Lecture Date:
Date: 17 Jul 2006
Mr Kuldip Kawatra
.
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.
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 Sales
Avg 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 = 55,000
2
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 = 9500
2
Avg inventory for year 2002 = 11000+17000 = 14000
2
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 | 750000 |
|Depreciation | 30000 |
|Interest Payment | 140000 |
|Sale of Fixed Assets | 20000 |
|Payment of debt principal | 300000 |
|Dividends | 90000 |
|Capex | 280000 |
Find 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/Profit |
|Net Income | | 750000 |
|Adjustments | | |
| Depreciation | 30000 | |
| Sale of Fixed Assets | (20000) | 10000 |
|Total | | 760000 |
|Add Back Interest Payment | | 140000 |
|Total Operating Income | | 900000 |
|Liabilities |
|Interest Payment | | 140000 |
|Payment of Debt Principal | | 300000 |
|Dividend | | 90000 |
|Capital Expense | | 280000 |
|Total 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.
= [pic]
= [pic]
TAX MKTG TURN OVER LEVERAGE
MGMT MGMT TO CAPITAL
Explanations –
PAT – Profit after Tax
NW – Net Worth
PBT – Profit Before Tax
Investment = 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 utilisation
Investment to NW ratio indicates the leverage. How much loan has been taken against the shareholders funds.
ROI = [pic]
ROI = [pic]
ROI = Rate of Margin [pic] 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. Price
2. 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 | 80,000,000 |
|Collection Period | 2 Months |
|Terms |Net 30 (Officialese for declaring credit period of 30 days) |
|Minimum Rate of Return | 15% (Opportunity cost of Capital employed |
|Proposal of Marketing Department | |
|Offer 2/10 Net 30 discount |(Officialese for saying 2% discount for payment within 10 days) |
|25% customers will take advantage | |
|Collection period should decline to 1.5 months | |
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 units |
|Collection Period |1 month |
|Returns |24% |
|Proposal | |
|Liberalise credit | |
|Collection period |02 Months |
|Sales Increase Expected |20% |
|Bad Debt Increase |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) |(03 months) |(03 months) |
| | |(15% inc) |(30% inc) |(25% inc) |
|Sales | 30,00,000 | 34,50,000 | 39,00,000 | 37,50,000 |
|Number of Units | 10,000 | 11,500 | 13,000 | 12,500 |
|Variable cost @ Rs 200 | 20,00,000 | 23,00,000 | 26,00,000 | 25,00,000 |
|Contribution/Gross Margin | 10,00,000 | 11,50,000 | 13,00,000 | 12,50,000 |
|Fixed Cost | 3,00,000 | 3,00,000 | 3,50,000 | 3,00,000 |
|Net Contribution | 7,00,000 | 8,50,000 | 9,50,000 | 9,50,000 |
|Avg 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 |26,00,000/6 |29,50,000/4 |28,00,000/4 |
| |=1,91,667 |= 4,33,333 |= 7,37,500 |= 7,00,000 |
|(a) Opportunity cost of capital @ 20% of | 38,333 | 86,633 | 1,47,000 | 1,40,000 |
|investment | | | | |
|(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 | 3,17,500 |
|Net Gain from option - Net Contribution – |7,00,000 - 68,333 = |8,50,000 - 1,90,133 = |9,50,000 - 3,42,435 = |9,50,000 - 3,17,500 =|
|cost of policy |6,31,667 |6,59,867 |6,07,515 |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 5,00,000 |
|B | 4 % | 40 Days | Restricted | Rs 5,00,000 |
|C | 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 |C |
|Incremental Gross Profit | |5,00000 x 20% = 1,00,000 |7,00,000 x 20% = 1,40,000 |
|Investment in A/c Receivables (incremental) | |(5,00,000 x 40)/365 x 80% = |(7,00,000 x 70)/365 x 80% = |
| | |43,836 |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 |
