Appendix 2 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 appendi provides a basic introduction to measuring marketing financial analysis and is built around a hypothetical manufacturer of consumer electronics products!"#. This company is launching a ne$ product %a device that plays videos and television programming streamed over the &nternet on multiple devices in a home including highdefinition televisions, tablets, and mobile phones', and $e discuss and analy(e the various decisions "#)s marketing managers must make before and after launch. The appendi is organi(ed into three sections, and $hile the "# scenario is carried throughout all sections, instructors can select one or more sections at their discretion. *t the end of each section, +uantitative e ercises provide students $ith an opportunity to apply the concepts in that section to conte ts beyond the "# e ample. The sections are broken do$n as follo$s, 1. Pricing !reakeven and Margin Ana"ysis. This section covers pricing considerations and break-even and margin analysis assessments that guide the introduction of "#)s ne$ product launch. 2. #emand $stimates the Marketing !udget and Marketing Per%&rmance Measures. This section begins $ith a discussion of estimating market potential and company sales. &t then introduces the marketing budget, as illustrated through a pro forma profit-and-loss statement follo$ed by the actual profit-and-loss statement. -e t, the section discusses marketing performance measures, $ith a focus on helping marketing managers to better defend their decisions from a financial perspective. '. (inancia" Ana"ysis &% Marketing )actics. The final section analy(es the financial implications of various marketing tactics, such as increasing advertising e penditures, adding sales representatives to increase distribution, lo$ering price, or e tending the product line. &n this manual, solutions to the +uantitative e ercises follo$ the outline of the section in $hich each set of e ercises appears. *dditionally, fifteen additional +uantitative e ercises similar to those in the appendi are provided at the end of the material for this manual. These may be used in lectures, for additional student practice, or for e ams.

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Appendix Out"ine 1 *. Pricing !reakeven and Margin Ana"ysis A. Pricing +&nsiderati&ns 1. 2. The limiting factors are demand and costs. Determining Costs a' (ixed c&sts do not vary $ith production or sales %e.g., rent, interest, depreciation, clerical and managerial salaries'. b' ,ariab"es c&sts vary directly $ith the level of production %e.g., cost of goods sold and many marketing costs'. c' )&ta" c&sts are the sum of the fi ed and variable costs. Setting Price Based on Costs a' +&st-p"us pricing %or markup pricing' simply adds a standard markup to the cost of the product. %1' 2nit cost for "#,

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fi ed costs 32/,///,/// 2nit cost 4 variable cost 5 !!!!!! 4 3126 5 !!!!! 4 3106 unit sales 1,///,/// %2' &f "# desires a 267 markup on sales,

unit cost 3106 8arkup price 4 !!!!!!!!!!! 4 !!! 4 3193.33 %l - desired return on sales' %l - /.26' b' c' d' .e"evant c&sts are those that $ill occur in the future and that $ill vary across the alternatives being considered. Sunk costs are past costs that $ill not reoccur in the future and should not be considered. !reak-even price is the price at $hich unit revenue %price' e+uals unit cost and profit is (ero. %1' :or "#, breakeven price e+uals 3106, $hich is the unit cost determined above. .eturn &n investment /.O*0 pricing is determined by multiplying the desired return on investment by the investment and adding this figure to the fi ed costs. %1' &f "# desires a 3/7 return on an initial 31/ million investment,

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;<& investment /.3 31/,///,/// ;<& price 4 unit cost 5 !!!!!! 4 3106 5 !!!!!! 4 310= unit sales 1,///,/// 4. Setting Price Based on External Factors a' 8anufacturers do not have the final say concerning the final price to consumers>retailers do, so "# must start $ith its suggested retail price %8?;1' and $ork back through reseller margins to determine the price at $hich to sell the product to $holesalers. b' #&""ar markup is the difference bet$een a company)s selling price for a product and its cost to manufacture or purchase it, #ollar markup 4 selling price > cost c' 8arkups are usually e pressed as a percentage, and there are t$o different $ays to compute markups>on cost or on selling price,
8arkup percentage on cost 4 dollar markup cost dollar markup selling price

8arkup percentage on selling price 4

Teaching Note: Sometimes a retailer wants to convert markups based on selling price to markups based on cost, and vice versa. The formulas are:
markup percentage on cost 1//7 5 markup percentage on cost

8arkup percentage on selling price 4

8arkup percentage on cost 4

markup percentage on selling price 1//7 - markup percentage on selling price

Suppose a retailer uses a markup of 25% based on selling price and found that his competitor was using a markup of 3 % based on cost and wanted to know what this would be as a percentage of selling price. The calculation is:
3/7 3/7 4 4 237 1//7 5 3/7 13/7

