Using Rates as Stand Alone Measures of Performance! Ted Mitchell

You own a car Last month you got 30 miles per gallon. From this information can I tell how many miles you drove last month? From this information can I tell how many gallons of gas you used last month? Knowing the miles per gallon tells me nothing about the distance you travelled or the number of gallons you used.

Two Exam questions Biz-Café #1 is selling coffee at a rate of 18 cups per hour. 1) How many hours a week was it open? 2) How many cups did it sell last week? Knowing the Rate of Sales tells you nothing about the amount of coffee sold or the number of hours the café was open!

You have a car and You consider it to be a Two Factor Machine That converts an Input to an Output. You got 30 miles per gallon. What was the Output from your car/machine? What was the Input into your car/machine?

Car as a Two-Factor Machine Output: Distance in Miles= (conversion rate, r)x (Input: Gallons of Gas) Miles Travelled = 30 miles per gallon x (number of gallons) The rate of 30 miles per gallon implies the output and the input 30 units of output per one unit of input Rate is the output/input Rate is the miles/gallons, Rate is miles per gallon, mpg

We use rates and ratios to describe Business machines because the rates and ratios provide us with a short-hand description of a simple machine’s output and input! Conversion rate or Efficiency ratio Output Input Customers per day Sales per call Profit per sale Servers per hour Sales per Salesman

We use rates and ratios to describe Business machines because the rates and ratios provide us with a description of a simple machine’s output and input! Conversion rate or Efficiency ratio Output Input Customers per dayNumber of customers Sales per callNumber of sales or orders Profit per saleDollars of profit Servers per hourNumber of servers Sales per SalesmanNumber of sales or transactions

We use rates and ratios to describe Business machines because the rates and ratios provide us with a description of a simple machine’s output and input! Rate = Output / Input Conversion rate or Efficiency ratio Output Input Customers per dayNumber of customersNumber of days Sales per callNumber of salesNumber of calls Profit per saleDollars of profitNumber of sales Servers per hourNumber of serversNumber of hours Sales per SalesmanNumber of salesNumber of salesmen

You have a second version car and You consider it to be a Two Factor machine That converts an input to an output. You travel at a speed of 80 miles per hour. What was the output from your car/machine? What was the input to your car/machine? Output: Distance Travelled in Miles = (conversion rate, r) x (Input hours travelled) Conversion rate: Output/Input Conversion rate = miles / hour, Conversion rate = miles per hour, mph

Inputs and Outputs Can be very abstract Hours (measures of time) Awareness (measures of cognition) Loyalty (measures of commitment) Preference (measures of desire) Attention episodes Convenience (measures of utility)

Two More Exam questions Biz-Café #1 is selling coffee at a rate of 18 cups per hour. 1) When Biz-Café #1 is visualized as a marketing machine, what is the machine’s output? Output: Quantity of cups of coffee sold, Q 2) When Biz-Café #1 is visualized as a marketing machine, what is the input to the machine? Input: Number of Hours of Store Operation, H 18 units of output per 1 unit of input

Sometimes Rates are Ambiguous Rate or ratioOutputInput % Markup??? % Interest rate??? Return on Advertising Dollars, Calls, HitsDollars, insertions Advertising to Sales??? Return on Sales???

Sometimes Rates are Ambiguous Rate or ratioOutputInput % MarkupDollar profit per unitRevenue from a unit sale, Price % Interest rateInterest paymentprinciple Return on Advertising Dollars, Calls, HitsDollars, insertions % Advertising to Sales Advertising dollarsDollars of revenue % Return on SalesDollars of Net profitDollars of Revenue

Before You Calculate 1) Know the complete description of the machine’s factors and the output of the machine Output = Conversion rate x Input 2) Get rid of the percents

Basic Two-Factor Marketing Machine? Biz-Café #1 Input : Hours open, H Observation:1 12 hours Conversion rate: cups sold per hour r = Q/H Output : Cups sold, Q Observation:2, 016 cups

Two Factor Model of Biz-Cafe As a marketing machine that converts hours of operation, H, into cups of coffee sold, Q. Output: cups of coffee = ( conversion rate, r ) x (Input: the number of hours of operation) You have observed Biz-Café #1 selling 2,016 cups a week when it was open for 112 hours What is the conversion rate of the Biz-Café Machine #1? Conversion rate, r = Output/Input Conversion rate, r = 2,016 cups/112 hours Conversion rate, r = 18 cups per hour

Basic Two-Factor Marketing Machine? Biz-Café #1Calibration Input: Hours open, H Observation:1 12 hours Conversion rate: cups sold per hour r = Q/H Calculation Q/H = 2,016 cups/112 hours = 18 cups per hour Cups sold, QObservation:2, 016 cups

Can you use a Calibrated Two-Factor marketing machine for Forecasting? Answer: YES!