| | | | | | |
|Liabilities |Rs. Lacs | |Assets |Rs. Lacs | |
|Equity Capital |101.20 | |Net Fixed Assets |221.53 | |
|Reserves |43.20 | |Investment |22.10 | |
|Term Loans |70.63 | |Raw Material Inventory |46.69 | |
|Bank Borrowings |153.61 | |Work-in-progress |15.21 | |
|Deposits maturing |26.89 | |Finished goods stocks |74.35 | |
|in one year Sundry Creditors |75.53 | |Goods in transit |52.76 | |
|Other current Liabilities |122.48 | |Cash & Bank Balances |23.02 | |
|(including provisions) | | |Sundry Debtors |81.48 | |
| | | |Unsecured Advances |23.56 | |
| | | |Other 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 | |666.30 | | | |
|Material Cost | |239.17 | | | |
|Employee Costs | |172.41 | | | |
|Selling & General Administration |150.57 | | | |
|Interest | |35.34 | | | |
|Depreciation | |9.97 | | | |
|Investment Allowance | |0.96 | | | |
|Profit before Tax | |57.88 | | | |
|Tax | |34.73 | | | |
|Profit after Tax | |23.15 | | | |
| | | | | | |
|Note: Company maintained dividend at 10% for 1990. |
| | | | | | |
|SALES TO AND COLLECTIONS FROM PHARMAX LABORATORIES |
| |Sales |Outstanding | | |
| |(Rs. Lacs) |(Rs. Lacs as on 1st Sept. 91) | | |
|February 91 and before |0.74 |0.18 | | | |
|March 91 |0.36 |0.36 | | | |
|April 91 |0.22 |0.22 | | | |
|May 91 |0.64 |0.64 | | | |
|June 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 Lakh | |
| |Pharmax Contribution to Sales |4.81 Lakh |8.3% |
| |Growth Potential of Sales to Pharmax | |15% |
| |Outstanding of Ampouleagent |18.19 Lakh | |
| |Outstanding with Pharmax |4.25 Lakh |23% |
| |Average Outstanding of Ampouleagent |2.2 Months*1 | |
| |Outstanding with Pharmax |6 Months*2 | |
Notes
Average Outstanding of Ampouleagent = [pic]
Average Outstanding = [pic]
Outstanding with Pharmax Lab
Total Outstanding = 4.25 Lakhs
Average Monthly Sales to Pharmax Lab = [pic]
Average Outstanding = [pic]
2(a) Current Ratio = [pic]
= [pic]
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 Lakh
Depreciation 10 Lakh
Total 33 Lakh
Less - Div Payment 10 Lakh
Term 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 = [pic]
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 5,20,000
Cost of sales 2,50,000
Gross profit on sales 2,70,000
Selling and distribution costs
Salesmen’s salaries 24,500
Salesmen’s commission 27,500
Sales office expenses 14,800
Advertising 65,000
Warehouse 4,500
Packing and shifting 5,600
Transportation & delivery 8,400
Credit and collections 4,100
Bad debits 9,400
1,63,810
General and administrative expense 41,250 2,05,060
Net Profit 64,940
Additional Information:
| |Product A |Product B | Product C |
| | | | |
|Sales | 1,20,000 |1,50,000 | 2,50,000 |
|Cost of sales | 55,000 | 70,000 | 1,25,000 |
|Salesmen’s salaries | 8,000 | 7,000 | 9,500 |
|Salesmen’s commission | 11,000 | 6,000 | 10,500 |
|Advertising (%) | 20 | 20 | 60 |
|Warehouse space occupied | 1/3 | 1/3 | 1/3 |
|Invoice lines (packing and shifting) | 1,500 | 2,500 | 3,000 |
|Transportation and delivery | 5,500 | 6,000 | 8,500 |
|Average account receivable | 15,000 | 35,000 | 50,000 |
|Bad 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 Statement
| |Basis for Allocation |Total Exp |Prod A |Prod B |Prod C |
|Sales |Direct | 5,20,000 | 1,20,000 | 1,50,000 | 2,50,000 |
|Cost of Sales |Actuals | 2,50,000 | 55,000 | 70,000 | 1,25,000 |
|Gross Margin |Calculated | 2,70,000 | 65,000 | 80,000 | 1,25,000 |
|Salesmen Salaries |Actuals | 24,500 | 8,000 | 7,000 | 9,500 |
|Salesmen Commn |Actuals | 27,500 | 11,000 | 6,000 | 10,500 |
|Sales Office Exp |Invoice Lines (15:25:30) | 14800 | 3,171 | 5,286 | 6343 |