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!ecause the retailer is using a 25% markup on selling price for similar products, his markup is comparable with that of the competitor. See additional "uantitative e#ercise $ for another application. d' e' ,a"ue-based pricing uses buyers) perceptions of value and not the seller)s cost to determine the 8?;1. "# e ample, 8?;1 4 3299.99, but 33// is used in calculations for simplicity@ retailer)s margin is 3/7 and $holesaler)s is 2/7, both based on their selling prices. %1' Thus, the markup chain is, ?uggested retail price, minus retail margin %3/7', ;etailer)s costA$holesaler)s price, minus $holesaler)s margin %2/7', Bholesaler)s costA"#)s price, 33// 3 9/ 321/ 3 02 31C=

Teaching Note: Students should also be able to calculate prices when cost and markup information is known. %or e#ample, suppose a retailer knew his cost &'(2) 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 e"uation for markup percentage on selling price given previousl+ and solving for selling price gives the following formula for determining the selling price:
?elling price 4 cost 1 - markup 312 4 31C /.E6

?elling price 4

See "uantitative e#ercise (., and additional "uantitative e#ercises , and 5 for more applications of this e"uation. !. !reak-$ven and Margin Ana"ysis 1. Determining Brea e!en "nit #ol$me and Dollar Sales a' !reak-even ana"ysis determines the unit volume and dollar sales needed to be profitable given a particular price and cost structure. b' :ormula for determining break-even unit volume, Dreak-even volume 4 fi ed costs !!!!!!!!!!! price unit variable cost

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The denominator %price unit variable cost' is called unit c&ntributi&n %sometimes called contribution margin' and represents the amount that each unit contributes to covering fi ed costs. "#)s break-even unit volume is,

fi ed cost 32/,///,/// Dreak-even volume 4 !!!!!!!! 4 !!!!! 4 0C6,11C.2 units price variable cost 31C= 3126 ?o "# $ill break-even at 0C6,11E units. e' Dreak-even dollar sales can be determined by multiplying unit breakeven volume by selling price,

DE sales 4 DEvol price 4 0C6,11E units 31C= 4 3E=,139,C6C f' *nother $ay to calculate break-even sales is to use the percentage contribution margin %hereafter referred to as c&ntributi&n margin', $hich is the unit contribution divided by the selling price,

price - variable cost 31C= 3126 Contribution margin 4 !!!!!!!! 4 !!!!!! 4 /.26C or 26.C7 price 31C= fi ed costs 32/,///,/// Dreak-even sales 4 !!!!!!!! 4 !!!!!! 4 3E=,126,/// contribution margin /.26C %1' g' -ote, the difference bet$een the t$o break-even sales calculations is due to rounding. Contribution margin can also be calculated as follo$s, total sales > total variable costs Contribution margin 4 !!!!!!!!!!! total sales h' *nother $ay to determine contribution margin for any sales level is by setting sales e+ual to 1//7 and subtracting the percentage of variable costs from sales. :or "#, variable costs represent E07 of sales %$hich can be determined by dividing unit variable costs by price, or 3126 31C=', so contribution margin can be determined as follo$s,

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1//7 E07 1 /.E0 Contribution margin 4 !!!!!! 4 !!! 4 1 /.E0 4 /.2C or 2C7 1//7 1 2. Determining %Brea &e!en' (or Pro(it )oals a' Bhile break-even analysis is useful, most companies are more interested in making a profit. b' Bhen profit is e pressed as an absolute amount, simply add the profit figure to fi ed costs and again divide by the unit contribution to determine unit sales %"# $ould like to reali(e a 36 million profit in the first year',

fi ed cost + profit goal 32/,///,/// 5 36,///,/// 2nit volume 4 !!!!!!!!!! 4 !!!!!!!!!! 4 6=1,396.3 units price variable cost 31C= 3126 #ollar sales 4 6=1,39C units 31C= 4 39E,CE0,62= or fi ed cost + profit goal ?ales 4 !!!!!!!!!! 4 contribution margin 32/,///,/// 5 36,///,/// !!!!!!!!!! 4 39E,C6C,26/ /.26C

*gain, note that the difference in the sales calculations is due to rounding. c' 1rofit can also be stated as a return on investment goal. #etermine the absolute profit goal by multiplying the investment by the desired ;<& %"# $ants a 3/7 return on its 31/ million investment %31/,///,/// /.3/'',

fi ed cost + profit goal 32/,///,/// 5 33,///,/// 2nit volume 4 !!!!!!!!! 4 !!!!!!!!!! 4 630,==0 units price variable cost 31C= 3126 #ollar sales 4 630,==0 units 31C= 4 3=9,=C/,612 or fi ed cost + profit goal 32/,///,/// 5 33,///,/// #ollar sales 4 !!!!!!!!! 4 !!!!!!!!!! 4 3=9,=03,E6/ contribution margin /.26C

