lecture notes - marketing finance-jbims mumbai

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What is Marketing Finance?

Before we answer this question, let us answer a few other questions –

What is the purpose of business? Without being modest, let us admit that sole purpose of business is to earn PROFIT . And where does the profit come from? It comes from having the customers and customers are earned by Marketing. Marketing, most simply defined, is “Getting into consumers’ mind”.

Marketing is a capital intensive exercise. Starting from consumer survey (to know his needs and preferences) to advertising campaigns and establishing distribution channels and so on, every activity costs money. Thus, there is a financial perspective to almost every marketing activity.

Earning and retaining customers is very fine. But what is the cost benefit analysis? Are positive product-market results translating into positive financial results? Am I investing more to earn/keep a customer than I expect to earn from him? This cost benefit analysis is vital before taking any marketing decision. Therefore, the interface between Marketing & Finance is vital for any company.

Given a free hand, marketing department would splurge on marketing overdrive through advertisement campaigns, promotions, dealer appeasements and so on. But at the end of it all, have the profits grown? What are the financial consequences of marketing decisions? What is the ROI on each penny invested on marketing? Have the marketing people dumped the product in the market to paint a rosy picture of their performance before the CEO? A little analysis of financial data of marketing department would lift up the veil. This is the role of Marketing Finance.

Before going any further, let us revise fundamentals of Marketing.

As already said, Marketing most simply defined is getting into consumers’ mind. Finding out what his needs are (needs could be physical, psychological, security, social, etc, etc; apparent or dormant; etc) and then creating product or else packaging the product to fulfil those needs is Marketing. Take the classical real life case of repositioning an existing product to address consumers’ need.

Whirlpool launched its washing machines in India in 1997 and became a raging success in next two years against some well established competition, like, Videocon, Onida and BPL, through innovative marketing strategy. However, come 2001 and consumer durables market got stagnated due to economic conditions. When the markets stagnate, the only way to increase sales is by biting into the competitors’ share. It then becomes dog eat dog world. Price discounts, promotions, gifts, etc, galore and competition becomes tougher with passage of time. The story replayed as ever in washing machine market. However, Whirlpool, being an International brand, follows some strict profitability norms and therefore, could not match aggressive discount war in the market and began to lose market share.

of 59 - Marketing Finance (Ver 1.1) Jamnalal Bajaj Institute of Mgmt Studies

In addition,, a perception grew in the market that because of bigger agitator in Whirlpool washing machines, it could take less clothes than other machines. Such perception led to waning consumer interest in the product.

Whirlpool then launched an in-depth study regarding consumers’ expectation from a washing machine. Study revealed that while every machine was promising “whiter than milk” shirts and sarees, there was an unfulfilled demand for machine which could wash heavy clothes like curtains, bed covers, etc. Whirlpool decided to position their machine to fulfil this unfulfilled demand. They launched an ad campaign showing a wild party scene in a house. People were frolicking and food was every where, on table clothes, curtains, etc. Daughter was worried and asked her mother what she was going to do. The lady replies – “Mummy ka magic chalega”. And then she is seen washing all those heavy clothes in a whirlpool washing machine. Ad also justified its capability saying that because its agitator is big and heavy, it can wash those clothes.

Whirlpool recaptured its lost market share and more within a very short time.

What we see from above marketing success story is that by proper insight into consumers’ mind and little strategic marketing effort, whirlpool converted its perceived negative (heavy agitator) into a positive attribute of the machine and by repositioning the product, succeeded in the market.

Coming to more specifics about marketing finance –

“Finance provides control points in a marketing exercise. Such control points help in taking better marketing decisions” .

Let us understand above statement.

Any company sets its goals. Those goals are then converted into targets for each department/section/individual to achieve. Thereafter, plans are chalked out to achieve those targets. These are the System Inputs.

System output is ‘Performance’ in terms of achieving the set targets. Two questions are important here. One – Whether people are achieving their targets, Two – If yes, then at what cost? Are people maintaining profit levels while achieving their targets? As we will see in a short while, it is quite possible that company loses out when people achieve their targets.

Take the case of sales team achieving their sales target. It is quite possible that they could have dumped the product in the market/extracted orders from dealers on the promise of extended credit period. Such dumping may lead to any or all of the following consequences:

(a) Sluggish take off from factory in subsequent months owing to glut in the market due to dumping.

(b) Losses due to expiry of shelf life of perishable products. Remember that products which have tendency to quickly become obsolete due to technological upgrades, like, mobile phones, computers, and other electronic gadgets or cyclic products, like fashion clothes and accessories, also fall in the category of perishable goods, though theoretically speaking they are not.

(c) Higher inventory levels and consequent increased working capital cost.


(d) Higher receivables often translate into higher bad debts.

(e) If the company has No-Return policy, dealers are likely to sell those life expired products to unsuspecting customers and soil the brand name of the company.

Thus, while the sales team was able to demonstrate that target was achieved, did it boost the profit level? On the contrary, it has negatively impacted the profit levels. Application of a little marketing finance interface will be able to call the bluff by analysis of a few relevant financial ratios.

Where all do the Marketing and Finance interface?

Product Related

New Product Launch – Before launch of any new product, sales projections over the entire product life cycle are done. There after, the variable cost projections are done. Difference between the two gives the gross margin. From the gross margin, marketing expenses over the life cycle of the product are extracted. That gives the net margin. Those future earnings are then discounted to the present period to calculate profitability of the product.

Compare the DCF of all the options and decide which product to opt for launch.

Product Mix Decisions – Which product mix gives maximum contribution to the company given the constraints of labour, material, production capacity and profit margins? This calculation is done by finance department and communicated to the marketing deptt to enable them to draw their marketing strategy to achieve the desired product mix sales.

Whether to continue or drop a product? - A product could be incurring losses in the market. Should product be dropped? This is not a purely marketing or even finance decision which can be taken alone by either deptt without assistance of other. There could be other forces at play, like use of some by-product which otherwise may go waste. Or, this product pushing sales of some other profitable product indirectly. There could be many more such reasons where marketing finance interface will help in taking right decision.

Pricing Decisions – Pricing decisions are again some thing that often necessitate involvement of finance people. Production cost, variable cost, fixed cost, profit margin under various conditions, etc are all calculations which need involvement of finance people. But it is so only when price cuts are to be effected. During the price rise, marketmen’s wisdom is better not adulterated. Take the interesting case of Mercedes Benz Vs Toyota Lexus.

Toyota Lexus was launched in competition with Mercedes Benz. Lexus was priced tantalising lower than Merc though with same features. Mercedes Benz defied the normal wisdom and instead of


responding with a price cut, increased the prices of their cars. Lexus, with a considerable price gap now, was thus pushed into a lower strata and Merc’s sale increased despite price increase.

Product Modification Decisions – Product modifications, like added features, improved quality, etc, cost money. How much money? How much additional profit is expected out of modification? Is the expected additional profit commensurate with the risk of loss of investment?

Advertising Related

Advertising Effectiveness – Evaluation of effectiveness of advertising helps in proper channelising of the expenses. Which medium, which territory, which time of the day, which advertisement, etc are giving the maximum sales growth?

Advertising is effective when there is “Differentiation” benefit available (Product can boast of a benefit that others can not. Or it has taken the first mover’s advantage by a claim which may be generic but not yet exploited by others, like use of clove oil by Promise toothpaste. This is called USP-Unique Selling Proposition). If there are too many people advertising on same aspect of the product (all washing soaps claim to wash the whitest), each one will probably be able to maintain its existing share of pie. Any substantial shift of customer base can not be expected.

Evaluating ROI for various marketing alternatives. What is the sales growth/profit growth for each rupee spent on marketing in a particular medium or territory, etc.

Performance Evaluation – Performance evaluation in financial terms of each element of marketing like product, territory, dealer, salesmen, etc, is necessary for corrective measures.

Outsourcing Decisions – Decisions regarding outsourcing of marketing activities are often influenced by Finance deptt. Outsourcing could be for product manufacturing as is the case with most of the large manufacturers including giants like Hindustan Lever. Or it could be for distribution. Company may decide to have its own fleet of vehicle for distribution or decide to outsource the delivery of product to various destinations. Or it could be combination of the two. Long distance distribution could be outsourced and local distribution may be through company’s vehicles.

Service Level Decisions – After Sales Service can be a big USP for any company. Maruti and Tata score over every other automobile company on this count in car and heavy vehicle segments respectively. (Maruti uses it in its ad campaigns). But service level decisions are complex. Prompt service means better customer satisfaction and increased sales but also large infrastructure which translates into huge investments. Slow service means unsatisfied customers but lesser investments. Cost benefit analysis will help to decide at what level service should be kept.

CAPEX – Expansion of the distribution markets could be through company owned showrooms/offices or through dealership/retailers etc. Similarly, distribution could be through company owned vehicles or be outsourced. Such decisions are taken in


consultation with Finance deptt based on capital availability with company vis a vis profitability of investment.

Life Cycle Cost – Marketing resource allocation at different stages of product life cycle.

R&D expenses for assessing customer preferences/acceptance/needs, product modifications, etc.

Brand Valuation – Brand valuation is often required for mergers and acquisitions.

Marketing Finance

Marketing imposes high working capital requirement. Working capital has three basic components: Receivables, Inventory and Liquidity ie cash.

Level of finished goods inventory at various levels, like in transit, with C&F agents, stockists, retailers, etc, affects sales volume. Low level of inventory would reduce visibility and increase service time thereby affect sales adversely. However, higher inventory increases working capital and costs associated with it.

Credit period is also used as a marketing strategy. Increased credit period is sometimes offered to dealers as inducement for stocking the product. This again leads to higher inventory levels. Higher inventory levels, apart from increased working capital requirements, also increases various risks depending upon the nature of product. Products with low shelf life either due to frequent technological upgrades or perishable nature or susceptible to frequent changes in customer demands, like fashion goods, or with seasonal demand like Air conditioners, heaters, cooler, etc pose heightened risk.

Higher receivables again increase working capital requirement. Higher receivables also increase risk of bad debts. Often discounts are offered for early payment to reduce the receivables and the default risk.

Cash management is also vital. While idle cash carries a cost, inadequate cash may result in opportunity loss.

All the three components of working capital would be dealt with in detail in subsequent lectures.

Receivables Management

Health of receivables can be gauged by examining following 4 financial ratios-

1. Account Receivables Turn Over Ratio = Annual Credit SalesAvg Account Receivables


2. Collection Period in Days = . 365 ____ . Receivables Turn Over Ratio

3. Account Receivables to total assets

4. Account Receivables to sales

Also, percentage of bad debts to sales can be used.

