Promotion Profitability This module covers the concepts of baseline sales, incremental sales, promotional lift, return on marketing investment (ROMI), coupon redemption and pass-through percentages on promotions. Author: Paul Farris Marketing Metrics Reference: Chapter 8 © 2014 Paul Farris and Management by the Numbers, Inc.

Promotion Frameworks Promotion Frameworks There are many frameworks for analyzing promotions: Hierarchy of effects: Trial, repeat, loyalty Price discrimination: Different prices, different segments Brand equity: Franchise-building versus volume-building promotion Loyalty programs: Core consumer rewards versus customer acquisition Competitive dynamics: Price leadership and prisoners’ dilemma Insight These frameworks represent the purpose and rationale for various promotional approaches. Depending on the purpose, the promotional goals will differ. MBTN | Management by the Numbers

Analyzing Promotions Analyzing Promotions Once the rationale for the promotion is chosen, the next step is to measure its potential effectiveness. In this module our focus will be on the following analysis techniques: Incremental volume versus baseline volume (“lift”) Return on marketing investments Accounting for changes in volumes and margins as well as incremental fixed costs Trade promotion pass through to retail price promotions Economics of coupons and rebates MBTN | Management by the Numbers

Baseline, Incremental Sales, and Lift Definitions: Total Sales (in $ or Units) = Baseline Sales + Incremental Sales - where - Baseline Sales = Expected sales results in the absence of any marketing program or promotion - and - Incremental Sales = Sales “lift” attributable to marketing activities A common challenge in marketing is the ability to estimate the incremental effects, or sales “lift”, attributable to specific marketing activities. Justification of marketing expenditures (a.k.a. marketing “spend”) involves estimating the incremental effects of a program under evaluation. MBTN | Management by the Numbers

Baseline Sales Definition: Baseline Sales: Expected sales results in the absence of any marketing program or promotion. Estimates of baseline sales establish a benchmark for evaluating the level of incremental sales generated by specific marketing activities. Creating a baseline of expected sales helps to isolate any incremental sales that may actually be a result of other influences such as seasonality, market growth and competitive activity, etc. Insight: Baseline Sales are determined by historical sales patterns, controlling for seasonality, etc., and other non-marketing factors that would affect the expected level of sales without the marketing activities being considered. MBTN | Management by the Numbers

Incremental Sales Definition Incremental Sales: Sales “lift” attributable to marketing activities Incremental Sales: Total Sales – Baseline Sales OR Incremental Sales from Advertising + Incremental Sales from Trade Promotion + Incremental Sales from Consumer Promotion + Incremental Sales from Other Marketing Activities Insight: Establishing baseline sales and determining the lift attributable to marketing activities is more difficult than one might imagine, as the following example illustrates. MBTN | Management by the Numbers 6

Promotional Effectiveness Question 1: Francophile Tutors, a maker of high quality language DVDs is considering a back to school promotion in August. July’s sales were 26,028 and last August’s sales were 48,960. The price to distributors is regularly $48, but for August, distributors will receive a special discount of $6.40 per DVD if specific sales targets are met. If these sales targets are met, sales are estimated to reach 75,174 units. The variable costs for the DVDs and packaging is $25.76, but after considering allocated overhead and administrative costs, the company’s internal standard cost is $34.70. Francophile Tutors’ VP of Marketing is sure the promotion will be a success, but the President has hired a consultant who thinks otherwise. The Marketing VP calculates an incremental profit of $611,893 while the consultant’s analysis estimated an incremental loss of $132,467 on the promotion. Should Francophile run the promotion? MBTN | Management by the Numbers 7

Promotional Effectiveness Consultant Marketing VP These two estimates differ in both the assessment of the baseline volume that would have been achieved without the promotion and the variable cost of the product, so the differences in profitability estimated for the promotion are extreme. MBTN | Management by the Numbers 8

Promotional Effectiveness Answer: Probably neither the Consultant or the Marketing VP got it right. The consultant added in fixed cost inappropriately and the Marketing VP used a July baseline for a clearly seasonal product (educational sector) which would be a bad assumption. Whether last August is appropriate depends on other factors not included in the problem. Given the information provided, the best answer is probably calculated as follows: Promotion Contribution = 75174 * (41.60 – 25.76) = $1,190,756 Baseline Contribution = 48,960 * (48.00 – 25.76) = $1,088,870 Net Effectiveness = $1,190,756 – $1,088,870 = $101,886 Yes! Insight The point of this problem was to show the difficulty companies face when making these decisions and how different assumptions can lead to different outcomes. Things are not always as clear as in textbooks! MBTN | Management by the Numbers 9

