978-0134492513 Appendix Appendix Part 1

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APPENDIX 3 Marketing by the Numbers

Learning Objectives

1. Conduct pricing, breakeven, and margin analysis.

2. Estimate demand, develop a pro forma and actual profit-and-loss statement, and

calculate various marketing performance measures.

3. Conduct financial analyses of marketing tactics.

Appendix Overview

This appendix provides a basic introduction to measuring marketing financial analysis

and is built around a hypothetical manufacturer of consumer electronics products—HD.

This company is launching a new product (a device that plays videos and television

programming streamed over the Internet on multiple devices in a home including

high-definition televisions, tablets, and mobile phones), and we discuss and analyze the

various decisions HD’s marketing managers must make before and after launch.

The appendix is organized into three sections, and while the HD scenario is carried

throughout all sections, instructors can select one or more sections at their discretion. At

the end of each section, quantitative exercises provide students with an opportunity to

apply the concepts in that section to contexts beyond the HD example. The sections are

broken down as follows:

1. Pricing, Breakeven, and Margin Analysis. This section covers pricing

considerations and break-even and margin analysis assessments that guide the

introduction of HD’s new product launch.

2. Demand Estimates, the Marketing Budget, and Marketing Performance

Measures. This section begins with a discussion of estimating market

potential and company sales. It then introduces the marketing budget, as

illustrated through a pro forma profit-and-loss statement followed by the

actual profit-and-loss statement. Next, the section discusses marketing

performance measures, with a focus on helping marketing managers to better

defend their decisions from a financial perspective.

3. Financial Analysis of Marketing Tactics. The final section analyzes the

financial implications of various marketing tactics, such as increasing

advertising expenditures, adding sales representatives to increase distribution,

lowering price, or extending the product line.

In this manual, solutions to the quantitative exercises follow the outline of the section in

which each set of exercises appears. Additionally, fifteen additional quantitative

exercises similar to those in the appendix are provided at the end of the material for this

manual. These may be used in lectures, for additional student practice, or for exams.

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Appendix Outline

I. Pricing, Breakeven, and Margin Analysis

A. Pricing Considerations

1. The limiting factors are demand and costs.

2. Determining Costs

a) Fixed costs do not vary with production or sales (e.g., rent,

interest, depreciation, clerical and managerial salaries).

b) Variables costs vary directly with the level of production

(e.g., cost of goods sold and many marketing costs).

c) Total costs are the sum of the fixed and variable costs.

3. Setting Price Based on Costs

a) Cost-plus pricing (or markup pricing) simply adds a

standard markup to the cost of the product.

(1) Unit cost for HD:

fixed costs $20,000,000

Unit cost = variable cost + —————— = $125 + ————— = $145

unit sales 1,000,000

(2) If HD desires a 25% markup on sales:

unit cost $145

Markup price = ——————————— = ——— = $193.33

(l – desired return on sales) (l – 0.25)

b) Relevant costs are those that will occur in the future and

that will vary across the alternatives being considered.

c) Sunk costs are past costs that will not reoccur in the future

and should not be considered.

d) Break-even price is the price at which unit revenue (price)

equals unit cost and profit is zero.

(1) For HD: breakeven price equals $145, which is the

unit cost determined above.

e) Return on investment (ROI) pricing is determined by

multiplying the desired return on investment by the

investment and adding this figure to the fixed costs.

(1) If HD desires a 30% return on an initial $10 million

investment:

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ROI  investment 0.3  $10,000,000

ROI price = unit cost + —————— = $145 + —————— = $148

unit sales 1,000,000

4. Setting Price Based on External Factors

a) Manufacturers do not have the final say concerning the

final price to consumers–retailers do, so HD must start with

its suggested retail price (MSRP) and work back through

reseller margins to determine the price at which to sell the

product to wholesalers.

b) Dollar markup is the difference between a company’s

selling price for a product and its cost to manufacture or

purchase it:

Dollar markup = selling price – cost

c) Markups are usually expressed as a percentage, and there

are two different ways to compute markups–on cost or on

selling price:

Teaching Note: Sometimes a retailer wants to convert markups based on

selling price to markups based on cost, and vice versa. The formulas are:

Suppose a retailer uses a markup of 25% based on selling price and found

that his competitor was using a markup of 30% based on cost and wanted

to know what this would be as a percentage of selling price. The

calculation is:

price sellingon percentage markup – 100%

price sellingon percentage markup

=cost on percentage Markup

coston percentage markup + 100%

coston percentage markup

= price sellingon percentage Markup

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price selling

markupdollar

= price sellingon percentage Markup

cost

markupdollar

=cost on percentage Markup

23% =

130%

30%

30% + 100%

30%

Because the retailer is using a 25% markup on selling price for similar

products, his markup is comparable with that of the competitor.