Problems :

Prob: Company A shows the following financial data

As On 31.12.2001 As on 31.12.2002

Sales 4,20,000 5,30,000

Total Assets 6,10,000 6,70,000

Account Receivables 60,000 1,00,000

Account Receivables as on 01 Jan 2001 were Rs 50,000.

Solution:

Average Account Receivables for year 2001 = 50000 + 60,000 = 55,0002

Average Account Receivables for year 2002 = 60,000 + 1,00,000 = 80,000 2

Receivables Turnover Ratio for year 2001 = 4,20,000 = 7.63 55,000

Receivables Turnover Ratio for year 2002 = 5,30,000 = 6.625 80,000

Collection Period in Days in 2001 = 365 = 48 7.63

Collection Period in Days in 2002 = 365 = 55 6.625

Account Receivables to total assets in 2001 = 55,000 = 9%6,10,000

Account Receivables to total assets in 2002 = 80,000 = 12%6,70,000


Analysis –

Against 26% growth in sales there is 66% rise in receivables. This is a sure sign of dumping.

Company B presents the following financial data: -

As On 31.12.2001 As on 31.12.2002 Effect

Sales 90000 120000 ↑33%

Account Receivables 28000 31% 39000 43% ↑40%

Bad Debts 3000 3.33% 3500 2.91% ↑16%

When we analyse the performance in percentage terms, we see that against 33% increase in sales, there is 40% increase in account receivables which gives the impression of dumping. There is also an increase of Rs 500 in bad debts.

However, when the data is analysed in absolute terms, sales have grown by Rs 30000. Taking a profit percentage of measly 20%, profit growth is Rs 6,000. Increased account receivables is Rs 11,000. Even at a high capital cost of 20%, it means an increase of Rs 2,200. Add to that additional bad debts of Rs 500 and total cost is Rs 2,700 against income of Rs 6000. Thus, there is a net minimum gain of Rs 3,300.

Inventory

In order to check the health of the inventory, we check two ratios –

1. Inventory Turnover Ratio – Cost of Sales Avg Inventory

(Please note that it is Cost of Sales and not Sales because sales includes profit margin which has no bearing on inventory)

2. Age of Inventory = . 365 .Inv T/O Ratio

Company C gives following financial data of its performance -As On 31.12.2001 As on 31.12.2002

Finished Goods 11,000 17,000

Cost of Sales 73,000 85,000

As on Jan 01, 2001, finished goods were Rs 8,000.


Solution:

Avg inventory for year 2001 = 8000 + 11000 = 95002

Avg inventory for year 2002 = 11000+17000 = 140002

Inventory Turnover Ratio in 2001 – 73000 = 7.68 9500

Inventory Turnover Ratio in 2001 – 85000 = 6.07 14000

Age of Inventory in 2001 = 365 = 47.5 days 7.68

Age of Inventory in 2002 = 365 = 60 days 6.07

Thus, inventory turnover has gone up by from 47.5 days to 60 days which is an increase of 25%. This will lead to increase in working capital requirement. Also some risk is associated with higher inventory turnover if it is low shelf life item but not much if it is a standardised product.


Date: 24 Jul 2006

Liquidity (Cash) Management

Company B reports the following info for the year ended on 31 Dec 2001.

Net Income 750000Depreciation 30000Interest Payment 140000Sale of Fixed Assets 20000Payment of debt principal 300000Dividends 90000Capex 280000Find if company’s liquidity position is satisfactory.

Solution :

The Key to solving above problem is to first find out the operating income and thereafter deduct the expenses from it.

Operating Income/ProfitNet Income 750000Adjustments

Depreciation 30000Sale of Fixed Assets (20000) 10000

Total 760000Add Back Interest Payment 140000Total Operating Income 900000LiabilitiesInterest Payment 140000Payment of Debt Principal 300000Dividend 90000Capital Expense 280000Total Liabilities 810000

Cash Position after meeting the liabilities = 900000 – 810000 = 90000

Thus company will be left with Rs 90000 after meeting all its liabilities. Now it is hard to say if this cash balance is adequate or not. One way to examine this is to check the historical cash to sales ratio.


Cash holding of the company depends upon the nature of business, business model and standing of the company in the market. A company like Reliance can get away with far less cash holding than most other companies as it can raise cash from banks and market whenever required. Thus, adequacy of cash is a completely subjective decision of the company’s management.

ROSE or ROSHE – Return on Share Holders Equity.

=

=

TAX MKTG TURN OVER LEVERAGE MGMT MGMT TO CAPITAL

Explanations – PAT – Profit after TaxNW – Net WorthPBT – Profit Before TaxInvestment = Net Worth or Shareholders funds + Borrowed Funds.

PAT to PBT ratio is basically indicator of tax management efficiency.PBT to Sales ratio is the marketing department’s efficiency indicator.Sales to Investment ratio is indicator of efficiency of capital utilisationInvestment to NW ratio indicates the leverage. How much loan has been taken against the shareholders funds.

ROI =

ROI =

ROI = Rate of Margin Turnover of Capital

Thus, we see that ROI is dependent on two factors. One – Rate of Margin or profit margin on sales and Two – Turnover of capital. Both these are independent factors and affect the ROI independently.

Now, let us compare Kamath Restaurants and the Five Star Hotels.


In case of Kamath Restaurants, the is small investment. Business starts from early morning and continues whole day till late in the night. Customers’ visits are short and often tables are shared by two or more unrelated customers. A single table could have been used by 50 or even 100 people during the day. There is high turnover of customers but the bills are small. Margins are also very small. The business basically runs on volume of customers.

A five star hotel require huge investment. Business starts late in the early afternoon. Becomes dull again in late afternoon and picks up again in the night. Customers visits are leisurely. One table is never shared by two different groups. A single table is rarely used by more than 4 groups in a day. But bills are considerably larger. Thus, a Five Star Hotel business runs on very heavy margins but less customer volume and capital turnover.

Managing Account Receivables

It is business fact that most businesses run on credit.

If all the other factors are same, there are basically two ingredients of a business success story

1. Price2. Credit

While high amount of credit is sure to increase the sales, it will also increase the cost through increased working capital requirement besides higher bad debts. On the other hand, though low credit will save cost due to low working capital cost, it will affect the sales. Thus, there is a need to optimise the credit.

But why indulge in credit sales at all?

Credit sales are a way of life in business world due to following reasons:

1. To be able to compete successfully in the market and get more sales.

2. To win over shelf or dealer space. – This is the strategy that was adopted by Whirlpool in the initial years of launch in 1996-97 to gain penetration in the market. Being a multinational company, it was cash rich and could afford large credit line. But once the product was established in the market and demand grew, credit line are squeezed. Credit strategies are different during launch and growth phase.

The companies/product which have good “MARKET MUSCLE” generally offer less or nil discount. Market Muscle means – A well differentiated and in-demand product. Product demand is so good that shop keepers are forced by market dynamics to stock that product to earn profit. Nirma had once achieved that status.

Elements of Credit Policy for Management of Account Receivables: -


1. Who to give credit? (Setting Credit Worthiness)

2. How much credit to be given to each? (Setting Credit Limit for each customer)

3. For how long to give credit? (Declaring stated credit duration policy)

4. Discounts for early payment of credit

5. Liberal credit to increase sales.

Checking Credit Worthiness –

(a) By checking past records of old customers

(b) By obtaining Bank Reference for new customers. (This is not a very reliable method since customer may have good relations with bank management).

(c) Check with other suppliers.

(d) Check from own old customers.

(e) From own sales people who have market intelligence through their friends working for different companies.

Steps in Receivables Management –

(a) Formulate a well defined billing cycle. Customer should be able to anticipate when he is likely to get the bill. Phone Bills and Credit Card Bills are payable always by the same date. Customer arranges finances in advance for payment

(b) Stamp Bill – “Pay By ____” clearly.

(c) Indicate late payment penalty even though it is never levied.

(d) Bill big customers immediately.

(e) Carry out age analysis of A/c Receivables customer-wise. This will make customer credit rating easy.

(f) Start chasing customers for old dues payments

(g) Go for Bill Discounting (Sell your dues to another company/bank for a discounted price. The company pays the amount due immediately and collects the dues from customer. In case of default by the customer, you will need to pay back the company).

(h) Don’t allow credit to doubtful customers. At least, reduce the credit period.

(i) Ask customers to pay when due. (In many case marketmen fight shy of reminding the customer to pay because they work with those customer on personal relations basis. So, those customers are not defaulting on company but on the sales person).


Problems:

Prob 1: Blake company provides following data:

Current Annual Credit Sales 80,000,000Collection Period 2 MonthsTerms Net 30 (Officialese for declaring credit period of 30

days)

Minimum Rate of Return 15% (Opportunity cost of Capital employedProposal of Marketing Department

Offer 2/10 Net 30 discount25% customers will take advantageCollection period should decline to 1.5 months

(Officialese for saying 2% discount for payment within 10 days)

Should the Marketing Department proposal be accepted? Why?

Solution:

Avg amount locked in credit sales before proposal = 2 months worth of sales

= Rs 80,000,000 x 2 12

= Rs 13,333,333

Avg amount in credit sales after the proposal = Rs 13,333,333 – 25%

= Rs 10,000,000

Amount released from credit = Rs 3,333,333

Working Capital Cost saved = Rs 3,333,333 x 15%

= 500,000

Cost of implementation of proposal = 2% of 25% of sales

= 2% x 20,000,000

= 400,000

Net Gain by implementing the proposal = 500,000 – 400,000

= 100,000


Prob 2: Long Corp gives following data:

Selling Price per Unit Rs 5/-Variable Cost per Unit Rs 2/-Fixed Cost per Unit Rs 2/-Annual Credit Sales 6,00,000 unitsCollection Period 1 monthReturns 24%Proposal

Liberalise creditCollection periodSales Increase Expected Bad Debt Increase

02 Months20%Rs 90,000

Please assess if the credit period should be liberalised.