Promotional Lift Definition Definition Promotion Lift Definition Lift (%): a key metric in measuring the incremental sales generated from a marketing program, as a percentage of baseline sales Lift (%) = Incremental Sales ($,#) / Baseline Sales ($,#) Definition Cost of Incremental Sales ($): Cost associated with an additional unit of sales Cost of Incremental Sales ($) = Marketing Spend ($) Incremental Sales ($,#) Both measures can be utilized to determine short-term effects of marketing efforts. MBTN | Management by the Numbers 10

Return on Marketing Investment (ROMI) Definition Return on Marketing Investment (ROMI) = a measure of the rate at which spending on marketing contributes to profits Return on Marketing Investment (ROMI) = (Incremental Sales * Contribution Margin – Marketing Spending) / Marketing Spending Question 2: Francophile Tutors spends $100K on a new ad campaign that generates incremental DVD sales of $200K.  Francophile’s profit margin is 65% and the company’s baseline sales for the same period is $800K. What is the lift% (based on $)? What is the ROMI? What is the promotional cost per incremental sales dollar?  MBTN | Management by the Numbers 11

Lift and ROMI Examples Answers MBTN | Management by the Numbers Lift % = Incremental Sales ($) / Baseline Sales ($) = $200,000 / $800,000 = 25% ROMI = (Incremental Sales * Contribution Margin – Marketing Spending) / Marketing Spending = (($200 * .65) - $100) / $100 = ($130 - $100) / $100 = 30% (Note: not 130%) Incremental Cost = Marketing Spending / Incremental Sales = $100 / $200 = $0.50 or 50% MBTN | Management by the Numbers

Coupon Redemption Definitions Coupon Redemption Rate: the percentage of distributed coupons or rebates that are redeemed by consumers Coupon Redemption Rate (%) = Coupons Redeemed (#) Coupons Distributed (#) Cost per Redemption ($) = Coupon Face Amount ($) + Redemption Charges ($) Coupon Redemption Rate is a key metric in assessing the effectiveness of a coupon distribution strategy, helping to determine if the coupons are reaching those customers most likely to use them. Cost per Redemption helps measure the variable cost associated with each coupon redeemed. Generally, coupon distribution costs are considered to be fixed costs. MBTN | Management by the Numbers

Coupon Redemption Examples Question 3: Francophile Tutors decided to try a mid-semester promotion by distributing coupons of $10 off in October via direct mail to students enrolled in language programs. The company distributed 30,000 coupons and 600 were redeemed. What is the coupon redemption rate? If it costs $2 to process each coupon, what is the cost per redemption? Answers Redemption Rate = Coupons Redeemed / Coupons Distributed = 600 / 30,000 = 2% Cost / Redemption = Face Amount + Redemption Charges = $10 + $2 = $12 Insight Redemption rates alone are not a good measure of success, as sometimes even low redemption rates may be profitable while high rates may be damaging. MBTN | Management by the Numbers 14

PROMOTION AND PASS-THROUGH Pass-Through Percentage is the portion of the promotional value provided by a manufacturer to a retailer or distributor that ultimately reaches the end consumer. Definition Pass-Through Percentage (%) = Value of Promotional Discounts Provided to Consumers by the Trade ($) Value of Promotional Discounts Provided to Trade by Manufacturer ($) Percentage Sales on Deal tracks the percentage of sales that are sold under a temporary discount of any kind. Definition Percentage Sales on Deal (%) = Sales with temporary discount / total sales. MBTN | Management by the Numbers

Coupon Redemption Examples Question 4: In December, Francophile Tutors decided to provide its distributors with a $5 per unit discount. Normally, the list price of the DVD is $99, but the company’s largest distributor would be selling it for $89 in December thanks to the promotion. Overall, for the year, 750,000 units were sold, 250,000 of which were sold during one of the periods of special promotions. What is the pass-through percentage rate (%)? What is the percent of sales on deal for the year? Answers Pass Through Rate = Value Consumer Disc. / Value Trade Disc. = $10 / $5 = 200% Sales on Deal = Sales on Deal (#) / Total Sales (#) = 250,000 / 750,000 = 33.3% MBTN | Management by the Numbers 16

Further Reference Further Reference Marketing Metrics by Farris, Bendle, Pfeifer and Reibstein, 2nd edition, chapter 8. MBTN | Management by the Numbers