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1rofit goals can also be e pressed as a percentage of sales. &n this case, $e incorporate the profit goal into the unit contribution as an additional variable cost %"# $ants a 267 return on sales', fi ed cost !!!!!!!!!! %/.E6 price' variable cost

fi ed cost 2nit volume 4 !!!!!!!!!!! or price variable cost %/.26 price' ?o,

32/,///,/// 2nit volume 4 !!!!!!!!! 4 2/,///,/// units %/.E6 31C=' 3126 #ollar sales necessary 4 2/,///,/// units 31C= 4 33,3C/,///,///

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Marketing by the Numbers $xercise 1et One

Elkins, a manufacturer of ice makers, reali(es a cost of 326/ for every unit it produces. &ts total fi ed costs e+ual 36 million. &f the company manufactures 6//,/// units, compute the follo$ing, a. unit cost b. markup price if the company desires a 1/7 return on sales c. ;<& price if the company desires a 267 return on an investment of 31 million -nswer: a.' 2nit cost 4 variable cost 5 fi ed costs 36,///,/// !!!!!! 4 326/ 5 !!!!! 4 32C/ unit sales 6//,///

unit cost 32C/ b.' 8arkup price 4 !!!!!!!!!!!!! 4 !!! 4 32==.=9 %l desired return on sales' %l /.1'

;<& investment

%/.26 31,///,///' E

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c.' ;<& price 4 unit cost 5 !!!!!!! 4 32C/ 5 !!!!!! 4 32C/.6/ unit sales 6//,/// 1.2. * gift shop o$ner purchases items to sell in her store. ?he purchases a chair for 3126 and sells it for 32E6. #etermine the follo$ing, a. dollar markup b. markup percentage on cost c. markup percentage on selling price -nswer: a.' #ollar markup 4 selling price cost 4 32E6 3126 4 316/ dollar markup 316/ b.' 8arkup percentage on cost 4 !!!!!!! 4 !!! 4 1.2 4 12/7 cost 3126 dollar markup 316/ c.' 8arkup percentage on price 4 !!!!!!! 4 !!! 4 /.606 4 60.67 price 32E6 1.3. * consumer purchases a coffee maker from a retailer for 39/. The retailer)s markup is 3/7, and the $holesaler)s markup is 1/7, both based on selling price. :or $hat price does the manufacturer sell the product to the $holesalerF -nswer:

price cost 8arkup percentage on price 4 !!!!!! price so, Cost at each level 4 price %price markup7' The retailer)s cost 4 39/ %39/ /.3' 4 3C3, $hich is the price the $holesaler sells it to the retailer. The $holesaler)s cost 4 3C3 %3C3 /.1/' 4 36C.E/, $hich is the price the manufacturer sells the product to the $holesaler. *nother $ay to compute this is, ;etail price, 39/.// minus retail margin %3/7', 32E.// ;etailer)s costA$holesaler)s price, 3C3.// minus $holesaler)s margin %1/7', 3 C.3/ Bholesaler)s costAmanufacturer)s price 36C.E/

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1.0.

* la$nmo$er manufacturer has a unit cost of 310/ and $ishes to achieve a margin of 3/7 based on selling price. &f the manufacturer sells directly to a retailer $ho then adds a set margin of 0/7 based on selling price, determine the retail price charged to consumers. -nswer:

price cost 8arkup percentage on price 4 !!!!!! price ?o, at any level in the chain, cost price 4 !!!!! %1 markup' cost 310/ 8anufacturer)s price 4 !!!!! 4 !!!!! 4 32// %1 markup' %1 /.3' cost 32// ;etailer)s price 4 !!!!! 4 !!!!! 4 3333.33 %1 markup' %1 /.0' 1.6. 1*dvanced Electronics manufactures #G#s and sells them directly to retailers $ho typically sell them for 32/. ;etailers take a 0/7 margin based on the retail selling price. *dvanced)s cost information is as follo$s, #G# package and disc ;oyalties *dvertising and promotion <verhead 32.6/A#G# 32.26A#G# 36//,/// 32//,///

Calculate the follo$ing, a. contribution per unit and contribution margin b. break-even volume in #G# units and dollars c. volume in #G# units and dollar sales necessary if *dvanced)s profit goal is 2/7 profit on sales. d. net profit if 6 million #G#s are sold -nswer: a.' 2nit contribution 4 selling price unit variable cost

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To determine *dvanced)s selling price, $e must subtract the retailer)s margin from the retail price, *dvanced)s price 4 retail price %retail price percentage retailer margin' 4 32/ %32/ /.0' 4 312. To determine *dvanced)s variable cost, $e must add up the variable costs. 2nit variable costs 4 32.6/ 5 32.26 4 30.E6 Therefore, the contribution per unit 4 312 30.E6 4 3E.26 unit contribution 3E.26 Contribution margin 4 !!!!!!!! 4 !!!! 4 /.C/0 or C/.07 price 312