Solution:

Additional Earnings due to proposal

Increase in unit sales due to proposal = 20% x 6,00,000

= 120,000

Increase in sales (Rs) due to proposal = 1,20,000 x Rs 3 (Contribution per unit for additional units of sales)

= Rs 3,60,000

Cost of Implementing the Proposal

Additional Working Capital to be locked up due to increase in additional sales

= Mfg cost of 2 months of additional sales

= Additional Unit Sales x variable cost 6

= 1,20,000 units x Rs 2/- 6

= Rs 40,000

Additional Cost incurred on existing WC due to increase in credit period by one month

= 50,000 units x Rs 5 x 2%

= Rs 5,000


Additional Cost of Capital = Cost of existing WC for one month + Cost of Additional capital for two months

= 50,000 units x Rs 5 x 2% + 2,40,000 x 24%

= 5,000 + 57,600

= 62,600

Cost of bad debt = 90,000

Total cost of proposal = 1,52,600

Net Gain = 3,60,000 - 1,52,600

= 2,07,400


Date: 31 Jul 06

Prob 1: Ponds Ltd has annual sales of 10,000 units at Rs 300 per unit. Tha variable cost is Rs 200/-. Fixed cost amounts to Rs 3,00,000/- per annum. The present credit period is one month. The company is considering proposal to increase credit period to 2 months or 3 months and has made the following estimates: -

Credit Policy Existing Proposed(01 month) (02 months) (03 months)

Increase in Sales -- 15% 30%% of bad debt 01% 3% 5%There will be increase in fixed cost by Rs 50,000/- if the sales increase beyond 25% of present level. The company plans to earn pretax return of 20% on investement in account receivables.

What should company do? Please advice.

Solution:

Credit Policy Existing Proposed(01 month) (02 months)

(15% inc)(03 months)(30% inc)

(03 months)(25% inc)

Sales 30,00,000 34,50,000 39,00,000 37,50,000Number of Units 10,000 11,500 13,000 12,500Variable cost @ Rs 200 20,00,000 23,00,000 26,00,000 25,00,000Contribution/Gross Margin 10,00,000 11,50,000 13,00,000 12,50,000Fixed Cost 3,00,000 3,00,000 3,50,000 3,00,000Net Contribution 7,00,000 8,50,000 9,50,000 9,50,000Avg Account Receivable (Sales/12 x months)

2,50,000 5,75,000 9,75,000 9,37,500

Investment in Receivables 23,00,000/12=1,91,667

26,00,000/6= 4,33,333

29,50,000/4= 7,37,500

28,00,000/4= 7,00,000

(a) Opportunity cost of capital @ 20% of investment

38,333 86,633 1,47,000 1,40,000

(b) Bad Debts (1,3,5% of sales)

30,000 1,03,500 1,95,000 1,77,500

Cost of option (a+b) 68,333 1,90,133 3,42,435 3,17,500Net Gain from option - Net Contribution – cost of policy

7,00,000 - 68,333 = 6,31,667

8,50,000 - 1,90,133 = 6,59,867

9,50,000 - 3,42,435 = 6,07,515

9,50,000 - 3,17,500 = 6,32,500

From above analysis of profits, it is clear that increase in credit period from one month to two months is beneficial to the company. However, any further increase in credit period is counterproductive due to steep rise in opportunity cost of capital as well as on account of bad debts.


Points to Ponder

1. If credit period is increased by one month, sale is increased by 15% only. Ideally, it should have been to the extent of 20 or 25%.

2. For credit period increase by one month or two months, increase in bad debt rate from one to 3 and 5 % is not acceptable.

Prob 2: Company D classifies its customers by risk ratings

Category Uncollectable Amount

Collection Period

Credit Policy Increase in Annual Sales

A 1 % 20 Days Unlimited Rs 5,00,000B 4 % 40 Days Restricted Rs 5,00,000C 18 % 70 Days Restricted Rs 7,00,000

Given profit is average 20% of sales. Minimum rate of rate on investment is 14%. Recommend should the company relax credit policy.

Solution:

Category A B CIncremental Gross Profit 5,00000 x 20% =

1,00,0007,00,000 x 20% = 1,40,000

Investment in A/c Receivables (incremental)

(5,00,000 x 40)/365 x 80% = 43,836

(7,00,000 x 70)/365 x 80% = 1,07,397

Bad Debts on increased sales 4% of 5,00,000 = 20,000

18% of 7,00,000 = 1,26,000

Opportunity Cost of Capital invested @ 14%

14% of 43,836 = 6,137

14% of 1,07,397 = 15,036

Cost of Policy 20,000 + 6,137 = 26,137

1,26,000 + 15,036 = 141,036

Net Profit 1,00,000 - 26,137 = 73,863

1,40,000 - 141,036 = (1,036)

Thus, it is seen that if restriction of credit policy is removed for B category of customers, there is likelihood of increased profits of Rs 73,863 per annum. However, restriction on credit policy is recommended to be continued as any relaxation in policy is likely to lead to losses.


Date: 21 Aug 2006

CASE STUDY: AMPOULEAGENTS

In September 1991, Mr. Marwari, the Credit Controller of Ampouleagents, wrote to the Sales Manager of the Company requesting him to stop the supply of Rs. 1.5 lacs worth of goods to Messrs. Pharmax Laboratories as many past dues from the party were yet to be recovered.

Ampouleagents were suppliers of ampoules and vials for injectibles manufactured by the pharmaceutical industry. It was a prosperous and growing company in a competitive environment with its base and major market in Bombay. The Company was now having big expansion plans with an eye for exports. The Sales Manager and the Managing Director kept reminding everyone that “we must consolidate our base in India before entering world market”.

Pharmax Laboratories was a Delhi based pharmaceutical company which the Sales Manager of Ampouleagents had recently converted into a customer after much wooing and persistent efforts. This party represents a market worth about 15 Lacs per year and moreover the Sales Manager felt that this would be the beginning to secure business from many more such medium size pharmaceutical companies in Northern India.

The Credit Controller, Mr. Marwari, had consistently pointed out to the Sales Manager and Managing Director that it is necessary to analyse the cost at which these new markets were being pursued. In his most recent note he had written: “In spite of my many suggestions to the contrary, I find that we are getting ready to dispatch goods worth Rs. 1.5 Lacs to Pharmax Laboratories. I find that the party has an overtraded financing pattern and does not deserve any more credit. Our outstanding from the party are now overdue by more than six months. I am also attaching some relevant figures which I hope will prove my point”.

Discussion Areas: 1) Is Mr. Marwari making a mountain out of a mole hill.2) Evaluate credit worthiness of Pharmax Laboratories.

BALANCE SHEET OF PHARMAXIA BROTHERS As on 31.12.1990

LiabilitiesRs. Lacs Assets

Rs. Lacs

Equity Capital 101.20 Net Fixed Assets 221.53Reserves 43.20 Investment 22.10

Term Loans 70.63Raw Material Inventory 46.69

Bank Borrowings 153.61 Work-in-progress 15.21

Deposits maturing 26.89Finished goods stocks 74.35

in one year Sundry 75.53 Goods in transit 52.76


Creditors

Other current Liabilities 122.48Cash & Bank Balances 23.02

(including provisions) Sundry Debtors 81.48Unsecured Advances 23.56Other current Assets 32.84(including advance tax)

Total 593.54 Total 593.54

Coarsened Income Statement for year ending 31.12.1990

(Rs. In lacs)

Sales 666.30Material Cost 239.17Employee Costs 172.41Selling & General Administration 150.57Interest 35.34Depreciation 9.97Investment Allowance 0.96Profit before Tax 57.88Tax 34.73Profit after Tax 23.15

Note: Company maintained dividend at 10% for 1990.

SALES TO AND COLLECTIONS FROM PHARMAX LABORATORIESSales Outstanding

(Rs. Lacs) (Rs. Lacs as on 1st Sept. 91)

February 91 and before 0.74 0.18March 91 0.36 0.36April 91 0.22 0.22May 91 0.64 0.64June 91 -- --July 91 2.85 2.85(No sales of collection since then up to Sept 91)Total 4.81 4.25

Note: Up to July end 1991, Ampouleagents had registered total sales of Rs. 57.9 lacs and the outstanding as at July end stood at Rs. 18.19 lacs. It was normal practice of Ampouleagents to give 45 days credit.


Financial Analysis

Ampouleagents

1 Sales up to Jul 57.90 LakhPharmax Contribution to Sales 4.81 Lakh 8.3%Growth Potential of Sales to Pharmax 15%Outstanding of Ampouleagent 18.19 LakhOutstanding with Pharmax 4.25 Lakh 23%Average Outstanding of Ampouleagent 2.2 Months*Outstanding with Pharmax 6 Months*

Notes

Average Outstanding of Ampouleagent =

Average Outstanding =

Outstanding with Pharmax Lab

Total Outstanding = 4.25 Lakhs

Average Monthly Sales to Pharmax Lab =

Average Outstanding =

2(a) Current Ratio =

=

Current Ratio should ideally be in the range of 1.33 to 1.5. Thus, current ratio is bad and the company is facing liquidity problems.

2(b) Another thing which is evident from the balance sheet is that 54% of the assets are inventory which are the least liquid kind of assets. Thus, company has poor inventory control.

2(c) Bank borrowing are short term loans which stand at 153 lakhs which is considered to be quite high considering that Equity + Reserves are only 144 Lakhs.

3. Cash Position (Liquidity)


PAT 23 LakhDepreciation 10 LakhTotal 33 Lakh

Less - Div Payment 10 LakhTerm Loan Repayment 10 Lakh - (20 Lakh)

Balance Cash 13 Lakh

Considering that there are current liabilities worth 378 lakhs which are also to be satisfied, company’s liquidity position is very bad and company is likely to default on some payment obligations.

This is what the financial analysis of the Pharmax Lab tells us which is all gloomy. Going purely by the financial analysis, there is every reason to stop further supplies to Pharmax Lab.

Now let us examine the issue from marketing perspective.

First some unwritten ground realities

Company is a North Indian Company. North Indian companies are traditionally hard at paying debts. It is a universal truth.

Balance Sheet shows that Pharmax had an owing of Rs 75.53 Lakhs against its total purchases of Rs 239.7 Lakhs.

Thus, Credit Payment period =

It is clear that company has a history of paying its dues in about 4 months. Major part of Ampouleagents dues are of Jul vintage only (Rs 2.85 Lakhs) which as per Pharmax payment philosophy are not due for payment yet (in Sep). Previous months’ dues are just a few thousand each.

Secondly, 90% of the marketing works on relationship management. Pharmax Lab being a new customer, marketing people were vary of pushing the company too hard on payment issue. Now, there is a need for marketing people to use their negotiation skills to extract some payment from the company.

Company aspires to enter international market. International markets are far more difficult than Indian markets. If the company is not careful, it will lose all its money. So, if the company can not tackle the difficult clients in India, international trade will be disastrous.

Pharmax Lab promises to be worth almost 15% of the total sales market of the Ampouleagent which is considerably large pie to let go easily.