|Advertising |1:1:3 | 65000 | 13,000 | 13,000 | 39,000 |
|Warehousing |1/3:1/3:1/3 | 4,500 | 1,500 | 1,500 | 1,500 |
|Pack & Shipping |15:25:30 | 5,600 | 1,200 | 2,000 | 2,400 |
|Transport 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 | 4,613 |
|Total | | 1,63,810 | 43,141 | 41,183 | 79,436 |
|General Admin |Sales 12:15:25 | 41,250 | 9,519 | 11,899 | 19,832 |
|Total Costs | | 2,05,060 | 52,660 | 53,082 | 99,308 |
|Net 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 salesmen | 36 | 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. | | | | |
|0-2,000 | | | | |
|2,001 – 4,000 | | | | |
|4,001 – 6,000 |1 |0.6 |1 |0.5 |
|6001 – 8,000 |1.8 |1.6 |1 |1.4 |
|over 8,001 |2.9 |2.8 |2.7 |2 |
| |5 |4.3 |4.1 |3.2 |
| |5.2 |5.2 |5.1 |5.1 |
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 | 3,71,000 |
|No. of trucks | 15 | 2 | 3 | 12 |
|Avg. annual miles per truck | 28,000 | 12,000 | 12,600 | 20,000 |
|Avg. no. of daily deliveries | 12 | 16 | 15 | 8 |
|per truck | | | | |
|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 | 80,000 | 51,000 | 99,000 | 83,000 |
|handlers | | | | |
|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, 1983
| |Southern Zone | |Northern Zone | |Mid Central Zone | |Far Eastern Zone |
| |Amount (Rs) |% of sales | |
|Unit Selling Price |Rs 18 |Rs 16 |Rs 13 |
|Estimated Unit sales |9,00,000 |8,50,000 |8,25,000 |
|Selling and Distribution Cost per unit |Rs 2.5 |Rs 2 |Rs 1.80 |
|Cost of Production |Rs 3 |
|Fixed 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 | 1,07,25,000 |
|Variable Cost @ 3 | 27,00,000 | 25,50,000 | 24,75,000 |
|Selling and Distribution Cost | 22,50,000 | 17,00,000 | 14,85,000 |
|Operating Profit | 1,12,50,000 | 93,50,000 | 67,65,000 |
|Fixed Cost | 6,00,000 | 6,00,000 | 6,00,000 |
|Net 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 |3 |
|Per Unit Selling & Distribution Cost |2.5 |2 |1.80 |
|Per Unit Variable cost |5.5 |5 |4.80 |
|Per Unit Selling Price |18 |16 |13 |
|Per Unit Contribution |12.50 |11 |8.20 |
|Total Contribution | 1,12,50,000 | 93,50,000 | 67,65,000 |
| Less: Fixed Cost | 6,00,000 | 6,00,000 | 6,00,000 |
|Profits | 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 Deptt |
|1. |Capital Employed in Fixed Assets | 100 |10 |
|2. |Working Capital Employed |100 |60 |
| |Total |200 |70 |
|3. |Sales |400 |400 |
|4. |Cost of Sales (as pre transfer pricing) |300 |350 |
|5. |Gross Margin/Profit |100 |50 |
|6. |Operations Cost |40 |23 |
|7. |Finance Charge/Interest/Opportunity Cost |20 |7 |
|8. |Net Profit |40 |20 |
|9. |ROI |[pic] = 20% |[pic] = 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 |Maintained high inventory level to ensure customer satisfaction |
|by better inventory review and forecasting and thus incurred low |but had to incur high Working Capital costs. |
|working capital costs | |
|Ensured quick receivables collection and kept working capital |Allowed longer credit period to push sales and thus blocked |
|requirements and costs low. |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 [pic]
[pic]
[pic]
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, [pic]
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 10,00,000
Net Profit = Rs 80,000
Assets = Rs 5,00,000
Liabilities
Current = Rs 2,00,000
Capital = Rs 2,00,000
Retained Earnings = Rs 1,00,000 Rs 5,00,000
Total Investment = Capital + Retained Earnings
= 2,00,000 + 1,00,000 = Rs 3,00,000
[pic]
Prob 2. Profits = Rs 1,00,000
Sales = Rs 10,00,000
Assets = Rs 5,00,000
[pic]
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?
[pic]
Thus, we see that ROI has improved to 25% because of 20% reduction in assets.