fi ed costs 3E//,/// b.' Dreakeven volume 4 !!!!!!!! 4 !!!! 4 9C,662 units unit contribution 3E.26 Dreakeven sales 4 breakeven volume price 4 9C,662 units 312 4 31,16=,C20 or fi ed costs 3E//,/// Dreakeven sales 4 !!!!!!!! 4 !!!! 4 31,16=,90/ contribution margin /.C/0 The difference bet$een the t$o calculations for breakeven sales is due to rounding. fi ed costs c.' 2nit volume 4 !!!!!!!!!!!!!! price variable cost %/.2 price' 3E//,/// 4 !!!!!!!!!! 4 100,33/ units 312 30.E6 %/.2 312' ?ales necessary 4 100,33/ units 312 4 31,E31,9C/ %-ote, The ne$ contribution margin is 0/7 %i.e., 30.=6 312', so sales can also be calculated as 3E//,/// /.0 4 31,E6/,///, $ith the difference due to rounding.'

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d.' -et profit 4 total revenue total costs Total revenue if 6 million units are sold 4 6,///,/// 312 4 3C/ million Total cost is e+ual to T:C 5 TGC, so if 6 million units are sold, Total cost 4 3E//,/// 5 %30.E6 6,///,///' 4 320,06/,/// -et profit 4 3C/,///,/// 320,06/,/// 4 336,66/,/// %-ote, ?tudents may merely subtract the fi ed costs from the total contribution, %3E.26 6,///,/// units' 3E//,/// 4 336,66/,///.'

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#emand $stimates )he Marketing !udget and Marketing Per%&rmance Measures A. Market P&tentia" and 1a"es $stimates 1. Bhile determining sales needed to break even or attain various profit goals is useful, companies need more information regarding demand in order to assess the feasibility of attaining the needed sales levels. )&ta" market demand for a product or service is the total volume that $ould be bought by a defined consumer group in a defined geographic area in a defined time period in a defined marketing environment under a defined level of mi of industry marketing effort. The upper limit of market demand is called market p&tentia". <ne practical method for estimating total market demand uses three variables, a' number of prospective buyers b' +uantity purchased by an average buyer per year c' price of an average unit d' 8arket demand can be determined as follo$s, .4n"p $here . 4 total market demand n 4 number of buyers in the market
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" 4 +uantity purchased by an average buyer per year p 4 price of an average unit 6. * variation of this approach is the chain rati& meth&d, $hich involves multiplying a base number by a chain of adHusting percentages. a' "# can estimate 2.?. demand using a chain of calculations like the follo$ing, Total number of 2.?. households I The percentage of "#TG-o$ning 2.?. households $ith broadband &nternet access I The percentage of these households $illing and able to buy this device &ndustry and company research estimates the follo$ing, *ppro imately 113 million 2.?. households@ C/7 o$n at least one "#TG and have broadband &nternet access@ 3/7 of households are $illing and able to buy this device. ?o the total number of potential households is, 113 million households /.C/ /.3/ 4 2/.30 million households. "ouseholds need only one device. *verage retail price across all brands is 336/. Estimating total market demand for product can be calculated as, 2/.30 million households 1 device per household 336/ 4 3E.119 billion. *s can be seen, this estimate of market potential relies heavily on assumptions regarding adHusting percentages, average +uantity, and average prices. Thus, companies must make certain that its assumptions are reasonable and defendable. Decause market potential sales estimates can vary given the average price used, "# uses unit sales potential to determine its sales estimate for ne t year. "# e pects to attain 3.CC7 market share in the first year after launching this product, resulting in a forecasted unit sales of 2/.30 million units /./3CC 4 E00,000 units. *t a price of 31C= per unit, estimated sales are 3126,/CC,692 %E00,000 units 31C= per unit'. :or simplicity, further analyses use forecasted sales of 3126 million.

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)he Pr&%it-and-L&ss 1tatement and Marketing !udget 1. * *ro (orma %or proHected' pr&%it-and-"&ss statement %also called an inc&me statement or &perating statement' sho$s proHected

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revenues less budgeted e penses and estimates the proHected net profit for an organi(ation, product, or brand during a specific planning period, typically a year. 2. * profit-and-loss statement typically consists of several maHor components %see Table and ?preadsheet *2.1 at the end of this material', 2se )ab"e *2.1 and 1preadsheet *2.1 here. a' /et sales>gross sales revenue minus returns and allo$ances %e.g., trade, cash, +uantity, and promotion allo$ances'. "#)s net sales for 2/13 are estimated to be 3126 million, as determined in the previous analysis. 0ost of goods sold %sometimes called cost of sales'>the actual cost of the merchandise sold by a manufacturer or reseller and includes the cost of inventory, purchases, and other costs associated $ith making the goods. :or "#, it is estimated to be 6/7 of net sales, or 3C2.6 million. 1ross margin %or gross profit'>the difference bet$een net sales and cost of goods sold. :or "#, it is estimated to be 3C2.6 million %3126 million 3C2.6 million'. 2perating e#penses>the e penses incurred $hile doing business and include all other e penses beyond the cost of goods sold. &n the "# e ample, e penses are presented as marketing e#penses and general and administrative e#penses, %1' 8arketing e penses include sales e penses, promotion e penses, and distribution e penses. %a' ?ales e penses include 36 million for sales salaries %fi ed cost' plus 1/7 commission on sales %variable cost'. Thus, total budgeted sales e pense is 31E.6 million %36 million plus 1/7 of 3126 million'. %b' 1romotion e penses include 31/ million budgeted for advertising and promotion %fi ed cost' plus 07 of sales %36 million' for cooperative advertising allo$ances to retailers %variable cost' for a total of 316 million. %c' #istribution e penses include freight and delivery charges that are budgeted at 1/7 of sales %variable cost' for a total of 312.6 million %1/7 of 3126 million'.