Marketing Deptt wants to use this big company as a mascot for approaching other Pharma companies. Losing this client will be a serious set back for expansion plans in North India.

If supplies are stopped, there is a risk that entire credit of Rs 4.25 lakh may sink.

Considering all the above points, it may be worthwhile to continue the supplies but with a tactful thrust by Sales Deptt for recovery of dues.


CASE STUDY PRODUCT LINE PROFITABILITY ANALYSIS

MMF Ltd. decided to analyse its selling and distribution costs for products A, B, and C and arrive at product-wise profit figures.

The income statement of the company for the past year is at follows:

Sales 5,20,000Cost of sales 2,50,000Gross profit on sales 2,70,000Selling and distribution costsSalesmen’s salaries 24,500Salesmen’s commission 27,500Sales office expenses 14,800Advertising 65,000Warehouse 4,500Packing and shifting 5,600Transportation & delivery 8,400Credit and collections 4,100Bad debits 9,400

1,63,810General and administrative expense 41,250 2,05,060Net Profit 64,940

Additional Information:Product A Product B Product C

Sales 1,20,000 1,50,000 2,50,000Cost of sales 55,000 70,000 1,25,000Salesmen’s salaries 8,000 7,000 9,500Salesmen’s commission 11,000 6,000 10,500Advertising (%) 20 20 60Warehouse space occupied 1/3 1/3 1/3Invoice lines (packing and shifting) 1,500 2,500 3,000Transportation and delivery 5,500 6,000 8,500Average account receivable 15,000 35,000 50,000Bad Debits 1.8% 1.5% 1.7%Sales office expenses: Allocated in the same ratio as packing and shifting.General and administrative expenses: Allocated on the basis of sales.Require: A product-wise P & L Account.


Profit and Loss StatementBasis for Allocation Total

ExpProd A Prod B Prod C

Sales Direct 5,20,000 1,20,0001,50,000 2,50,000

Cost of Sales Actuals 2,50,000 55,000 70,0001,25,000

Gross Margin Calculated 2,70,000 65,000 80,0001,25,000

Salesmen Salaries Actuals 24,500 8,000 7,000 9,500Salesmen Commn Actuals 27,500 11,000 6,000 10,500Sales Office Exp Invoice Lines

(15:25:30)14800 3,171 5,286 6343

Advertising 1:1:3 65000 13,000 13,000 39,000Warehousing 1/3:1/3:1/3 4,500 1,500 1,500 1,500Pack & Shipping 15:25:30 5,600 1,200 2,000 2,400Transport and Delivery

55:60:85 8,400 2,310 2,520 3,570

Credit and Collections

A/c Outstandings 15:35:50

4,100 615 1,435 2,050

Bad Debts 216:225:425 9,410 2,345 2,422 4,613Total 1,63,810 43,141 41,183 79,436General Admin Sales 12:15:25 41,250 9,519 11,899 19,832Total Costs 2,05,060 52,660 53,082 99,308Net Profit 64,940 11,297 26,537 27,106

The ‘Key’ to solving this question is to find the correct figures. In many cases, the total that is given in summary of expenses in Exhibit II does not match with break-up given in other two exhibit. Whenever such a situation occurs, use the detailed break-up as ratio and distribute the expenditure given in same proportion.

Analysis

Analysis of above table indicates that Product B is most profitable since a profit of Rs 26,537 is earned through a sale of Rs 1,50,000 which is 17.7% of sales. Product C which is second most profitable gives a net profit of Rs 27,106, which though numerically marginally higher than Product B profit, comes from a sale of Rs 250,000.

The heads that have resulted in less than optimum profit for Products A and B are Salesmen Salary and Commissions. Similarly, excessive advertisement expense has resulted in poor profit margins for product C. However, it is hard to comment whether these excess expenditures on salesmen’s salaries, commissions and advertising are unjustified. It is quite possible that nature of product and market may have necessitated such expenses.


CASE STUDY: COOL INDIA LTD.

Early in 1984, Mr. Lingnath, the General Manager of Cool India Ltd. called a meeting of the controller and the Far Eastern Zone Manager to discuss what action he should take with regard to the Far Eastern Zone in which the company had been incurring losses from, year to year.

Cool India is one of the fast coming up companies in India in the field of Industrial accessories. The technical nature of the product line requires substantial promotion effort by the company’s salesmen, besides the amount spent on advertising and promotion. In view of the importance of effective marketing, right from the beginning the Indian market has been divided into 4 zones: Southern, North-Western, Mid Central, and Far Eastern and each zone is placed under the charge of a zonal manager who is given complete freedom on regard to operations and who is responsible for the entire range of marketing operations in his territory i.e. receiving goods from the company’s plant, warehousing, sales promotion, sales control, delivery and ROL of the division.

The company’s manufacturing is located at Fridabad where from the stocks are supplied to zonal warehouse as per requirements. The zonal managers are required to sell the product at uniform prices in all the territories and maintain stocks in warehouses so as to ensure an inventory turnover of at least 4 times. Likewise he should ensure that the receivables turn every 30 days.

IN view of the rising price level, the market value today of the warehouse building is considered equal to their original gross book value and the market value of warehouse equipment and delivery truck is estimated to be one half of their original book value.

Mr. Lingnath observed that the Far Eastern Zone could not make any progress in eliminating the losses and if that zone was to continue its operations it would be a drain on the resources generated by other divisions. The company’s investment in the Far Eastern division was producing a negative return of over 10% per year which facts greatly disturbed Mr. Lingnath for reason that a losing division not only eats away other divisions’ profits but also corrodes its own investment. He therefore asked the committee whether as a strategy the company should attempt divestment in Far Eastern Zone reducing the volume of operations OR seek expansion and sink possibly additional investment, so as to salvage the zone. In any case, he said, the present state of affairs should not continue.


Exhibit II

Cool India Ltd.

Selling Statistics for year ending Dec.31, 1983

Southern Zone

North Western

Zone

Mid Central Zone

Far Eastern Zone

(Rs.) (Rs.) (Rs.) (Rs.)

No. of salesmen36 20 32 15

Avg. sales per salesman 2,00,000 2,15,000 2,18,750 2,66,666

Avg. direct selling, advertising & promotion expenses for salesmen 13,000 14,600 13,800 18,300

Avg. no. of calls per customer per month (according to customer annual sales volume)Rs.0-2,0002,001 – 4,0004,001 – 6,0006001 – 8,000over 8,001

11.82.9

55.2

0.61.62.84.35.2

11

2.74.15.1

0.51.4

23.25.1


Exhibit III

Cool India Ltd.

Delivery Expenses and Statistics for year ending December 31, 1983

Southern Zone

North Western Zone

Mid Central Zone

Far Eastern Zone

(Rs.) (Rs.) (Rs.) (Rs.)

Truck Drivers 1,60,000 20000 30000 1,20,000

Drivers’ Assistant 54000 30000

Depreciation of trucks(25%)

1,50,000 20,000 30,000 1,20,000

Gas, oil & supplies 56,000 24,000 26,000 49,000

Taxes, Insurance & Licence

23,000 3,000 5,000 18,000

Repairs & Maintenance

44,000 6,000 8,000 34,000

Freight out 2,28,000 3,30,000

Total 4,87,000 3,01,000 4,29,000 3,71,000No. of trucks 15 2 3 12

Avg. annual miles per truck

28,000 12,000 12,600 20,000

Avg. no. of daily deliveries per truck

12 16 15 8

Avg. value of order delivered

83.3 100 105 86.75


Exhibit IV

Cool India Ltd.

Warehouse Expenses for year ending December 31, 1983

Southern Zone

North Western Zone

Mid Central Zone

Far Eastern Zone

(Rs.) (Rs.) (Rs.) (Rs.)(square feet) (4,000) (3,300) (5,000) (4,000)

Variable expenses ( with sales)Salaries of storekeepers and mineral handlers

80,000 51,000 99,000 83,000

Fixed Expenses

Depreciation of equipment (10%)

8,000 7,200 9,100 7,800

Depreciation of warehouse (2%)

6,000 5,400 7,500 6,300

Supervision 15,000 12,800 17,400 15,400

Clerical 10,000 6,300 12,600 10,000

Utilities 5,000 3,900 5,000 5,200

Taxes & Insurance 4,000 3,800 5,100 4,900

Repairs and maintenance 14,000 6,400 17,400 9,300

Supplies & Misc. 10,000 8,200 9,900 7,100

Total 1,52,000 1,05,000 1,83,000 1,50,000


Exhibit V

Cool India Ltd.

Warehouse Expenses for year ending December 31, 1983Southern Zone Northern Zone Mid Central Zone Far Eastern ZoneAmount

(Rs)% of sales

Amount (Rs)

% of sales

Amount (Rs)

% of sales

Amount (Rs)

% of sales

Sales units 14,000 5,620 10,800 6,000

Market Share 10.5 10.1 11 8.7

Sales value 72,00,000 100 43,00,000 100 70,00,000 100 40,00,000 100Cost of sales 46,80,000 65 30,10,000 70 50,40,000 72 32,00,000 80

26,20,000 35 12,90,000 30 19,60,000 28 8,00,000 20Direct territoryExpenses:

Selling(Salaries only) 3,32,000 4.6 1,88,000 4.3 3,20,000 4.6 1,80,000 4.5

Delivery 4,87,000 6.7 3,01,000 7 4,29,000 6.1 3,71,000 9.3Warehousing 1,52,000 2.1 1,05,000 2.5 1,83,000 2.6 1,50,000 3.7Direct Direct Advertising & Sales promotion

1,37,000 1.9 1,05,000 2.5 1,20,000 1.7 95,000 2.4

Office (fixed) 90,000 1.2 72,000 1.6 83,000 1.2 70,000 1.811,98,000 16.5 7,71,000 17.9 11,35,000 16.2 8,66,000 21.7

Allocated selling & Admin expenses of sales

2,88,000 4 1,72,000 4 2,80,000 4 1,60,000 4

Margin before allocated selling & Administrative expenses

13,22,000 18.5 5,19,000 12.1 8,25,000 11.8 66000 -1.7

P/L before income tax 10,34,000 14.5 3,47,000 8.1 5,45,000 7.8 2,26,000 -2.3


Solution:

Sales 40,00,000Cost of Sales 32,00,000Contribution/margin 8,00,000Other Expenses 8,66,000Net Loss 66,000Add : Depreciation

Trucks 1,20,000Equipment 7,800Ware House 6,300 1,34,000

Operating Profit 68,000

We see that while the region is running into net loss, it is still generating gross profit. As a policy, don’t drop a product or region as long as operating profit are in positive. Since fixed costs are beyond the control of manager and recovery on their sale may entail heavy losses, it is worthwhile normally to continue the business and try and revive it by improving the operating efficiencies and cost management exercises.

