the territory's net profit. (If the
    pay plan is based in part on the territory's contribution-to-margin, then the
    indirect expenses are not at all involved in determining the compensation of
    a sales rep or a territory manager.)
   The pay plan ideally should be based on factors controllable by a rep or a
    manager.
       Reps have no control over the indirect expenses so it is not
        fair to base their pay on a territory's profit
       Under the cost-allocation basis in question, the better a
        sales rep does in generating sales volume or gross margin,
        the larger the share of indirect expenses charged to that
        rep.
   Such a system simply is not fair or ethical to that rep.
Marketing Cost Analysis


    Contribution – Margin Approach
Income and Expense Statement by Sales Region, Col Ski Co 2002, in
      $000, using contribution-margin approach (Fig. 15-7)

                                             Total Eastern M idwestern    Western
      Net sales                           $27,000 $9,000        $4,500    $13,500
      Less cost of goods sold               18,900   6,300        3,150      9,450
      Gross margin                           8,100   2,700        1,350      4,050
      Less direct operating expenses:
        Personal selling                     3,082       845       595       1,642
        Advertising                            732       254       127         351
        Warehousing/shipping                   160        64        42          54
        Order processing                       130        43        30          57
      Total direct expenses                  4,104     1,206       794       2,104
      Contribution margin                  $ 3,996   $1,494      $ 556     $1,946
      Less indirect operating expenses:
        Personal selling                      765
        Advertising                           488
        Warehousing/shipping                  320
        Order processing                       110
        Administration                         513
      Total indirect expenses              $2,196
      Net profit                           $1,800
Full Cost v. Contribution Margin

            Full Cost                      Contribution Margin
Purpose of mktg cost analysis is    Not possible to accurately
to determine net profitability of   allocate indirect costs
units                               Full cost method may show a
Contribution-margin method          unit with a net loss, but it may
misleading                          still be contributing to covering
                                    overhead
ROI v. ROAM

   ROI (return on investment)
    Net profit        Sales
                 x
    Sales             Investment

   ROAM (return on assets managed)
   Variation of ROI calculation
   Used to evaluate the performance of
    managerial segments of field sales
    organization
                                  Return on Assets Managed (ROAM)
Sales                               $ 10,000,000
Cost of goods sold                     7,000,000
Gross margin                           3,000,000
Salaries                                 150,000
Commission                               850,000
Travel                                   150,000
District office expense                  400,000
  Total direct expenses                 150,000
Contribution margin                 $ 1,450,000
Accounts receivable                   2,200,000
Inventories                           2,000,000
Total assets                         $ 4,200,000

                          Contribution margin           1,450,000
 Profit on sales % =         Sales volume           =   10,000,000       x    100    =   14.5%



                                    Sales volume                       $10,000,000
 Asset turnover     =     Accounts receivable + Inventories     =      $ 4,200,000   =   2.38



        ROAM = Profit on sales % x Asset turnover

               =   1,450,000              x        10,000,000
                   10,000,000                      4,200,000

               =          14.5%          x           2.38       =    34.5%
"Large-annual-volume customers never present a
small-order problem, while low-annual-volume
customers always create small-order problems." Do
you agree?
   No.
   Large annual-volume customers may be a
    small-order problem in at least two ways:
       by buying all year on a hand-to-mouth basis,
        possibly placing orders once or twice a week
           JIT
       by placing a large order at beginning of each
        month and a small fill-in order about the 27th of
        the month.
      Fig. 15-8 Ways to Increase Order Size and
         Reduce Small Order Marketing Costs
•Educate customers who buy from several different
suppliers. Stress the advantages of purchasing from
one supplier.
•For customers who purchase large total quantities in
frequent small orders, stress the advantages of
ordering once a month instead of once a week. Point
out that the buyer eliminates all handling, billing, and
accounting expenses connected with three of the four
orders. Note further that the buyer writes only one
check and one purchase order. In addition, stress
that there will be only one bill to process and one
shipment to put into inventory instead of three or four.
      Fig. 15-8 Ways to Increase Order Size and
         Reduce Small Order Marketing Costs
•Educate the sales force as well as customers. In
fact, it may be necessary to change the compensation
plan to discourage acceptance of smaller orders.
•Substitute direct mail or telephone selling for sales
calls or unprofitable or small-order accounts; or
continue to call on these accounts, but less frequently.
•Shift an account to a wholesaler or some other type
of middleman rather than dealing directly, even by
mail or telephone.
     Fig. 15-8 Ways to Increase Order Size and
        Reduce Small Order Marketing Costs
•Drop a mass-distribution policy and adopt a selective
one. This new policy may actually increase sales
because sales reps can spend more time with
profitable accounts.
•Establish a minimum-order size.
•Establish a minimum charge or a service charge to
combat small orders
CASE 15-1: SEAL RITE ENVELOPE COMPANY
(B) – Profitability Analysis

   Overview:
   Rose Douglas's review of a profitability analysis
    of customers leads her to believe that many of
    the current customers Seal Rite is serving are
    unprofitable.
   Reviewing some summary sales figures for the
    previous year she finds that sales to the smaller
    accounts (those under $2,000 annual sales) are
    unprofitable.
What are the problems indicated from
the data in Table 1?
   Problems with the data:
   Rose needs to look at her figures in more detail. While in the previous Seal
    Rite case (Case 14-1) she used too much detail, here she appears to be
    looking at too much aggregate.


   Problems indicated by the data:
       Accounts under $2,000 annual sales are not profitable based on this
        information.
           From an operating profit % of sales standpoint, Seal Rite seems
            to do just about as well with any sale over the $3,000 level.
           Gross margins are large, and the total sales to this category
            represents about 7 percent of total sales.
           The problem is that overall selling expenses are high.
       In general, the data shows that there is an inefficient allocation of sales
        calls among the various customer groups.
       One other interesting finding is that the same approximate number of
        sales calls are made to each of the top two categories, but the top
        category accounts for more than 3-times the sales of the second
        category.
     What should Rose Douglas do about
     those problems?
1.       Better define her information needs and get the appropriate level of
         information.
2.       Rose needs to get her reps calling on the right customers the right
         number of times.
3.       Spend less time with smaller clients and more time with larger
         clients:
          May involve limiting the number of calls (quarterly) made on small
           accounts (under $2,000 in purchase volume per year) and ―building the
           sales‖ on each call. Requires planning ahead with the customer for
           supply needed in the next fiscal quarter.
          May decide to use telemarketing, direct mail, or their Web page for
           small accts. Small accts may not ordering enough to justify reps' time.
           Although the reps should always be prospecting for new business, they
           must be efficient in selecting who they spend their valuable time with.
          May want reps spending more time calling on customers who buy in
           higher volumes. Since they are so profitable in terms of the operating
           profit they provide, the firm would do well to move other customers into
           this class.
Implementation

   Meet with her sales force and share this data with
    them.
     Many of the reps are probably under the impression
      that frequent calls on these small buyers is just as
      profitable an approach as calling on larger
      customers.
   Review her sales force compensation plan to ensure
    that the insight provided by her analysis is
    incorporated.
   Perhaps training to aid in efficient prospecting
Next Class

   Make-up Quiz
   Chapter 16: Evaluating a Salesperson’s
    Performance
   Prepare Case 16-2: Seal-Rite Envelope
    Company (C)
   Prepare Exercises: 1,2,3,4,8,and 9
   Read articles on the Course Website
   Final Exam Location  This Classroom

				
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