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Total marketing e penses are estimated to be 306 million %31E.6 million + 316 million + 312.6 million'. %2' Jeneral and administrative e penses are estimated at 36 million %fi ed cost', broken do$n into 32 million for managerial salaries and e penses for the marketing function and 33 million of indirect overhead allocated to this product by the corporate accountants. /et profit before ta#es>profit earned after all costs are deducted. "#)s estimated net profit is 312.6 million.

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Table *2.1 %and Table *2.2' also indicates the percentage of sales that each component of the profit-and-loss statement represents. These percentages are determined by dividing the cost figure by net sales.

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Marketing Per%&rmance Measures 1. Bhereas the pro forma profit-and-loss statement sho$s proHected financial performance, the statement given in Table *2.2 sho$s "#)s actual financial performance based on actual sales, cost of goods sold, and e penses during the past year. 2se )ab"e *2.2 and 1preadsheet *2.2 here. 2. Bhy did "# lose 31 million rather than make the 312.6 million proHected profitF a' -et sales $ere only 31// million, $hich is 326 million short of estimated sales. b' Cost of goods sold as a percentage of sales e ceeded e pectations %667 rather than the 6/7 budgeted'. c' *llocated indirect overhead $as 36 million rather than the estimated 33 million. *t $hat level of sales $ould "# have broken evenF a' Contribution margin $as 217 rather than the estimated 2C7 %variable cost represented E97 of sales, so contribution margin 4 1 /.E9 4 /.21 4 217'. b' Dreak-even sales can be calculated,

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fi ed costs 322,///,/// Dreak-even sales 4 !!!!!!!!! 4 !!!!!! 4 31/0,EC1,9/6

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contribution margin 0.

/.21

&ndustry sales fell short of forecasted sales and $ere 32.6 billion, so "#)s market share $as 07 %31// million 32.6 billion 4 /./0 4 07'. ,nal-tic .atios a' Operating rati&s are the ratios of selected operating statement items to net sales. b' 2r&ss margin percentage indicates the percentage of net sales remaining after cost of goods sold that can contribute to operating e penses and net profit before ta es. %1' :or "#,

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gross margin 306,///,/// Jross margin percentage 4 !!!!!! 4 !!!!!! 4 /.06 4 067 net sales 31//,///,/// %2' &f there $as previous history for this product and this ratio $as declining, management should e amine it more closely to determine $hy it has decreased %i.e., decrease in sales volume or price, an increase in costs, or a combination of these'. Net pr&%it percentage sho$s the percentage of each sales dollar going to profit. %1' :or "#,

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net profit 31,///,/// -et profit percentage 4 !!!!! 4 !!!!!! 4 /./1 4 1./7 net sales 31//,///,/// d' Operating expense percentage indicates the portion of net sales going to operating e penses. %1' :or "#,

total e penses 30C,///,/// <perating e pense percentage 4 !!!!!! 4 !!!!!! 4 /.0C 4 0C7 net sales 31//,///,/// e' *nvent&ry turn&ver rate %also called stockturn rate for resellers' is the number of times an inventory turns over or is sold during a specified time period %often one year'. Teaching Note: 3t ma+ be computed on a cost, selling price, or a unit basis. The formulas are: 0ost of goods sold

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Stockturn rate 4 55555555555 -verage inventor+ at cost or Selling price of goods sold Stockturn rate 4 55555555555 -vg. selling price of inventor+ or Sales in units Stockturn rate 4 55555555555 -verage inventor+ in units %1' *ssuming "#)s beginning and ending inventories $ere 33/ million and 32/ million, respectively, the inventory turnover rate computed on a cost basis is,

366,///,/// 366,///,/// &nventory turnover rate 4 !!!!!!!!!!! 4 !!!!!! 4 2.2 %33/,///,/// 5 32/,///,///'A2 326,///,/// %2' The higher the turnover rate, the higher the management efficiency and company profitability, but this rate should be compared to industry averages, competitors) rates, and past performance. .eturn &n investment /.O*0 is used to measure managerial effectiveness and efficiency. %1' &t is the ratio of net profits to total investment, $hich includes capital investments in land, buildings, and e+uipment plus inventory costs. %2' :or "#, total investment includes the initial 31/ million to refurbish the manufacturing facility plus average inventory %326 million determined in the previous inventory turnover rate calculation',

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net profit before ta es 31,///,/// ;eturn on investment 4 !!!!!!! 4 !!!!!! 4 ./2=C 4 2.=C7 investment 336,///,/// /. 0ar eting Pro(ita1ilit- 0etrics a' &f "# drops this product, the profits of the total organi(ation $ill decrease by 30 millionK b' Net Marketing +&ntributi&n /NM+0. 8easures marketing profitability.