Micro analysis of the financial data indicates that: -

1. Cost of sales = 80% of sales which is the highest in all the regions. High cost of sales could be due to inappropriate product mix in the region. Profit margins on all the products of the same company are never the same. Profit margins are function of market forces. It is responsibility of the management to employ more thrust on higher profit margin product and thus change product mix to ensure higher margins even while sales do not improve. Second reason for higher cost of sales could be due to higher transportation cost from works in Faridabad to Warehouses in Far Eastern Region since the distance is large compared to other regions (Delivery expenses are for moving the items from warehouse to customer’s premises. Prior to that there are transportation expenses involved in moving the items from works to warehouses which has been clubbed with cost of sales). This factor is beyond the control of Regional Managers or even company’s control unless company adopts differential pricing norms for different regions. (Company currently has a policy of uniform pricing all over India).

2. Far Eastern Region consists of seven north eastern states. Individual figures of sales in each of states are not given. It may be necessary to check if sales in any states are too low. It may be useful to appoint strengthen distribution network in those states by appointing distributors and C&F agents.

3. Delivery expenses in FE region are over 9% of sales compared to 6-7 % in other regions. It is recognised that FE regions have hilly terrain and are less densely populated and therefore delivery costs ought to be high there. However, figures indicate sufficient scope for fine tuning delivery system which would result in substantial savings in fuel and operating cost of trucks. If reorganisation of delivery system can result in reduction of one truck and improve fuel efficiency marginally, profits can improve by as much as Rs 35,000.


4. Possibility of outsourcing the delivery system was also examined. Two things were highlighted during discussions. First, private distribution system in Far Eastern Region is not much developed and therefore unlikely to be cost effective. Secondly, cost of outsourcing is comparable in Western and Mid Central sectors with Southern Sector which has its own delivery system. Therefore, worthwhile savings are unlikely to be accrued by outsourcing.

5. Another high cost area is Warehousing. Following issues were highlighted: -

(a) The warehouse is too large to meet current requirements. For a sale of Rs 40 lakh, it has 4000 sqm area which is same as southern region with 80% more sales. A smaller warehouse would save on capital cost. However, in could be a long term investment to cater for growth of business.

(b) Despite handling 80% less stores, salaries of storekeepers and mineral handlers is 4% higher than southern zone. Staff requires to be trimmed.

(c) Similarly, clerical and supervisory are very high and need to be curtailed.

What we have seen so far is control of expenses which in case has a limit. Another way, and that too more effective, is to increase sales.

Analysis of exhibit II reveals that there are only 15 salesmen and sales per salesman are highest in the region. It is clearly stated in case study that the technical nature of the product line requires substantial promotion effort by the company’s salesmen, besides the amount spent on advertising and promotion. It seems that low number of salesmen is affecting sales in the region, which is also borne out of facts that FE Zone has lowest market share among all zones as well as lowest number of avg calls per customer. Increasing number of salesmen is likely to increase the sales and any further increase in sales is likely to have higher contribution.

On the whole, even though Far Eastern Region is incurring losses at present, there does not seem to be any requirement to close the operations due to following reasons: -

1. Zone has positive operating profits and as a rule, operations should not be terminated till operating profits are positive. (When there is net loss but contributions and operating profits are positive, it means that though selling price is higher than variable cost, fixed costs are very high leading to losses. Since fixed costs have already been taken care of, increased sales will increase contribution and losses will be wiped out. However, when operating profits are negative, it means that selling price is lower than even variable cost and any increase in sales will increase the losses. Situation then is beyond redemption and it is prudent to close the operations).

2. There are enough prospects to improve the profitability of the zone, both by controlling expenses and by increasing sales and altering product mix.


Prob: A company plans to supply its products to ultimate consumer through wholesaler, retailer or directly. The objective is to maximise sales, earn better prices and better profits. Advice manager as to which distribution channel to adopt from following info: -

Direct (I) Retailer (II) Wholesaler (III)Unit Selling Price Rs 18 Rs 16 Rs 13Estimated Unit sales 9,00,000 8,50,000 8,25,000Selling and Distribution Cost per unit

Rs 2.5 Rs 2 Rs 1.80

Cost of Production Rs 3Fixed Cost Rs 6,00,000

Please also explain which other factors you will consider.

Solution:

Direct (I) Retailer (II) Wholesaler (III)Sales 1,62,00,000 1,36,00,000 1,07,25,000Variable Cost @ 3 27,00,000 25,50,000 24,75,000Selling and Distribution Cost 22,50,000 17,00,000 14,85,000 Operating Profit 1,12,50,000 93,50,000 67,65,000Fixed Cost 6,00,000 6,00,000 6,00,000Net Profit 1,06,50,000 87,50,000 61,65,000

Another way of solving the same problem is by calculating the unit contribution and then finding profits.

Direct (I) Retailer (II) Wholesaler (III)Per Unit Cost of Production 3 3 3Per Unit Selling & Distribution Cost 2.5 2 1.80Per Unit Variable cost 5.5 5 4.80Per Unit Selling Price 18 16 13Per Unit Contribution 12.50 11 8.20Total Contribution 1,12,50,000 93,50,000 67,65,000 Less: Fixed Cost 6,00,000 6,00,000 6,00,000Profits 1,06,50,000 87,50,000 61,65,000

Other factors which need to be considered while taking the decision are

1. Resources Available – Having own selling and distribution network is capital as well as manpower intensive exercise. S&D network would probably require more resources as well time, energy, attention and manpower than required for production. Thus, availability of resources is major criteria.

2. Nature of Products – Nature of product plays very important part on intensity of selling and distribution operations. The S&D chain of a product with limited shelf


life, like milk and newspaper, is far more vigorous, complex and sensitive to administer than say Cars. Again, the mechanics of distribution of milk and newspaper, which are daily purchase and consumed items, are far different from items which are consumed daily but purchased at little longer intervals, like soap. Having own distribution network (without the help of that friendly neighbourhood Kiranawala) for such items is literally impossible.


Date: 04 Sep 2006

MARKETING ROI

Marketing ROI is defined as relationship between marketing net profit and capital employed/investment for marketing operations (it is expressed as percentage/ratio).

There are basically two kind of investments in marketing: -

(a) Working Capital Investments in finished goods inventory and receivables.

(b) Investments in Fixed Assets for marketing purposes, like sales office, delivery logistics (Trucks, vans, etc), office equipments, etc.

Let us see how is marketing ROI different from business ROI.

SNo Total Mktg Deptt1. Capital Employed in Fixed Assets 100 102. Working Capital Employed 100 60

Total 200 703. Sales 400 4004. Cost of Sales (as pre transfer pricing) 300 3505. Gross Margin/Profit 100 506. Operations Cost 40 237. Finance Charge/Interest/Opportunity Cost 20 78. Net Profit 40 209. ROI

= 20% = 28.6%

Role of ROI in Sales Management

How is a Sales Manager’s performance evaluated?

It can be done by measuring his performance vis a vis target in terms of volume or value. But what if he has achieved his target by giving huge discounts to dealers which affected the profitability of marketing operations or increased bad debts enormously. So, achievement of targets in terms of volume or value are not authentic measures of performance of a Sales Manager)

To overcome such problems, profit targets are set for the sales managers. Now if we have to compare performance of two Sales Managers who have both achieved their respective targets, what should be the basis?

Suppose there are two managers Mr “A” and Mr “B” who have both achieved equal sales. How do we determine who is more efficient?


Manager “A” Manager “B”Maintained low inventory levels and ensured customer satisfaction by better inventory review and forecasting and thus incurred low working capital costs

Maintained high inventory level to ensure customer satisfaction but had to incur high Working Capital costs.

Ensured quick receivables collection and kept working capital requirements and costs low.

Allowed longer credit period to push sales and thus blocked substantial amount of working capital.

Now, despite the two managers being equal in terms of sales and profit generated, Manager “B” has earned same profit as Manager “A” by much higher investment in marketing effort. Thus, Manager “A” is more efficient than Manager “B”. Thus, even net profit is not the correct measure for evaluating Marketing Manager’s performance.

Next method that is employed now a days is ROI concept. ROI deals with the question – “How much profits for how much investment?” What is the rate of return for each Rupee invested in business? In marketing ROI, it means finding out the rate of return for each Rupee invested in marketing activity.

Functions/Role of Sales Manager

There are three primary functions: -

1. Manage Product Mix – (We have discussed about impact of product mix on profitability on page 30. We will discuss this issue again and in greater detail with the help of a numerical problem a little later).

2. Control Field Cost like travelling expenses, communication expenses, bonus, commission, stationery expenses, office expenses, etc.

3. Sales Management – Sales Management covers entire gamut of sales exercise. It covers: -

(a) Recruit, Train and retain sales team.

(b) Allocate territories to sales people.

(c) Prepare route plans for sales people to ensure that entire territory is covered on a regular basis.

(d) Allocate targets and quota for each salesman.

(e) Performance evaluation of sales people.

(f) Collect receivables.

(g) Manage finished goods inventory.

(h) Plan and launch sales promotion activities.


Now

Let us revisit the two managers whose performance we examined earlier. They both have earned a profit of 10% on their sales of Rs 12 Lakh. But, while Manager “A” had an average investment on inventory and receivables of Rs 3 Lakhs, Manager “B” had an average investment of Rs 4 Lakh. Thus, turn over ratios for “A” and “B” were 4 and 3 respectively.

Now,Manager “A” = 10% x 4 = 40%

Manager “B” = 10% x 3 = 30%

Thus, we see that despite achieving equal sales and having equal profit margin on products sold, Manager “A” has performed better due to utilisation of lesser resources in terms of working capital employed. The Return on Investment in his case is 40% against 30% of Manager “B”.

Problems

Prob 1. Sales = Rs 10,00,000Net Profit = Rs 80,000Assets = Rs 5,00,000Liabilities

Current = Rs 2,00,000Capital = Rs 2,00,000Retained Earnings = Rs 1,00,000 Rs 5,00,000

Total Investment = Capital + Retained Earnings = 2,00,000 + 1,00,000 = Rs 3,00,000

Prob 2. Profits = Rs 1,00,000Sales = Rs 10,00,000Assets = Rs 5,00,000

Suppose that the Sales Manager was able to bring down the Working Capital invested to Rs 4,00,000 from 5 lakhs. What will be impact on ROI?


