McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 15 Marketing Cost and Profitability Analysis Profit in business comes from repeat customers, customers that boast about your project or service, and that bring friends with them. W. Edwards Deming

15-2 A Comparison of Marketing Cost Analysis and Production Cost Accounting (Fig. 15-1) Relatively easy to measure Difficult to measure Cost is a function of volume C=f(V) Volume is a function of cost V=f( C ) Cost-volume relationship More precise Less exact Machines and closely supervised workers Salespeople in the field Source of cost incurred Relatively simple More complex Unit of product Marketing unit: territory, customer group, order size, as well as product Bases for computing costs Production Cost Accounting Marketing Cost Analysis Comparison Factors

15-3 Income and Expense Statement, 2006, Colorado Ski Company ($000) (Fig. 15-2)

15-4 Expense Distribution Sheet, Colorado Ski Company, 2006 (Fig. 15-3) (showing allocation of ledger expense items to activity categories)

15-5 Allocation of Activity Costs to Sales Regions, Colo. Ski Co (Fig. 15-4) ActivityPersonal SellingAdvertising Warehousing & Shipping Order ProcessingAdministration Allocation Scheme Allocation basis Direct expense to each region Number of pages of advertising Number of orders shipped Number of invoice lines Equally among regions Total activity cost $3,847,000$1,220,000$480,000$240,000$513,000 Number of allocation units –61 pages9,600 orders120,000 lines3 regions Cost per allocation unit – $20,000 per page $50 per order$2 per line $171,000 per region RegionAllocation of Costs Eastern units –21 pages3,800 orders39,500 lines1 cost $1,070,000$420,000$190,000$79,000$171,000 Midwest units –11 pages2,500 orders28,000 lines1 cost $747,000 $125,000$56,000$171,000 Western units –29 pages3,300 orders52,500 lines1 Cost $2,030,000 $165,000$105,000$171,000

15-6 Income and Expense Statement, by Sales Region, Col Ski Co ($000) (Fig. 15-5)

15-7 Methods Used to Allocate Indirect Costs (Fig. 15-6) MethodEvaluation Divide cost equally among territories or whatever market segments are being analyzed. Easy to do, but inaccurate and usually unfair to some market segments. Allocate costs in proportion to sales volume obtained from each territory (or product or customer group). Underlying philosophy: apply cost burden where it can best be borne. That is, charge a high-volume market segment with a large share of the indirect cost. This method is simple and easy to do, but may be very inaccurate. Tells very little about a segment’ Allocate indirect costs in same proportion as the total direct costs. Thus if product A accounted for 25 percent of the total direct costs, then A would also be charged with 25 percent of theindirect expenses. Again, easy to do but can be inaccurate and misleading. Falsely assumes a close relationship between direct and indirect expenses.

15-8 Contribution-Margin vs. Full-Cost Contribution-Margin Method Sales volume -Cost of goods sold Gross margin -Direct expenses Contribution margin* * The amount available to cover overhead expenses plus a profit. Full-Cost Method Sales volume -Cost of goods sold Gross margin -Direct expenses -Indirect expenses Net profit

15-9 Income and Expense Statement by Sales Region, Colo. Ski Co. 2006, in $000, Using Contribution-Margin Approach (Fig. 15-7)

15-10 Fig Ways to Increase Order Size and Reduce Small Order Marketing Costs Ed ucate customers who buy from several different suppliers. Stress the advantages of purchasing from one supplier. For customers who purchase large total quantities in frequent small orders, stress the advantages of ordering once a month instead of once a week. Point out that the buyer eliminates all handling, billing, and accounting expenses connected with three of the four orders. Note further that the buyer writes only one check and one purchase order. In addition, stress that there will be only one bill to process and one shipment to put into inventory instead of three or four. Educate the sales force as well as customers. In fact, it may be necessary to change the compensation plan to discourage acceptance of smaller orders. Substitute direct mail or telephone selling for sales calls or unprofitable or small-order accounts; or continue to call on these accounts, but less frequently. Shift an account to a wholesaler or some other type of middleman rather than dealing directly, even by mail or telephone. Drop a mass-distribution policy and adopt a selective one. This new policy may actually increase sales because sales reps can spend more time with profitable accounts. Establish a minimum-order size. Establish a minimum charge or a service charge to combat small orders

15-11 Return on Assets Managed (ROAM) Sales$ 10,000,000 Cost of goods sold 7,000,000 Gross margin 3,000,000 Salaries 150,000 Commission 850,000 Travel 150,000 District office expense 400,000 Total direct expenses 150,000 Contribution margin $ 1,450,000 Accounts receivable 2,200,000 Inventories 2,000,000 Total assets $ 4,200,000 Contribution margin Sales volume 1,450,000 10,000,000 Asset turnover = = Sales volume Accounts receivable + Inventories Profit on sales % = = x 100 $10,000,000 $ 4,200,000 = 14.5% ROAM = Profit on sales % x Asset turnover 1,450,000 10,000,000 = x 10,000,000 4,200,000 = 14.5% x 2.38 = 34.5% = 2.38