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#oes not include operating e penses not under marketing)s control %e.g., allocated indirect overhead'. %2' -8C 4 net sales cost of goods sold marketing e penses %3' :or "#, -8C 4 31// million 366 million 301 million 4 30 million %a' 8arketing e penses include sales e penses %316 million', promotion e penses %310 million', freight e penses %31/ million', and the managerial salaries and e penses of the marketing function %32 million', $hich total 301 million. %b' The product contributed 30 million to "#)s overall company profits. %c' &f the product is dropped, the 36 million in fi ed overhead e penses $ill not disappear> it $ill simply have to be allocated else$here, but the 30 million in -8C $ill disappear. Marketing .eturn &n 1a"es and *nvestment %1' Marketing return &n sa"es /.O10 sho$s the net sales attributable to the net marketing contribution. %a' :or "#,

net marketing contribution 30,///,/// 8arketing ;<? 4 !!!!!!!!!!! 4 !!!!!! 4 /./0 4 07 net sales 31//,///,/// %2' Marketing .O* measures the marketing productivity of a marketing investment. %a' :or "#,

net marketing contribution 30,///,/// 8arketing ;<& 4 !!!!!!!!!!! 4 !!!!!! 4 /./9EC 4 9.EC7 marketing e penses 301,///,/// %b' 8arketing ;<& could be greater than 1//7, $hich can be achieved by attaining a higher net marketing contribution andAor a lo$er total marketing e pense.

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#. 2.1.

Marketing by the Numbers $xercise 1et )w&

#etermine the market potential for a product that has 2/ million prospective buyers $ho purchase an average of 2 per year and price averages 36/. "o$ many units must a company sell if it desires a 1/7 share of this marketF -nswer: .4n"p $here . 4 total market demand n 4 number of buyers in the market " 4 +uantity purchased by an average buyer per year p 4 price of an average unit The upper limit of market demand is called market potential. &t)s a straightfor$ard calculation, L 4 2/,///,/// buyers 2 units per buyer 36/ per unit 4 32 billion 8arket share 4 %2/,///,/// buyers 2 units per buyer' /.1 4 0 million units

2.2.

#evelop a profit-and-loss statement for the Bestgate division of -orth &ndustries. This division manufactures light fi tures sold to consumers through home improvement and hard$are stores. Cost of goods sold represents 0/7 of net sales. 8arketing e penses include selling e penses, promotion e penses, and freight. ?elling e penses include sales salaries totaling 33 million per year and sales commissions %67 of sales'. The company spent 33 million on advertising last year, and freight costs $ere 1/7 of sales. <ther costs include 32 million for managerial salaries and e penses for the marketing function and another 33 million for indirect overhead allocated to the division. a. #evelop the profit-and-loss statement if net sales $ere 32/ million last year. b. #evelop the profit-and-loss statement if net sales $ere 30/ million last year. c. Calculate Bestgate)s breakeven sales.

Teaching Note: The profit6and6loss statements can be developed using Spreadsheet -2.( or -2.2, but the e"uations in some cells will need to be changed to reflect the percentages for this problem.

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a.' The profit-and-loss statement at 32/ million net sales, ?ales Cost of goods sold Jross 8argin 8arketing E penses ?ales e penses 1romotion e penses :reight Jeneral and *dministrative E penses 8anagerial salaries and e penses &ndirect overhead -et profit before income ta $here, Cost of goods sold 4 0/7 of 32/ million sales 4 3=,///,/// Jross margin 4 net sales cost of goods sold 4 32/,///,/// 3=,///,/// 4 312,///,/// ?ales e penses 4 33 million for salaries 5 67 of 32/ million sales 4 33,///,/// 5 31,///,/// 4 30,///,/// 1romotion e penses 4 33,///,/// %fi ed cost' :reight 4 1/7 of 32/ million sales 4 32,///,/// 8anagerial salaries and e penses 4 32,///,/// %fi ed cost' &ndirect overhead 4 33,///,/// %fi ed cost' -et profit before ta es 4 gross margin marketing e penses general and administrative e penses 4 312,///,/// 39,///,/// 36,///,/// 4 32,///,/// 30,///,/// 3,///,/// 2,///,/// 32,///,/// 3,///,/// 32/,///,/// =,///,/// 312,///,///

9,///,///

6,///,/// %32,///,///'