Thus, we see that ROI has improved to 25% because of 20% reduction in assets.

Prob 3: Sales 10,00,000Factory Costs 7,00,000 3,00,000Direct ExpensesSalary & Fringe Benefits 1,10,000Travel & Entertainment 28,000Field Office 12,000 1,50,000Operating Profit 1,50,000Capital EmployedReceivables 2,10,000Finished Goods Inventory 1,20,000 4,00,000

Case I –

Sales increase by 2,00,000Rate of profit = 15%Capital employed = 4,00,000

Case II –

Sales increase by 2,00,000Rate of profit = 15%Capital employed = 3,00,000


Rate of profit is affected by following factors: -

(i)Sales Volume (Economies of scale)(ii) Price(iii) Product Mix(iv) Field Expense(v) Cost of goods sold(vi) Marketing Expenses(vii) Administrative Expenses

Problem – This problem will demonstrate how product mix impacts the profits.

Given below is budgeted and achieved data a company manufacturing three products A, B and C.

SNo A B C Total1. Gross Profit 40% 20% 30%2. Budgeted Sales 500 200 300 1,0003. Budgeted Gross Margin

= (1) x (2) 500 x 40% = 200

200 x 20% = 40

300 x 30% = 90

330

4. Actual Sales 100 500 400 1,000(as budgeted)

5. Actual Gross Margin 40 100 120 260

What we see from above is that though the Actual Sales were same as budgeted, profits have reduced from budgeted 330 to 260. That is because, the sales of higher profit product Viz A were replaced by low profit “B” and “C” sales.

Other Effects of Deviations from Budgeted Product Mix

Large deviations from budgeted product mix can lead to various other complications besides affecting the profits. Production schedules are drawn on the basis of product mix estimates. Purchase indents for raw material are raised accordingly. When product mix changes, and there is sudden rise in demand for any product, entire production schedule gets upset. There is shortage of raw material for that product and according distress purchase of same. On the other hand, there is pile up of inventory of finished goods and raw material of other item consuming space and capital. Panic sets in purchase, production departments and even in the sales department because of uncertainty about delivery of orders.Thus, while there is loss of profit on the sales front, there is loss at production and purchase end as well.

There are situations (especially in capital goods like large machinery, etc) where the company keeps its schedule but customer fails to take the delivery and requests for delayed supply. Typically what happens is that project gets delayed due to various reasons (almost regularly in govt contracts) and then customer makes a request to delay the supply. Such requests block the fund flow (orders are executed on the basis of small advance only). Large capital invested in manufacturing the machine is blocked and incurs finance charges. At the same time, there could be paucity of space to store the machine and overheads on maintaining the


machine is good condition till delivery. Sales Department thus is required to not only obtain the order but also keep tab on progress of project to insure against such eventualities.

Problem - Sales 10,00,000Profits 1,50,000 15 %Assets Employed 4,00,000 TO Ratio = 2.5ROI 37.5%

Proposal from Sales DepartmentIncrease sales by 2,00,000 by going to new markets or selling through new distribution channels. Because of extra efforts, profits (marginal) will be 10% on additional sales (not 15%). Marginal investment in receivables and finished goods inventory will be Rs 1,00,000. Should the proposal be accepted.

ROI of additional investment proposal = Rate of Profit x Turn over ratio=10% x 2,00,000 / 1,00,000 = 20%

Consolidated ROI after implementing the proposal =

It is evident that the ROI is going down after the new investment. However, any decision based on percentages and ratios alone should be avoided.

Purpose of business is to earn profits. Therefore, litmus test of any business proposal is “Will this proposal increase my profits?” All the ratios have been designed to explore this basic fact. In the present case, Even though the ROI has gone down, additional sales have positive contribution and net profits have increased from Rs 1,50,000 to Rs 1,70,000. And any proposal which increases the net profits should be acceptable (provided there is no better proposal. And mind the word “NET” here. This word has a wide connotation and encompasses not only monetary profits but other forms of profit as well. It does not cover only today’s profits but also takes into account its effect on tomorrow’s profits. It does not only take its effect on current business but also its effect on group’s other businesses).

Secondly, returns on investment in any new market are bound to be low in the beginning (even negative in most cases). Returns improve over the time. So, there is every chance that ROI in new market will match the existing market in due course.

Thus, on both the counts, proposal merits acceptance.

Evaluating a Sales Representative Performance

1. Quantitative Parameters

(a) Sales Volume/Value

(b) Profit Generated/PV Ratio


(c) Field Expenses

(d) Calls made on clients

(e) Productive Calls – Closure of sales achieved

(f) No of Orders

(g) Avg Value of orders – Size of order affects profitability since there is a fixed cost involved in processing the order. So, larger the order size, lesser per unit fixed cost of order processing

(h) Market Share

(i) Cost to Sales ratio – Product Mix achieved

(j) Receivables Management/Days outstanding

(k) Customer complaints

(l) New Customers

2. Qualitative Factors

(a) Product Knowledge

(b) Market Knowledge

(c) Reporting (daily, weekly, monthly)

(d) Market Information

(e) Customer Relationships

(f) Handling promotion material/product display

3. Personality Factors

(a) Attitude to work

(b) Motivation/Energy level

(c) Personal Hygiene

(d) Communication Skills


Problem : (From BK Chatterjee Book) Evaluate the performance of Salesmen A, B and C from the following data: -

SNo Criteria for Evaluation

Wei

ghta

ge

Nor

ms

Bonus Points AchievementsA B C

Ach

ieve

d

Scor

e

Wei

ghte

d Sc

ore

Ach

ieve

d

Scor

e

Wei

ghte

d Sc

ore

Ach

ieve

d

Scor

e

Wei

ghte

d Sc

ore

1. Market Share 30 25% ± 1 for every 5% deviation 35% 8 240 20% 5 150 40% 9 2702. Value of Orders 15 10 L ± 1 for every 1 Lakh deviation 8 L 4 60 11 L 7 105 9 L 5 753. Avg Value per order 10 25 K ± 1 for every 1 K deviation 27 K 6 60 22 K 5 50 20 K 5 504. Sales Value 10 20% ± 1 for every 1 Lakh deviation 9 L 5 50 10 L 6 60 13 L 9 905. PV Ratio 15 40% ± 1 for every 5% deviation 35% 5 75 30% 4 60 40% 6 906. Marketing ROI 20 20% ± 1 for every 5% deviation 27% 7 140 12% 4 80 30% 8 160

Total 635 505 735

Basic Score for achieving the norm – 6 points

Max Score in any one discipline - 12 Points

Analysis

1. A is an Avg performer, B is weak and C is Star performer.

2. B has exceeded his target for value of targets. But he has obtained too many small orders. Also his product mix was poor which led to his below avg performance. He is also poor in collection of receivables. He needs to be trained.

3. A has failed to achieve his target in terms of value of orders. His product mix is also inappropriate. Though his performance is satisfactory, he needs training in these areas.

4. Though C is a Star performer, even he needs training in the field of sales closure and size of orders.


Date: 11 Sep 2006

RETURN ON PROMOTION INVESTMENT

Problem:

Modern Pharmaceuticals has five product lines. All advertisings expenses are first divided in to direct and indirect. Only directly allocable promotional expenses are traced for each product. Contribution margin and sales for each product is given as follows.

Product

Expense

1 2 3 4 5

Sales 350 225 150 175 100

Contribution Margin

40% 50% 60% 30% 45%

Expense Head

Product

Advertising(Direct)

Sampling(Direct)

DetailingAllocated on time basis

Total

1 4 10 14 282 6 3 5 143 3 4 16 234 5 5 5 155 7 8 5 20

Find, which product gives maximum return on promotional investment.

Solution:

Product

Expense1 2 3 4 5

Sales 350 225 150 175 100Contribution Margin

40% 50% 60% 30% 45%

Contribution Margin in Rs

140 112.5 90 52.5 45

Contribution net of Promo Expense

140-28 = 112

112.5 – 14 = 98.5

90 – 23 = 67

52.5 – 15 = 37.5

45 – 20 = 25


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1 4 10 14 28 350/28 = 12.5 112/28 = 42 6 3 5 14 225/14 = 16 98.5/14 = 7.033 3 4 16 23 150/23 = 6.5 67/23 = 2.914 5 5 5 15 175/15 = 11.66 37.5/15 = 2.55 7 8 5 20 100/20 = 5 25/20 = 1.25

From above figures it is evident that product 2 has highest sales per rupee of promotion expense. Same product also has highest contribution margin per Re of promotion. While in this case, same product tops both the tests, it may not always be the case. In case two ratios are not in agreement, decision should be taken based on contribution margin per Re of promotion which is the true measure of profitability and not stand alone Sales.

Another issue which attracts our attention here is about taking allocated costs into account while calculating profitability of each product line. During the case study on Cool India Ltd on page 30 it was stated that fixed costs and allocable expenses are be not to be considered while taking decision, where as in the instant case we have taken allocated expenses in to account. The reason is that we need to take all RELEVANT expenses into account while taking any decisions. In the instant case, though Detailing expenses are allocated expenses, they are directly related to the product. These expenses can be saved if so desired, but at the cost of losing sales. In case of Cool India case, fixed expenses were a legacy left behind by earlier management, and allocated expenses were Head Office expenses which would have continued even if operations of Far Eastern Region had been wound up. So, your decision to wound up or otherwise had no bearing on HO expenses. Thus, to reiterate, while taking management decisions, take all relevant expenses in to account no matter whether they are fixed, variable, direct or allocated. A thumb rule that can be followed is that any expense that will be affected by your decision is to be considered. An expense that will not be affected by your decision is not to be considered.


CASE STUDY :COOKWELL EQUIPMENT LIMITED

The Cookwell Equipment Company Limited sells two distinct lines of kitchenware, one to the restaurants and one to retail stores. Restaurants sales are made to distributors and stores sales through company salesmen.

The company has been successful and is operating at full capacity. However, its cash position is very tight and therefore it will not be able to construct an additional plant to meet the increasing demand for its products.

The company has rented for a two year period additional space adjacent to its present factory. The rental expenses is included among the allocated costs in Exhibit 1, this space is adequate to permit a 20 percent sales expansion in either of the restaurant line or the retail line. Either line could absorb the added factory output without requiring any additional sales effort.

The average price per unit in the restaurant line is Rs.20/- and in the retail line Rs.5/-. The restaurant products are packed at the plant and the packing costs are included in the cost of sales. The retail items are packed at the warehouse.

You are requested to review the data contained in Exhibit I and suggest the product line to be expanded.

