managing the profit returned on marketing investment with hurdle rates ted mitchell

Managing the Profit Returned on Marketing Investment with Hurdle Rates

Ted Mitchell

Profit From More Investment?

Profit, Z

Amount of Investment, I

Bank profit

Z = (interest rate, i) x investment, I

Marketing profitZ = (average rate, r) x (investment, I)

Z = (a – bI) x IZ = aI – bI2

I

Average Rate of profit being returned On Marketing Investment, ROMI

Profit, Z


Bank profit

Z = (interest rate, i) x investment, I

Marketing profitZ = (average rate, r) x (investment, I)

Z = (a – bI) x IZ = aI – bI2

Managerial Guide to Adjustments in Marketing Investment

Direct Quadratic

Profit Profit

Input, I I I

Average Rate at which profit is being returned On Investment, ROMI, at a particular point of performance, (I, Z). r = Z/I

r = bwhere b has a constant value

r = ƒ(I)r = a –bI

Output, Z = ƒ(I)Output, Z = r x I

Z = bI Z = (a –bI) x IZ = aI –bI2

Marginal rate at which profit is being returned on investment, dZ/dI

dZ/dI = b dZ/dI = a –2bI

Elasticity of average rate of profit returned on investment, ROMI

%∆r/%∆I = –bI/(a-bI)Average Rate of Return: Total Profit/Total Investment, Z/IMarginal Conversion Rate: Speed at the point (I, O)When I increase my input by 1 unit by how many units will I increase my output?

Calculating Profit From InvestmentZ = (average rate, r) x (investment, I)

Average rate of return, r


Average rate of return on bank savings

r = constant value, i

Profit, Z = r x I

I

Average rate of return on marketing investmentr = a – (b)I

Profit, Z = r x IZ = (a–bI) x I

I

Z = (a-bI) x I

Introduction to Marginal Rate of profit being returned On a Marketing Investment

• The marginal rate is the rate at which profit is being returned for each additional dollar of investment

• The average rate is the amount of profit that is being returned for the average dollar in the total investment, Z/I

Average and Marginal Rates of profit being returned On Marketing Investment, ROMI

Profit, Z


Average Rate at which profit is being returned on investment, Z/I = a-bI

Marginal Rate at which profit is being returned on investment, dZ/dI= a-2bI

Maximizing Profit From a Marketing Investment

Profit, Z


To find the level of investment, I*, you need to maximize marketing profit you need to calculate the marginal rate at

which profit is being returned per dollar invested, dZ/dI, at any point and solve

for amount of investment that makes the dZ/dI = 0

I* = a/2b

The marginal rate at any

point dZ/dI = a–2bI

Managerial Guide to Adjustments in Marketing Investment

Direct Quadratic

Profit Profit

Input, I I I

Average rate at which profit is being returned on investment, ROMI, r = Z/I

r = b r = a –bI

Output, Z = ƒ(I)Output, Z = r x I

Z = bI Z = (a –bI) x IZ = aI –bI2

Marginal rate at which profit is being returned on investment, dZ/dI

dZ/dI = b dZ/dI = a –2bI

Elasticity of average rate of profit returned on investment, ROMI

%∆r/%∆I = –bI/(a-bI)

Average Rate of Return: Total Profit/Total Investment, Z/IMarginal Conversion Rate: Speed at the point (I, O)When I increase my input by 1 unit by how many units will I increase my output?

Marginal Rate of profit From a Bank deposit

Profit, Z


The Direct Relationship Bank profit, Z, and the level of investment, I, Z = (interest rate, i) x investment, I

Means that the marginal rate, dZ/dI, at which profit is being returned on each dollar invested is equal to the average rate

which has the constant value of the interest rate, IdZ/dI = i

There is no optimal level of investment

The Marginal Rate of return on Marketing Investment

• Is the amount of profit that is generated by one additional dollar of marketing investment

Maximizing Profit From a Marketing Investment

Profit, Z


To find the level of investment, I*, you need to maximize marketing profit you need to calculate the marginal rate at

which profit is being returned per dollar invested, dZ/dI, at any point and solve

for amount of investment that makes the dZ/dI = 0

I* = a/2b



Marginal Rates of profits being returned On Marketing Investment, MROMI

Profit, Z


Marginal rates are negative

I* = a/2b



Marginal rates are positive

Exploring the Marginal Rates of Profit being returned on Investment

rates of return


Marginal rate of return on bank savings

dZ/dI = constant value, i

Average rate of return on marketing investmentr = a – (b)I

I* = a/2b

Marginal rate of Return on marketing investment

dZ/dI = a-2bI

Negative Marginal Rate

Positive Marginal

Rate

Profit From More Investment?

Profit, Z


Bank profit

dZb/dI = interst rate, i

To Maximize profit from investments in marketing and/or in the bank the

marginal returns are set equal to each other

Marginal rate of Return on

marketing investment

dZa/dI = a- 2bI

dZa/dI = dZb/dI

To maximize total profit invest first in marketing effort and then into the bank

rates of return



dZ/dI = constant value, i

I*= a/2b

Marginal rate of Return on marketing investment

dZ/dI

The key to Managing

• The Profits derived from Investing in Marketing Effort is the marginal rates at which profit is being returned on marketing investment

You own a well managed coffee shop

• The shop is providing customers with the coffee they enjoy, at the times they enjoy drinking it, and at the price that maximizes the revenue for the business. You are aware that an increase in customer service will increase the profit the shop is earning each year. The quadratic equation that explains and predicts the amount of profit, Za, from dollars invested in service, I, as Za = (1.1)I – (0.00025)I2

• You have a choice between investing your money into • 1) the customer value found in your offering by increasing the

number of servers in the shop and/or• 2) a saving’s account at your local bank• The bank’s interest rate is 5% a year and there is a direct relationship

between the bank profit, Zb, and the amount of the investment, I, Zb = (0.05)I

• At what level of investment will you be indifferent between the two investment opportunities?

To maximize total profit invest first in marketing effort and then into the bank

rates of return



dZb/dI = constant value, i

I*= 1.1/2(.00025)I* = $2,200

dZa/dI = a-2bI

Level of indifference

Answer

• Set the marginal rate at which profit is being returned from marketing investment, dZa/dI, equal to the marginal rate at which profit is being returned from the bank investment, dZb/dI,

• dZa/dI = dZb/dI• a – 2bI = i• 1.1 – 2(.00025)I = (0.05)• (1.1– 0.05)/0.0005 = I• I = $2,100 is the level of investment at which the two

choices are providing an equal contribution to profit

managing the profit returned on marketing investment with hurdle rates ted mitchell

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