Basic Two-Factor Marketing Machine? Biz-Café #1CalibrationForecast Output Input: Hours open, H Observation:1 12 hours Proposed Input, H Conversion rate: cups sold per hour r = Q/H Calculation Q/H = 2,016 cups/112 hours = 18 cups per hour 18 cups per hour Cups sold, QObservation:2, 016 cups Forecast, Q = 18 cph x Input

Will it be a good forecast? With only a single performance having been observed and used for the machine’s calibration it is NOT likely to be a very accurate forecast

Improving the Forecasting accuracy requires two or more observations Performance #1 Performance # 2 Meta- Marketing Machine forecasting Slope- Intercept Machine forecasting Hours open, H H1H2∆H = H2 - H1 Proposed H Conversion rate r = Q1/Q1r = Q2/H2m = ∆Q/∆H a + m(H) Quantity sold, Q Q1Q2∆Q = Q2 - Q1 Forecasted Q

Six Exam Questions Biz-Café run by student #1 is selling coffee at a rate of 18 cups per hour Biz-Café run by student #2 is selling coffee at a rate of 22 cups per hour. 1) Which café is open longer? 2) Which café is selling more coffee? 3) Is it safe to assume that both students sold the same amount of coffee? 4) Is it safe to assume that both cafes were open for the same number of hours? 5) Did café #1 sell less cups than café #2? 6) Did Café #2 stay open more hours than café #1?

What is the average rate? Biz-Café #1Biz-Café #2 Hours open, H Conversion rate: cups sold per hour r = Q/H 18 cups per hour 22 cups per hour Average rate is??? Cups sold, Q

Two Exam Questions Biz-Café run by student #1 is selling coffee at a rate of 18 cups per hour Biz-Café run by student #2 is selling coffee at a rate of 22 cups per hour. 1) What is the average rate at which the two cafes are selling coffee? 2) How much information do you need to calculate the average rate of the two cafes?

What is the average rate? Biz-Café #1Biz-Café #2Average Hours open, H Need Total Input Conversion rate: cups sold per hour r = Q/H 18 cups per hour 22 cups per hour Not 20 cups per hour Cups sold, Q Need Total Output

Is there any useful information in the knowledge of cups per hour??? Biz-Café run by student #1 is selling coffee at a rate of 18 cups per hour Biz-Café run by student #2 is selling coffee at a rate of 22 cups per hour. 1) Which café is more efficient at converting hours of operation into cups sold

What can you say? Biz-Café #1Biz-Café #2Difference Hours open, H Conversion rate: cups sold per hour r = Q/H 18 cups per hour 22 cups per hour #2 is more efficient Cups sold, Q

Knowing the machine’s efficiency Tells us nothing about the machine’s relative performance in terms of output and input Do N OT assume that higher efficiency resulted in higher levels of output or less amounts of input You need more information! The machine is an identity if you know one more piece of information you can calculate the third!

Need the Full Description? Biz-Café #1Biz-Café #2Difference Hours open, H112 hours80 hours ∆H = -32 H Conversion rate: cups sold per hour r = Q/H 18 cups per hour 22 cups per hour ∆r = +4 cph Cups sold, Q2,016 cups1,760 cups ∆Q = -256 cups

Avoid making Dumb assumptions? Biz-Café #1Biz-Café #2Difference Hours open, H112 hours80 hours ∆H = -32 H Conversion rate: cups sold per hour r = Q/H 18 cups per hour 22 cups per hour ∆r = +4 cph Cups sold, Q2,016 cups1,760 cups ∆Q = -256 cups You can NOT assume that a higher efficiency resulted in a larger output!

In finance and investing it is common To adopt a policy choosing investments or projects based on the largest projected rate of return (IRR) An investment policy of maximizing the rate of return is valid if and only if the projects have the same capital requirements (inputs) and risk In marketing it is invariably wrong to follow a policy of maximizing a rate of return if the goal is to maximize the size of the return

Avoid making Dumb assumptions? Biz-Café #1Biz-Café #2Difference Hours open, H112 hours80 hours ∆H = -32 H Conversion rate: cups sold per hour r = Q/H 18 cups per hour 22 cups per hour ∆r = +4 cph Cups sold, Q2,016 cups1,760 cups ∆Q = -256 cups Do NOT blindly adopt policies of maximizing a rate of return if the goal is maximize the return

To compare performances Of two machines and use the differences between them for diagnostic purposes You must have the description of the machines’ two factors of production and their outputs

Rules for Rates and Ratios 1) Do NOT use rates and ratios as stand alone measures of performance 2) Do NOT assume the inputs and/or the outputs are equal or constant 3) Do NOT calculate the average rate as the simple mean of the rates involved 4) Do NOT assume that a performance with a higher rate of efficiency must have a higher level of output 5) Do NOT adopt a policy of maximizing a rate of return when choosing between machines when the goal is to maximize marketing output

DO NOT use Rates as Stand Alone Measures of Performance! Ted Mitchell