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b.' The profit-and-loss statement at 30/ million net sales, -et ?ales Cost of goods sold Jross 8argin 8arketing E penses ?ales e penses 1romotion e penses :reight Jeneral and *dministrative E penses 8anagerial salaries and e penses &ndirect overhead -et profit before income ta $here, Cost of goods sold 4 0/7 of 30/ million sales 4 31C,///,/// Jross margin 4 net sales cost of goods sold 4 30/,///,/// 31C,///,/// 4 320,///,/// ?ales e penses 4 33 million for salaries 5 67 of 30/ million sales 4 33,///,/// 5 32,///,/// 4 36,///,/// 1romotion e penses 4 33,///,/// %fi ed cost' :reight 4 1/7 of 30/ million sales 4 30,///,/// 8anagerial salaries and e penses 4 32,///,/// %fi ed cost' &ndirect overhead 4 33,///,/// %fi ed cost' -et profit before ta es 4 gross margin marketing e penses general and administrative e penses 4 320,///,/// 312,///,/// 36,///,/// 4 3E,///,/// 36,///,/// 3,///,/// 0,///,/// 32,///,/// 3,///,/// 30/,///,/// 1C,///,/// 3 20,///,///

12,///,///

6,///,/// 3E,///,///

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c.' Dreakeven sales can be determined by,

fi ed costs Dreak-even sales 4 !!!!!!!!!! contribution margin Total fi ed costs 4 sales salaries 5 advertising 5 managerial salaries and e penses 5 indirect overhead 4 33,///,/// 5 33,///,/// 5 32,///,/// 5 33,///,/// 4 311,///,/// Gariable costs make up 667 of sales %i.e., C<J? 4 0/7, commissions 4 67, and freight 4 1/7 of sales'. ?o, Contribution margin 4 1 /.66 4 /.06 Therefore, fi ed costs 311,///,/// Dreak-even sales 4 !!!!!!!!!!! 4 !!!!!! contribution margin /.06 4 320,000,000

;eality check, Dreakeven sales should be bet$een 32/ million and 30/ million because Bestgate did not reali(e a profit at 32/ million but did at 30/ million. 1lus, breakeven sales should be closer to 32/ million because the company only reali(ed a 32 million loss at that sales level but e perienced a 3E million profit at sales of 30/ million. 2.3. 2sing the profit-and-loss statement you developed in +uestion 2.2b, and assuming that Bestgate)s beginning inventory $as 311 million, ending inventory $as 3E million, and total investment $as 32/ million including inventory, determine the follo$ing, a. gross margin percentage b. net profit percentage c. operating e pense percentage d. inventory turnover rate e. return on investment %;<&' f. net marketing contribution g. marketing return on sales %marketing ;<?' h. marketing return on investment %marketing ;<&' i. &s the Bestgate division doing $ellF E plain your ans$er.

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-nswer: a.' Jross margin percentage4 gross margin 320,///,/// !!!!!!! 4 !!!!!! 4 C/7 net sales 30/,///,///

net profit 3E,///,/// b.' -et profit percentage 4 !!!!!!! 4 !!!!!! 4 1E.67 net sales 30/,///,/// total e penses 31E,///,/// 4 !!!!!!! 4 !!!!!! 4 02.67 net sales 30/,///,///

c.' <perating e pense percentage

d.'

cost of goods sold &nventory turnover rate 4 !!!!!!!!!!! average inventory at cost 31C,///,/// 31C,///,/// 4 !!!!!!!!!!! 4 !!!!!! %311,///,/// 5 3E,///,///'A2 39,///,/// 4 1.E=

net profit before ta es e.' ;eturn on investment 4 !!!!!!!!! 4 investment

3E,///,/// !!!!!! 4 367 32/,///,///

f.' -8C 4 net sales cost of goods sold marketing e penses $here, marketing e penses 4 selling e penses 5 promotion 5 freight 5 managerial salaries and e penses 4 36,///,/// 5 33,///,/// 5 30,///,/// 5 32,///,/// 4 310,///,/// so, -8C 4 30/,///,/// 31C,///,/// 310,///,/// 4 31/,///,/// net marketing contribution 31/,///,/// g.' 8arketing ;<? 4 !!!!!!!!!!! 4 !!!!!! net sales 30/,///,/// 4 267

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net marketing contribution 31/,///,/// h.' 8arketing ;<& 4 !!!!!!!!!!! 4 !!!!!! marketing e penses 310,///,///

