Marketing costing & mix modeling


Determining Corrective Action

Here we are taking a lawn mover company for our examples to elaborate on different marketing situations for the purpose of better understanding of the readers.

It would be naïve to conclude that the company should drop garden supply shops and possibly hardware stores so that it can concentrate on department stores. The following questions need to be answered first:

Ø To what extent do buyers buy on the basis of type of retail outlet versus brand?
Ø What are the trends with respect to the importance of these three channels?
Ø How good are the company marketing strategies directed at the three channels?

On the basis the answers, marketing management can evaluate five alternatives:

1. Establish a special charge for handling smaller orders.
2. Give more promotional aid to garden supply shops and hardware stores.
3. Reduce the number of sales calls and the amount of advertising going to garden supply shops and hardware stores.
4. Do not abandon any channel entirely, but only the weakest retail units in each channel.
5. Do nothing.

In general, marketing-profitability analysis indicates the relative profitability of different channels, products, territories, or other marketing entities. It does not prove that the best course of action is to drop the unprofitable marketing entities, nor does it capture the likely profit improvement if these marginal marketing entities are dropped.

Direct versus full costing

Like all information tools, marketing-profitability analysis can lead or mislead marketing executives, depending on how well they understand its method and limitations. The lawnmower company showed some arbitrariness in its choice of bases for allocating the functional expenses to its marketing entities. “Number of sales calls� was used to allocate selling expenses, when in principle “number of sales working hours� is a more accurate indicator of cost. The former base was used because it involves less record keeping and computation.

Far more serious is another deciding factor affecting profitability analysis. The issue is whether to allocate full cost or only direct and traceable cost in evaluating a marketing entities performance. The lawn mover company side stepped this problem by assuming only simple cost that fit in with marketing activities, but the question cannot be avoided in real world analysis of profitability. The three types of costs have to be distinguished:

Direct costs: These are costs that can be assigned directly to the proper marketing quantities Sales commissions are a direct cost in profitability analysis of sales territories, sales representative, or customers. Advertising expenditure is a direct cost in a profitability analysis of product to the extent that each advertisement promotes only one product. Other direct costs for specific purposes are sales force salaries and traveling expenses.

Traceable Common costs: These are costs that can be assigned only indirectly, but on a plausible basis, to the marketing entities. In the example, rent was analyzed this way.

Non-traceable common costs: These are common costs whose allocation to the marketing entities is highly arbitrary. To allocate “corporate image� expenditures equally to all products would be arbitrary, because all products do not benefit equally. To allocate them proportionately to the sales of the various products would be arbitrary because relative product sales reflect many factors besides corporate image making. Other examples are top management salaries, taxes, interest, and other overhead.

No one disputes the inclusion of direct costs in marketing cost analysis. There is a small amount of controversy about including traceable common costs, which lump together costs that would change with the scale of marketing activity and costs that would not change. If the lawnmower company drops garden supply shops, it would probably continue to pay the same rent. In this event, its profits would not rise immediately by the amount of the present loss in selling to garden supply shops.

The major controversy concerns whether the non-traceable common costs should be allocated to the marketing entities. Such allocation is called the full-cost approach, and its advocates argue that all costs must ultimately be imputed in order to determine true profitability. However, this argument confuses the use of accounting for financial reporting with its use for managerial decision making. Full costing has three major weaknesses:

1. The relative profitability of different marketing entities can shift radically when one arbitrary way to allocate non-traceable common costs is replaced by another.

2. The arbitrariness demoralizes managers, who feel that their performance is judged adversely.

3. The inclusion of non-traceable common cause could weaken efforts at real cost control.

Operating management is most effective in controlling direct costs and traceable common cost. Arbitrary assignment of non-traceable common cost can lead managers to spend there time fighting arbitrary cost allocations instead of managing controllable costs well.

Companies are showing a growing interest in using marketing-profitability analysis or its broader version, activity based cost accounting (ABC) , to quantify the true profitability of different activities. To improve profitability, managers can then examine ways to reduce the resources required to perform various activities or make the resources more productive or acquire them at lower cost. Alternatively, management may raise prices on products that consume heavy amounts of support resources. The contribution of ABC is to refocus management’s attention away from using only labor or material standards cost to allocate full cost, and toward capturing the actual cost of supporting the individual products, customers, and other entities.

Marketing Mix Modeling

Marketing accountability also means that marketers can more precisely estimate the effects of different marketing investments. Marketing-mix models analyze data from a variety of sources, retailers’ scanner data, company shipment data, pricing, media, and promotion spending data, to understand more precisely the effects of specific marketing activities. To deepen understanding, multivariate analysis are conducted to sort through how each marketing elements influences marketing outcomes of interest such as brand sales or market share.

Especially popular with package goods marketer such as Procter& Gamble, Clorox, Colgate, the findings from marketing-mix modeling are used to allocate or reallocate expenditure. Analyzers explore which parts of ad budgets are wasted, what optimal spending levels are, and what investment level should be. Although marketing-mix modeling helps to isolate effects, it is less effective at assessing how different marketing elements work in combination.