Chapter 12 Marketing Profitability Analysis Mc GrawHillIrwin 2003

Nature and Purpose Of Marketing Cost Analysis v Marketing cost analysis involves a detailed study of a firm’s entire marketing and distribution cost structure. v It is designed to identify and measure marketing and distribution cost elements. v The goal is to determine the productivity of different segments, such as products, customers, territories, channels, so as to eliminate unprofitable marketing efforts. Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Need for Marketing and Customer Cost Data • To obtain better marketing and customer cost data: • Define types of decisions requiring better information, and then determine the value expected from this better information • Know profit changes in response to sales volume shifts that occur when marketing expenditures change • Know incremental profit contribution Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Contributions To Pricing • 1. Assists in precise measure of marketing and distribution costs • 2. Estimate the profitability of various sales segments at past and future alternative prices • 3. Assess when a price change is needed – to make certain distributors, customers, order-sizes profitable – to discourage growth of unprofitable sales segments – to encourage growth of profitable segments Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Contributions To Pricing • 4. Defense for differential pricing practices based on cost justification • 5. Improve distribution support by understanding distributors’ marketing and distribution costs and modifying price structures appropriately Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Marketing Cost Classifications • Common fixed marketing costs are costs incurred in common for different profit segments and do not vary with the volume of sales or activities in any profit segment • Direct variable marketing costs vary with an activity and can be assigned to profit segments • Separable fixed marketing costs are costs that can be assigned to specific profit/sales segments Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Contribution Approach • Contribution method avoids arbitrary assignment of common, fixed marketing costs – Once the contribution for each product or profit segment is determined, a PV ratio can be computed and alternative prices for each product can be analyzed exactly Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Net Profit Approach • Net Profit Approach attempts to assign all indirect costs among profit segments – Marketing expenditures of a business are reclassified from a natural-expense basis into activity-cost groups – Activity cost groups are assigned to profit segments on the basis of measurable factors that exhibit causal relationships to the activity costs Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Cost Groups And Bases Of Assignment Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies,

The Concept of Customer Profitability Customers can be viewed as the main source of profits for the business firm • 1. Measuring customer profit includes – Identifying the customer – Measuring the net revenue received (transaction price x volume) and actual costs incurred while serving the customer – Combining these elements into an estimate of profitability for each customer Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

The Concept of Customer Profitability • 2. Distinguish between customer acquisition and customer retention when estimating costs associated with each customer • 3. Combine the revenues and costs associated with each customer into an estimated profitability for each customer Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Enhancing Customer Profitability • Analyzing the historical profitability of customers allows managers to then assess: – 1. The relative success of marketing strategies – 2. The relationship between customer-related costs and customer-based revenues – 3. The relationship between customer profitability and financial performance The real benefit is that it provides a basis for developing a Customer Profitability Management program Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Enhancing Customer Profitability • Although the cost of customer acquisition is higher than the cost of customer retention, customer acquisition should be viewed as an investment • It is important to understand how and why current customers behave to determine the profit potential of current customers • Customer loyalty enhances revenue growth through repeat purchases and referrals, reduces costs of acquiring new customers, and reduces employee turnover costs and enhances employee productivity Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Solutions For Unprofitable Customers • 1. Reassign marketing and selling resources to profitable customers – Establish call frequencies for profitable vs. Unprofitable customers. – Encourage mail, telephone, or electronic orders for unprofitable customers. – Unbundle services and make available on a fee basis. – Change channel of distribution. Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Solutions For Unprofitable Customers • 2. On small orders: – Require customers to pick up orders or arrange for delivery – Charge for delivery – Establish a minimum order size • • • Mc. Graw-Hill/Irwin Include a surcharge for orders below minimum size Require cash on orders below minimum size Eliminate small orders © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Solutions For Unprofitable Customers • 3. Establish a price structure – Volume discounts – Surcharges for small oders – End-of-year patronage discounts (rewards) • 4. Establish a credit policy – Establish credit lines – Include cash discounts in price structure (early payment rewards) Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Improving Distribution Management With Cost Information • By separating the costs of transportation, warehousing, ordering, billing, and invoicing into their fixed and variable cost components, it is possible to determine the effects of costs and profits to changes in volume, rates, transportation mode mix, and distribution center origin or destination • End result = improved customer service while realizing overall cost savings Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Improving Retail Management With Better Cost Information • Distribution costs, selling costs, and inventory costs should all be identified and classified according to their behavior and attributability • End result = the firm will be in a position to make better buying decisions, pricing and promotion decisions, and operating decisions related to store size and layout, department space allocations, and inventory management Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

Starting a Profitability Analysis Program Ø Concentrate initially on products that contribute a substantial amount of sales and profits Ø Simplify the analysis and reduce the costs of developing and implementing the program Mc. Graw-Hill/Irwin © 2003 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.