Prob 3: Sales 10,00,000
Factory Costs 7,00,000 3,00,000
Direct Expenses
Salary & Fringe Benefits 1,10,000
Travel & Entertainment 28,000
Field Office 12,000 1,50,000
Operating Profit 1,50,000
Capital Employed
Receivables 2,10,000
Finished Goods Inventory 1,20,000 4,00,000
[pic]
Case I –
Sales increase by 2,00,000
Rate of profit = 15%
Capital employed = 4,00,000
[pic]
Case II –
Sales increase by 2,00,000
Rate of profit = 15%
Capital employed = 3,00,000
[pic]
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 |Total |
|1. |Gross Profit | 40% | 20% | 30% | |
|2. |Budgeted Sales | 500 | 200 | 300 | 1,000 |
|3. |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 10,00,000
Profits 1,50,000 15 %
Assets Employed 4,00,000 TO Ratio = 2.5
ROI 37.5%
Proposal from Sales Department
Increase 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 =
[pic]
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 |Weight|Norms |Bonus Points |Achievements |
| | |age | | | |
| | | | | |A |B |C |
| | | | | |Achieved |
|Sales |350 |225 |150 |175 |100 |
|Contribution Margin |40% |50% |60% |30% |45% |
| Expense Head |Advertising |Sampling |Detailing |Total |
| |(Direct) |(Direct) |Allocated on time | |
|Product | | |basis | |
|1 |4 |10 |14 |28 |
|2 |6 |3 |5 |14 |
|3 |3 |4 |16 |23 |
|4 |5 |5 |5 |15 |
|5 |7 |8 |5 |20 |
Find, which product gives maximum return on promotional investment.
Solution:
| Product |1 |2 |3 |4 |5 |
| | | | | | |
|Expense | | | | | |
|Sales |350 |225 |150 |175 |100 |
|Contribution 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 |
| Expense Head |
| |
| |
| |
|Product |
|Income Statement for the year ended December 31, 1990. |
| |Restaurant Line |Retail Line |Total |
|Sales |1,800,000 |1,700,000 |3,500,000 |
|Cost of Sales | | | |
|Materials |400,000 |320,000 |720,000 |
|Labour |300,000 |240,000 |540,000 |
|Variable overheads |200,000 |250,000 |450,000 |
|Fixed Overheades |270,000 |210,000 |480,000 |
|Total |1,170,000 |1,020,000 |2,190,000 |
|Gross 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 |136,000 |
| Salesman's travel & E’tainment |0 |85,000 |85,000 |
| Truck depreciation |14,400 |0 |14,400 |
| Insurance & Licences | | | |
| Truck driver's salaries |65,000 |0 |65,000 |
| Truck garage rental |3,600 |0 |3,600 |
| Gasoline & other truck supplies |28,000 |0 |28,000 |
| Commissions to distributors |180,000 |0 |180,000 |
| Freights |6,000 |62,000 |68,000 |
| Bad Debts |4,500 |6,000 |10,500 |
| Total Direct |301,500 |289,000 |590,500 |
| Allocated | | | |
| Warehouse (basis of space) |40,000 |80,000 |120,000 |
| Selling (sales) |48,000 |32,000 |80,000 |
| Advertising (sales) |36,000 |24,000 |60,000 |
| Adminstrative (sales) |54,000 |36,000 |90,000 |
| Total Allocated |178,000 |172,000 |350,000 |
|Total selling & admin |479,000 |461,000 |940,000 |
|Profit before Income Taxes |150,000 |219,000 |369,000 |
|(% of Sales) |(8.4) |(12.9) |(10.9) |
| | | | |
|Capital employed | | | |
|Variable: | | | |
| Average monthly cash |72,000 |48,000 |120,000 |
| Average monthly inventories |120,000 |240,000 |360,000 |
| Average monthly receivable |162,000 |184,000 |346,000 |
| Total |354,000 |472,000 |826,000 |
|Fixed |1,144,000 |1,372,000 |2,516,000 |
|Total |1,498,000 |1,844,000 |3,342,000 |
|Return on capital |(10.0%) |(11.9%) |(11.6%) |
Solution:
| |Basis |Restaurant Line |OR |Retail Line |
|Incremental Sales |20% of total sales |700,000 | |700,000 |
|Units sale |Sales/per unit cost |35,000 | |140,000 |
|Cost of Sales |Mat + Lab + Var Exp |350,000 | |333,529 |
|Gross Margin |Sales - Cost of Sales |350,000 | |366,471 |
|Going by Gross Margin, Retail Line seems to be preferable. However let us explore further. |