In the course of your examination of the company’s income statement, you discover the following additional information.

1. If the rented space is to be devoted to restaurant products no additional trucks will be required. However, present truck running time will have to be increased by 108. The additional 10% running time will require proportionate overtime payment to truck drivers, at time and a half.

2. From the allocated selling and administrative expenses, you will find the following:

(a) Variable billing costs are estimated at 40 paise on invoice. The average value of an invoice to restaurant customers is Rs.500/- and to retail customer Rs.100/-

(b) Advertising includes counter displays for the retail line which amounts to one percent of sales.

(c) Variable shipping salaries at the warehouses are equal to 80 paise per unit for restaurant products and 5 paise per unit for retail products. Warehouse packing costs (including cartons) amount to 4 paise per unit.


COOKWELL EQUIPMENT LTDIncome Statement for the year ended December 31, 1990.

Restaurant Line Retail Line TotalSales 1,800,000 1,700,000 3,500,000Cost of Sales Materials 400,000 320,000 720,000Labour 300,000 240,000 540,000Variable overheads 200,000 250,000 450,000Fixed Overheades 270,000 210,000 480,000Total 1,170,000 1,020,000 2,190,000Gross Profit 630,000 680,000 310,000(% of Sales) (35.0) (40.0) (37.4)Less: Selling & Admn. Exp

Direct:Salesman's Commission 0 136,000 136,000Salesman's travel & E’tainment 0 85,000 85,000Truck depreciation 14,400 0 14,400Insurance & Licences Truck driver's salaries 65,000 0 65,000Truck garage rental 3,600 0 3,600Gasoline & other truck supplies 28,000 0 28,000Commissions to distributors 180,000 0 180,000Freights 6,000 62,000 68,000Bad Debts 4,500 6,000 10,500Total Direct 301,500 289,000 590,500AllocatedWarehouse (basis of space) 40,000 80,000 120,000Selling (sales) 48,000 32,000 80,000Advertising (sales) 36,000 24,000 60,000Adminstrative (sales) 54,000 36,000 90,000Total Allocated 178,000 172,000 350,000

Total selling & admin 479,000 461,000 940,000Profit before Income Taxes 150,000 219,000 369,000(% of Sales) (8.4) (12.9) (10.9)

Capital employedVariable:

Average monthly cash 72,000 48,000 120,000Average monthly inventories 120,000 240,000 360,000Average monthly receivable 162,000 184,000 346,000Total 354,000 472,000 826,000

Fixed 1,144,000 1,372,000 2,516,000Total 1,498,000 1,844,000 3,342,000Return on capital (10.0%) (11.9%) (11.6%)

Solution:


BasisRestaurant

Line ORRetail Line

Incremental Sales 20% of total sales 700,000 700,000Units sale Sales/per unit cost 35,000 140,000Cost of Sales Mat + Lab + Var

Exp 350,000 333,529Gross Margin Sales - Cost of Sales 350,000 366,471Going by Gross Margin, Retail Line seems to be preferable. However let us explore further.

Selling and Admin ExpensesSales Commission to Salesmen same ratio as Orig 0 56,000Travel and Entertainment expenses of Salesmen same ratio as Orig 0 35,000Truck Drivers Salary 15% of orig salary 9,750 0Gasoline & Other Supplies 10% of origl exp 2,800Distribution Commission same ratio as Orig 70,000Freights same ratio as Orig 2,333 25,529Bad Debt same ratio as Orig 1,750 2,470Total Direct Expense 86,633 118,999

Indirect CostsAdvertising 1% of sales 0 7,000Variable Shipping Exp 80p and 5p per unit 28,000 7,000Invoice Cost @ 40p WN 3 560 2,800Packing Cost @ 4p WN 4 0 5,600Total allocable exp 28,560 22,400

Profits before allocable costs 263,367 247,472Profits after allocable costs 234,807 225,072

InvestmentsInvestment In same ratio 28,000 19,764Monthly Cash In same ratio 46,666 93,333Receivables In same ratio 63000 75764Total Investment 137,666 188,861ROI 1.71 1.19

Working Notes: -

1. Truck Drivers additional salary is @ 1.5 times. So for 10% extra running hours, they will get 15% extra payment.

2. Fuel expenses are proportionate to extra running.


3. Invoice Expense – No of invoices x Cost of invoice

= . Sales

x Cost of Invoice Avg Invoice Amount

Restaurant Line– 7,00,000 x 0.40 = 1400 x 0.40 = Rs 560 500

Retail Line – 7,00,000 x 0.40 = 7000 x 0.40 = Rs 2,800 100

4. Packing Cost – Only retail line products are packed in warehouse. So only that cost is to be considered.

Packing cost = No of units x packing cost per unit

= Total Sales x packing cost per unit Selling Price

= 7,00,000 x 0.04 = 1,40,000 x 0.04 = Rs 5,600 5


PRICING

(Refresh Pricing fundamentals from Philip Kotler)

Problem:

A company has maximum production capacity of 1,00,000 units. Its fixed cost is Rs 1,00,000 and Variable cost is Rs 2/- per unit. Domestic demand is 50000 units. It has received export order for 30,000 units @ Rs 3 per unit. Should it accept the order?

Solution:

Unit production cost when export order is not available =

= per unit

The export order is @ Rs 3 per unit which is Re 1/- less than the production cost for domestic demand.

Yet, the order should be accepted on marginal costing basis. Since the fixed costs have already been recovered from domestic demand of 50,000 units, and the capacity being 1,00,000, any incremental production will incur only variable cost of Rs 2/- per unit, thus leaving a contribution of Re 1/- per unit. Therefore, the export order should be accepted.

Factors which influence pricing

1. Cost – Though Cost Plus pricing is almost out of fashion due to intense competition, yet, cost plays an important role in pricing decisions. Lower the cost, better the leverage in business decisions regarding pricing.

2. Differentiation

3. Market Characteristics

(a) Demand Vs Supply

(b) Growth

(c) Market Share

(d) Market Sophistication

(e) Competitors

(f) Importance to the customers

(g) Trade Practice

4. Exchange Rate Movements – Exchange rate movement can increase or decrease profits. In case of imports of raw material, adverse movement of exchange rate will increase the material costs. Similarly, adverse movements after acceptance of export order will squeeze the profit margins.


5. Govt Regulations and incentives.

Problem:

The Delhi Mixie company manufactured and sold 1000 mixies @ Rs 800/- each. The cost structure is as follows:

Material - Rs 200/-Labour - Rs 100/-Variable Overheads - Rs 50/-Factory Cost - Rs 350/-Fixed Overheads - Rs 200/-Total Cost - Rs 550/-Profit - Rs 250/-Sales Price - Rs 800/-

Due to tough competition, the selling price for next year has to be brought down to Rs 750/-. Assuming no change in cost structure, how many mixies need to be manufactured and sold to ensure same level of profit.

Solution:

Old (Rs) New (Rs)Selling Price 800 750Variable Cost 350 350Contribution 450 400Fixed Cost 200 200Profit 250 200Total Profit 2,50,000 2,50,000Total Unit Sales 1,000 1,125

Problem:

In a purely competitive market 10,000 mobiles phones can be manufactured and sold at a certain price. It is estimated that 2000 mobile phones need to be manufactured and sold in a monopoly situation to make same profit. Profit under each condition is targeted at $ 2,00,000. Unit variable cost is Rs 100 and total fixed cost is Rs 37,000. Find the selling price in each situation.

Solution:

Competition MonopolyNo of units sold 10,000 2,000Profit 2,00,000 2,00,000Profit per unit $20 $100Variable Cost $100 $100Fixed Cost $37,000 $37,000Fixed Cost on per unit basis $3.70 $18.50


Total per unit Selling Price $123.70 $218.50


BUDGETING

A budget is a plan that quantifies a company’s goals in terms of specific and operating objectives. Goals setting most often takes a bottom to top approach rather than the opposite.

Goals are then broken into strategies and plan of action is developed to use those strategies in furtherance of the goals. In the course of development of plan of action, a host of factors have to be considered, like,

(a) Various business environment factors

(i) Market – Customer behaviour, demography, demand, etc.

(ii) Competition

(iii) Economy

(iv) Regulations

(v) Etc

(b) Product Life Cycle

(c) Company’s Financial Status – This is the starting point as every activity costs money and budget is limited by financial capacity of the firm.

Company’s Budget is broken into Departmental Budgets which are further broken into sub-budgets and so on. Each department has its own budget which is part of the company’s budget. Marketing Department also has its budget. The Marketing Budget consists of following sub-sub-budgets: -

(a) Sales Budget

(b) Advertising and Promotional Budget

(c) Market Research Budget

(d) Distribution Budget

(e) Logistics Budget – covers transporting cost, and

(f) Warehousing Budget

Factors which influence Budgets

(a) Sales Budget

(i) Market Size/growth – Market size and market growth gives a clue about a realistic growth potential possible.

(ii) Competitive position


(iii) Sales History – Sales Budget has to be within realistic estimates of previous sales growth record. If the sales in past were growing @ 20%, expecting 50% growth would be naïve.

(iv)Company’s Financial Strength – Even if growth is possible, company should have financial strength to invest in plant, machinery, infrastructure, distribution net work, advertising, etc.

(v) Brand Strength –

(b) Advertising and Promotion Budget

(i) Advertising Objectives – Short term or long term growth, etc.

(ii) Media Costs

(iii) Market Situation – Whether the market is booming or sluggish; how is the demand for the product, etc

(iv)Competitive Spending/Share of Voice – How much are the competitors spending? We need to match our spending with atleast our close competitors.

(v) Advertising Creative Strategy – Creative advertising may have higher returns and therefore reduces advertising cost per Re of sale.

(vi)Consumer Behaviour – Whether the consumers buy the product as an impulse reaction or it is a deeply drawn decision. In case of impulse decision products, advertising expenses are high due to need for higher top of the mind recall requirements. Soft Drinks are example of such products. In case of image oriented brands – sustained niche advertising is required.

(c) Market Research Budgets

(i) What methodology is being used for research – Whether primary data or secondary data, Group discussions or interviews, Face to face interviews or telecalling, etc

(ii) Data Processing

(iii) Data Analysis

(iv)Project Report Preparation

What ever amount of care may have been taken while preparing budget, The outcome will rarely match the plan. There will always be some variance, favourable or adverse. Whether favourable or adverse, analysis of this variance can be neglected only at grave cost to the


company. Variance analysis pin points the areas and persons whose performance was better than expected though overall performance was below expectation and vice versa. Thus, we know exactly where we underestimated and where we failed. Overall positive performance may some times hide some grave danger signals. Variance analysis brings them out in to open.

