Chapter 15 Marketing Cost and Profitability Analysis Business

Chapter 15 Marketing Cost and Profitability Analysis Business prophets tell us what should happen – but business profits tell us what did happen. Earl Wilson Copyright © 2003 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

A Comparison of Marketing Cost Analysis and Production Cost Accounting (Fig. 15 -1) Comparison Factors Marketing Cost Analysis Production Cost Accounting Bases for computing costs Marketing unit: territory, customer group, order size, as well as product Unit of product More complex Source of cost incurred Salespeople in the field Less exact Cost-volume relationship Volume is a function of cost V=f( C ) Difficult to measure Copyright © 2003 by The Mc. Graw-Hill Companies, Inc. All rights reserved. Relatively simple Machines and closely supervised workers More precise Cost is a function of volume C=f(V) Relatively easy to measure

Income and Expense Statement, 2002, Colorado Ski Company ($000) (Fig. 15 -2) Net sales Less cost of goods sold Gross margin Less operating expenses: Sales salaries and commissions $3, 240 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 Net profit Copyright © 2003 by The Mc. Graw-Hill Companies, Inc. All rights reserved. $27, 000 18, 900 8, 100 6, 300 $ 1, 800

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 Selling. Advertising and Shipping. Processing. Administration Ledger expenses Totals Sales salaries/commis $3, 240, 000 — Sales force travel 372, 000 — Supplies & telephone 178, 000 43, 200 22, 200 Media space 870, 000 — 870, 000 Advertising salaries 218, 000 — 218, 000 Property taxes 120, 000 14, 500 Heat and light 168, 000 15, 300 17, 400 Insurance 84, 000 12, 000 4, 200 Administ. salaries 930, 000 144, 000 62, 000 Other expenses 120, 000 10, 500 11, 700 Totals $6, 300, 000 3, 847, 000 1, 220, 000 Copyright © 2003 by The Mc. Graw-Hill Companies, Inc. All rights reserved. — — 40, 900 — — 66, 000 100, 500 46, 300 168, 000 58, 300 480, 000 — — 43, 500 — — 14, 000 16, 200 14, 000 126, 000 26, 300 240, 000 — — 28, 200 — — 15, 500 18, 600 7, 500 430, 000 13, 200 513, 000

Allocation of Activity Costs to Sales Regions, Col Ski Co. 2002 (Fig. 15 -4)

Income and Expense Statement, by Sales Region, Col Ski Co. 2002 ($000) (Fig. 15

Methods Used to Allocate Indirect Costs (Fig. 15 -6) Method Divide cost equally among territories or whatever market segments are being analyzed. Allocate costs in proportion to sales volume obtained from each territory (or product or customer group). Evaluation Easy to do, but inaccurate and usually unfair to some market segments. Allocate indirect costs in same proportion as the total direct costs. Thus if product A accounted for 25 percent of the total direct costs, then A would also be charged with 25 percent of the indirect expenses. Again, easy to do but can be inaccurate and misleading. Falsely assumes a close relationship between direct and indirect expenses. Underlying philosophy: apply cost burden where it can best be borne. That is, charge a 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’ Copyright © 2003 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Income and Expense Statement by Sales Region, Col Ski Co 2002, in $000, using

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. • 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. • 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 Copyright © 2003 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Return on Assets Managed (ROAM) Sales Cost of goods sold Gross margin Salaries Commission Travel District office expense $ 10, 000 7, 000 3, 000 150, 000 850, 000 150, 000 400, 000 Total direct expenses Contribution margin 150, 000 $ 1, 450, 000 Accounts receivable Inventories 2, 200, 000 2, 000 Total assets $ 4, 200, 000 Profit on sales % = Asset turnover = Contribution margin Sales volume = 1, 450, 000 10, 000 Sales volume Accounts receivable + Inventories = x 100 = 14. 5% $10, 000 $ 4, 200, 000 = 2. 38 ROAM = Profit on sales % x Asset turnover = 1, 450, 000 10, 000 = 14. 5% x x 10, 000 4, 200, 000 2. 38 Copyright © 2003 by The Mc. Graw-Hill Companies, Inc. All rights reserved. = 34. 5%