See additional quantitative exercise 6 for another application.

d) Value-based pricing uses buyers’ perceptions of value and

not the seller’s cost to determine the MSRP.

e) HD example: MSRP = $299.99, but $300 is used in

calculations for simplicity; retailer’s margin is 30% and

wholesaler’s is 20%, both based on their selling prices.

(1) Thus, the markup chain is:

Suggested retail price: $300

minus retail margin (30%):  $ 90

Retailer’s cost/wholesaler’s price: $210

minus wholesaler’s margin (20%):  $ 42

Wholesaler’s cost/HD’s price: $168

Teaching Note: Students should also be able to calculate prices when

cost and markup information is known. For example, suppose a retailer

knew his cost ($12) and desired markup on price (25%) for a product and

wanted to compute the selling price. Substituting (selling price – cost) for

dollar markup in the equation for markup percentage on selling price

given previously and solving for selling price gives the following formula

for determining the selling price:

See quantitative exercise 1.4 and additional quantitative exercises 4 and 5

for more applications of this equation.

B. Break-Even and Margin Analysis

1. Determining Breakeven Unit Volume and Dollar Sales

a) Break-even analysis determines the unit volume and dollar

sales needed to be profitable given a particular price and

cost structure.

b) Formula for determining break-even unit volume:

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$16 =

.750

$12

= price Selling

markup – 1

cost

= price Selling

c) The denominator (price  unit variable cost) is called unit

d) HD’s break-even unit volume is:

e) Break-even dollar sales can be determined by multiplying

unit breakeven volume by selling price:

f) Another way to calculate break-even sales is to use the

g) Contribution margin can also be calculated as follows:

h) Another way to determine contribution margin for any sales

level is by setting sales equal to 100% and subtracting the

percentage of variable costs from sales. For HD, variable

2. Determining “Break-even” for Profit Goals

a) While break-even analysis is useful, most companies are

b) When profit is expressed as an absolute amount, simply add

c) Profit can also be stated as a return on investment goal.

Determine the absolute profit goal by multiplying the

investment by the desired ROI (HD wants a 30% return on

its $10 million investment ($10,000,000  0.30)):

d) Profit goals can also be expressed as a percentage of sales.

In this case, we incorporate the profit goal into the unit

contribution as an additional variable cost (HD wants a

25% return on sales):

C. Marketing by the Numbers Exercise Set One

1.1. Elkins, a manufacturer of ice makers, realizes a cost of $250 for every unit it

produces. Its total fixed costs equal $5 million. If the company manufactures

500,000 units, compute the following:

a. unit cost

b. markup price if the company desires a 10% return on sales

c. ROI price if the company desires a 25% return on an investment of $1

million

Answer:

1.2. A gift shop owner purchases items to sell in her store. She purchases a chair for

$125 and sells it for $275. Determine the following:

a. dollar markup

b. markup percentage on cost

c. markup percentage on selling price

Answer:

1.3. A consumer purchases a coffee maker from a retailer for $90. The retailer’s

markup is 30%, and the wholesaler’s markup is 10%, both based on selling price.

For what price does the manufacturer sell the product to the wholesaler?

Answer:

1.4. A lawnmower manufacturer has a unit cost of $140 and wishes to achieve a

margin of 30% based on selling price. If the manufacturer sells directly to a

retailer who then adds a set margin of 40% based on selling price, determine the

retail price charged to consumers.

Answer:

1.5. Advanced Electronics manufactures DVDs and sells them directly to retailers who

typically sell them for $20. Retailers take a 40% margin based on the retail

selling price. Advanced’s cost information is as follows:

DVD package and disc $2.50/DVD

Royalties $2.25/DVD

Advertising and promotion $500,000

Overhead $200,000

Calculate the following:

a. contribution per unit and contribution margin

b. break-even volume in DVD units and dollars

c. volume in DVD units and dollar sales necessary if Advanced’s profit goal

is 20% profit on sales.

d. net profit if 5 million DVDs are sold

Answer:

a.) Unit contribution = selling price  unit variable cost

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fixed costs $700,000

b.) Breakeven volume = ———————— = ———— = 96,552 units

unit contribution $7.25

fixed costs

c.) Unit volume = ——————————————

price  variable cost  (0.2  price)

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