Problem:

A company’s sales budget for 2004 was as follows

Product A: 8000 units @ Rs 5.50 per unit = Rs 44,000

Product B: 24,000 units @ Rs 7.50 per unit = Rs 1,80,000Rs 2,24,000

Actual Performance

Product A: 6000 units @ Rs 6.00 per unit = Rs 36,000

Product B: 28000 units @ Rs 7.00 per unit = Rs 1,96,000Rs 2,32,000

Variance = 2,32,000 – 2,24,000 = Rs 8,000 (F)

Sales Price Variance = Actual Sales (Actual Selling Price – Planned Selling Price)

Product A = 6000 (6.00 – 5.50) = Rs 3000 (F)Product B = 28,000 (7.00 – 7.50) = Rs 14,000 (A)

Net Sales Price Variance = Rs 11,000 (A)

Volume Variance = Planned Price (Actual Volume – Planned Volume)

Product A = 5.50 (6,000 – 8,000) = Rs 11,000 (A)Product B = 7.5 (28,000 – 24,000) = Rs 30,000 (F)

Net Volume Variance = Rs 19,000 (F)

Net Total Variance = Rs 11,000 (A) + Rs 19,000 (F) = Rs 8,000 (F)

Analysis

Price increase of Product A had negative impact on turnover of the company since the gain from increase in price was only Rs 3000, while lost sales were Rs 11,000, leading to a reduction in turnover by Rs 8,000.

Price reduction of Product B had positive impact on turnover of the company since losses due to reduced price were Rs 14,000, while turnover increased by Rs 30,000, leading to a net increase in turnover by Rs 16,000.


On the whole, both products are highly price sensitive. Impact of price reduction on sales is considerably high in both cases.

However, even this data is not adequate for business decision.

Turnover is NOT profit. Increased turn over is not necessarily increased profit.

In case of product A, while gains due to increased price ADD IN FULL to the profit of the company, only a small percent of the sales loss will affect the profit. Let us assume that production cost of product A was Rs 5.

Planned profit = 8,000 (5.5 – 5.00) = Rs 4,000Actual Profit = 6,000 (6.00 – 5.00) = Rs 6,000

Thus, in this case, despite reduced sales, profits have increased by 50%.

Let us now see the state of Product B.

Suppose, cost of production of Product B is Rs 6.25

Planned profit = 24,000 (7.5 – 6.25) = Rs 30,000Actual Profit = 28,000 (7.00 – 6.25) = Rs 21,000

Thus, in this case despite increased sales, profits have plummeted by Rs 9,000.

Problem:

Variance for selling expenditure for covering a territory are as follows

Standard Cot Rs 2,40,000Standard Salesmen Days 2000 daysStandard cost per person per day Rs 120

Actual Cost Rs 2,38,000 Variance = Rs 2000 (F)Actual Salesmen Days 1,700 Variance = 300 days (F)Actual cost per person per day Rs 140 Variance = Rs 20 (A)

Variance due to Salesmen days = 120 (1700 – 2000) = Rs 36,000 (F)Variance due to Salesmen cost = 1,700 (140 – 120) = Rs 34,000 (A)Net Variance in Cost Rs 2,000 (F)


Case Study

Following are a company’s financial and marketing score boards

Financial Score BoardPerformance Rs Millions Base Year 1 2 3 4 5Sales Revenue 254 293 318 387 431 454Cost of Goods Sold 135 152 167 201 224 236Gross Contribution 119 141 151 186 207 218Manufacturing O/H 48 58 63 82 90 95Marketing and Sales 18 23 24 26 27 28R&D 22 23 23 25 24 24Admin O/H 15 15 15 16 16 16Net Profit 16 22 26 37 50 55Return on Sales % 6.3 7.5 8.2 9.6 11.6 12.1Assets 141 162 167 194 205 206Asset % of Sales 56 55 53 50 48 45Return on Assets

Marketing ScorecardMarket Based Performance

Base Year 1 2 3 4 5

Market Growth units % 18.3 23.4 17.6 34.4 24 17.9Sales Growth % 12.8 17.8 13.3 34.9 18.2 18.7Market Share 20.3 19.1 18.4 17.1 16.3 14.9Consumer Retention 88.2 87.1 85.0 82.2 80.9 80.0New Customers 11.7 12.9 14.9 24.1 22.5 29.2Dissatisfied Customers 13.6 14.3 16.1 17.3 18.9 19.6Relative Product Quality 19 20 17 12 9 7Relative Service Quality 0 0 -2 -3 -5 -8Relative new product sales 8 8 7 5 1 4

Analysis of above data reveals that

1. Sales Revenue and Profits are constantly growing. However, market share is constantly falling. This is indicative of boom in demand for the product in the market. Company’s growth is actually driven by general growth in the market. Even then company has failed to take full advantage of the opportunities in the market and increase its profits further. If and when demand for the product falls, company would be badly hit.

2. Expenditure on R&D is stagnant at about 24%. Considering as percentage of sales, the expenditure on R&D has actually fallen. Thus, company is not future oriented. It is not taking care of product life cycle. Same deduction can be drawn from the last row in marketing score board which shows constantly falling


new product sales. Company will be hard hit once the current product life cycle is on the wane.

3. Return on assets has grown from 11.3% to 26.7% which is almost 133% growth. However, new investments in assets are low as the assets have grown from 141 to 206 only. Despite high growth in return on assets, company has failed to invest on assets. Once again company is not investing for its future.

4. Company’s product quality and service quality both are continuously declining over the entire period. At the same time percentage of dissatisfied customers are increasing. Customer retention is also dropping. Entire growth is being driven by new customers. All the events are logical sequence. Company obviously has not looked at its Balanced Score Card.


BRAND VALUATION

A product becomes a brand after the company gives it a name or symbol or get-up.

Brand value is intangible and therefore, brand valuation exercise can not be very objective. It is subjective in nature and at the best a guess work.

Brand equity is the value built-up in a brand. It is measured based on how much a customer is aware of the brand. The value of a company's brand equity can be calculated by comparing the expected future revenue from the branded product with the expected future revenue from an equivalent non-branded product. This calculation is at best an approximation. An investment in brand equity is commonly claimed to work through the creation of brand knowledge. This knowledge in turn consists of two aspects of a brand: brand image and brand awareness. Brand image, in this context, consists of the mental associations consumers make with the brand; Tata means honest business; Mercedes means excellent car. Brand awareness is composed of the strength of the brand in consumers' minds, for example their ability to recall the brand.

In order to create brand equity, often lot of investment is required (but not always). Equity can not be measured in financial terms.

Fundamentals of building brand equity:

1. Perceived product quality

2. Name awareness

3. Brand loyalty

4. Brand association (Image), like Raymond suiting is associated with a warm and caring “complete” man. Reid & Taylor tried to claim to be the best by slogan “Bond with the Best”. But the icon of James Bond did not inspire much appeal in Indian psyche. Thus, they have now changed the mascot to Amitabh Bachchan.

5. Other brand properties – Gale mein Khich-khich – Vicks, Dove – one forth moisturising cream.

Brand Equity is good for the company as well as good for the consumer.

Consumer CompanyCustomer is assured of certain minimum level of quality and service from the company keen to maintain its brand equity.

Adds value to the firm

User satisfaction Wins loyal customersEasy purchase decision making. Customer’s confidence in brandInformation processing is easier Marketing programme is effective and

productive.


Leverage over trade. “Pull” strategy works and there is no need to adopt “Push” strategy. (For push and pull strategy, refer second semester Marketing answer bank question 18 page 21).Better product price/margins

How to measure brand equity?

It has been already pointed out in the beginning that brand equity is intangible and therefore it is difficult to arrive at an exact figure. Thus, each stalwart’s attempt to quantify brand equity is only one of the many ways available to hazard a guess but none coming close to a widely acceptable formula for measuring brand equity.

1. Young and Rubicam’s Brand Asset Valuation – Young and Rubicam is one of the largest advertising agency in the world and has been associated with over 450 brands in 32 countries. As per Young and Rubicam, the brand is to be assessed on following parameters on a scale of 1 to 5:

(a) Differentiation

(b) Relevance – Emotional/rational connection

(c) Esteem – Esteem = brand popularity x perceived quality.

(d) Knowledge.

How are the above parameters related?

Differentiation x Relevance = Brand Strength

Esteem x Knowledge = Brand Stature

2. Total Research’s Equitrend – As per this firm, brand equity can be measured by measuring brand’s performance on a 5 point scale for following attributes:

(a) Brand Saliency (uniqueness/differentiation)

(b) Perceived quality

(c) User satisfaction

Perceived Quality – Perceived quality can be assessed based on

(i) Brand liking

(ii) Brand Trust

(iii) Willingness to recommend

(iv) Pride


3. Interbrand Model of Brand Assessment Criteria

(a) Business prospects of a brand

(b) Brand Market Environment

(c) Consumer’s Perception

Each of the three attributes are judged on a several parameter on a 5 point scale

(i) Leadership – Gives economies of scale for production, advertisement, etc.

(ii) Stability of Brand – Like Lifebuoy, Sony, Lux have been around for decades now.

(iii) International Status

(iv) Markets – Growing/stable/declining, pricing structure/profitability, etc

(v) Protection (legal) – Like patent or license

(vi) Support – Financial, human, system

If you have a strong brand, you may not involve in manufacturing the product. You can outsource the production and only market it. Many companies around the globe are following this strategy.

Some of the methods of brand valuation are:

Historical Cost Method – The total cost incurred on building the brand ever since launch. However, this is not the right method. Cost never determines the value. The first factor is time value of money. Second issue is wastages in the process, third issue is the value already recovered from investments. What we are looking for is residual value in the brand. Take for instance Remington type writers. They enjoyed excellent brand valuation at one time. But once computers started taking over, there was little brand value left. A case of wastages is Signal toothpaste of Hindustan Lever. Despite investing lot of money in brand promotion, product never got much market share. Thus, most of the investment was a waste. Besides investment, there are a host of other factors that build the brand and probably they are more important than money pumped into it.

Replacement Cost Method – This method is good for theory only. It is impossible to find the replacement cost (for re- building the another brand with similar market).

Market Value – This is a more reaslistic method. Ultimately value is what customer is willing to pay. So, what does the consensus in the market among the prospective buyers says?

Value by Potential Earnings – This is another realistic method. It is possible to make an approximation of the future earnings and discount them to today’s value.


lecture notes - marketing finance-jbims mumbai

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