| | | | | |
|Selling and Admin Expenses | | | |
|Sales Commission to Salesmen |same ratio as Orig |0 | |56,000 |
|Travel and Entertainment expenses of Salesmen |same ratio as Orig |0 | |35,000 |
|Truck Drivers Salary |15% of orig salary |9,750 | |0 |
|Gasoline & Other Supplies |10% of origl exp |2,800 | | |
|Distribution Commission |same ratio as Orig |70,000 | | |
|Freights |same ratio as Orig |2,333 | |25,529 |
|Bad Debt |same ratio as Orig |1,750 | |2,470 |
|Total Direct Expense | |86,633 | |118,999 |
| | | | | |
|Indirect Costs | | | | |
|Advertising |1% of sales |0 | |7,000 |
|Variable Shipping Exp |80p and 5p per unit |28,000 | |7,000 |
|Invoice Cost @ 40p |WN 3 |560 | |2,800 |
|Packing Cost @ 4p |WN 4 |0 | |5,600 |
|Total allocable exp | |28,560 | |22,400 |
| | | | | |
|Profits before allocable costs |263,367 | |247,472 |
|Profits after allocable costs |234,807 | |225,072 |
| | | | | |
|Investments | | | | |
|Investment |In same ratio |28,000 | |19,764 |
|Monthly Cash |In same ratio |46,666 | |93,333 |
|Receivables |In same ratio |63000 | |75764 |
|Total Investment | |137,666 | |188,861 |
|ROI | |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 =
[pic] = [pic] 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 | 750 |
|Variable Cost | 350 | 350 |
|Contribution | 450 | 400 |
|Fixed Cost | 200 | 200 |
|Profit | 250 | 200 |
|Total Profit | 2,50,000 | 2,50,000 |
|Total 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 |Monopoly |
|No of units sold |10,000 |2,000 |
|Profit |2,00,000 |2,00,000 |
|Profit per unit |$20 |$100 |
|Variable Cost |$100 |$100 |
|Fixed Cost |$37,000 |$37,000 |
|Fixed 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 1,80,000
Rs 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 1,96,000
Rs 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 4,000
Actual 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 30,000
Actual 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 2,40,000
Standard Salesmen Days 2000 days
Standard 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 Board
|Performance Rs Millions |Base Year |1 |2 |3 |4 |5 |
|Sales Revenue |254 |293 |318 |387 |431 |454 |
|Cost of Goods Sold |135 |152 |167 |201 |224 |236 |
|Gross Contribution |119 |141 |151 |186 |207 |218 |
|Manufacturing O/H |48 |58 |63 |82 |90 |95 |
|Marketing and Sales |18 |23 |24 |26 |27 |28 |
|R&D |22 |23 |23 |25 |24 |24 |
|Admin O/H |15 |15 |15 |16 |16 |16 |
|Net Profit |16 |22 |26 |37 |50 |55 |
|Return on Sales % |6.3 |7.5 |8.2 |9.6 |11.6 |12.1 |
|Assets |141 |162 |167 |194 |205 |206 |
|Asset % of Sales |56 |55 |53 |50 |48 |45 |
|Return on Assets | | | | | | |
Marketing Scorecard
|Market Based Performance |Base Year |1 |2 |3 |4 |5 |
|Market Growth units % |18.3 |23.4 |17.6 |34.4 |24 |17.9 |
|Sales Growth % |12.8 |17.8 |13.3 |34.9 |18.2 |18.7 |
|Market Share |20.3 |19.1 |18.4 |17.1 |16.3 |14.9 |
|Consumer Retention |88.2 |87.1 |85.0 |82.2 |80.9 |80.0 |
|New Customers |11.7 |12.9 |14.9 |24.1 |22.5 |29.2 |
|Dissatisfied Customers |13.6 |14.3 |16.1 |17.3 |18.9 |19.6 |
|Relative Product Quality |19 |20 |17 |12 |9 |7 |
|Relative Service Quality |0 |0 |-2 |-3 |-5 |-8 |
|Relative 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 |Company |
|Customer is assured of certain minimum level of quality and service|Adds value to the firm |
|from the company keen to maintain its brand equity. | |
|User satisfaction |Wins loyal customers |
|Easy purchase decision making. |Customer’s confidence in brand |
|Information 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.
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