4 E1.07

i.' ?tudents) responses $ill vary on this +uestion. "o$ever, it should be noted that these ratios should be compared to previous ratios for the division, other divisions of the company, competitors, and industry averages. ***. (inancia" Ana"ysis &% Marketing )actics A. *ncrease Advertising $xpenditures 1. 2. 3. Bhat if "# increases national advertising by 6/7 to 316 million %assume no change in the variable cooperative component of promotional e penditures'F Bhat increase in sales $ill be needed to break even on this 36 million increase in fi ed costsF * +uick $ay to ans$er this +uestion is to divide the increase in fi ed cost by the contribution margin %$hich $as found in a previous analysis to be 217',

increase in fi ed cost 36,///,/// &ncrease in sales 4 !!!!!!!!! 4 !!!!!! 4 323,=/9,620 contribution margin /.21 Teaching /ote: This is the increase in sales necessar+ to break even on this increase in fi#ed costs. 7ecall, however, that 89 did not break even last +ear, so this increase in sales is in addition to the '5 million increase 89 needs to break even. !. *ncrease #istributi&n +&verage 1. "# currently employs C/ sales representatives $ho earn an average of 36/,/// in salary plus 1/7 commission on sales. 2. The product is currently sold through 1,=E6 retail outlets, and "# $ants to increase that to 2,6// outlets. 3. "o$ many additional salespeople $ill "# need, and $hat level of sales $ill be necessary to break even on the increased costF a' The w&rk"&ad meth&d uses the follo$ing formula to determine the salesforce si(e, -? -C :C MC 4 !!!!!!!! T*

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23

$here, -? 4 number of salespeople -C 4 number of customers :C 4 average fre+uency of customer calls per customer MC 4 average length of customer call T* 4 time an average salesperson has available for selling per year %1' "# reps typically call on accounts an average of 2/ times per year for about 2 hours per call, the average available time per sales rep per year is 1,26/ hours %6/ $eeks 26 hours per $eek devoted to selling'. ?o the number of sales reps "# $ill need to cover 2,6// retail accounts is, 2,6// 2/ 2 -? 4 !!!!!!! 4 =/ salespeople 1,26/ %3' b' ?o "# $ill need to hire 2/ more salespeople. The cost to hire these reps $ill be 31 million %2/ salespeople 36/,/// salary per rep'. Bhat increase in sales $ill be re+uired to break even on this increase in fi ed costsF *s seen in the previous analysis, divide the increase in fi ed cost by the contribution margin %$hich remains unchanged at 217 because the 1/7 commission $as already accounted for',

%2'

increase in fi ed cost 31,///,/// &ncrease in sales 4 !!!!!!!!!! 4 !!!!!! 4 30,EC1,9/6 contribution margin /.21 c' ?ince the average revenue generated per outlet is 363,333 %31// million in sales 1,=E6 outlets', "# $ould need about 9/ ne$ outlets %30,EC1,9/6 363,333 4 =9.3 outlets'. This seems reasonable given that current reps cover about 31 outlets apiece %1,=E6 outlets divided by C/ reps' and ne$ reps $ould only need to ac+uire about 0.6 outlets for "# to break even on this proposal %=9.3 outlets 2/ reps'.

d'

+.

#ecrease Price 1. Bhat increase in sales $ould be necessary to break even on a 1/7 decrease in priceF That is, $hat increase in sales $ill be needed to maintain the total contribution that "# reali(ed at the higher priceF

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a' b'

c'

d'

Current total contribution 4 contribution margin sales 4 /.21 31// million 4 321 million. 2nit variable costs do not change, ho$ever, and can be determined by multiplying the unit price by the percentage represented by variable costs %recall that variable costs represented E97 of sales'. Thus, unit variable costs e+ual 3132.E2 %31C= /.E9'. 1rice changes result in changes in unit contribution and contribution margin, so $e must calculate the ne$ contribution margin to determine the sales necessary to break even on this price reduction. -e$ unit contribution and contribution margin can be calculated as follo$s, O"d 31C= 3132.E2 336.2= 336.2=A31C= 4 /.21 or 217 New /reduced 1340 3161.2/ 3132.E2 31=.0= 31=.0=A3161.2/ 4 /.12 or 127

1rice 2nit variable cost 4 2nit contribution Contribution margin e'

To determine the sales level needed to break even on this price reduction, calculate the level of sales that must be attained at the ne$ contribution margin to achieve the original total contribution of 321 million,

-e$ contribution margin ne$ sales level 4 original total contribution ?o, original contribution 321,///,/// -e$ sales level 4 !!!!!!!!!! 4 !!!!!! 4 31E6,///,/// ne$ contribution margin /.12 f' ?ales must increase by 3E6 million, and the marketing manager must assess $hether or not this is a reasonable goal.

#.

$xtend the Pr&duct Line 1. "# is considering introducing a lo$er-price model in addition to the original model. 2. +anniba"i5ati&n is the situation in $hich one product sold by a company takes a portion of its sales from other company products.

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a'

3. 0.

&f the ne$ product has a lo$er contribution than the original product, the company)s total contribution $ill decrease on cannibali(ed sales. b' "o$ever, if the ne$ product can generate enough ne$ volume, it is $orth considering. c' To assess cannibali(ation, $e must look at the incremental contribution gained by having both products available. *ssume the first model offered by "# is called "#1 and the ne$, lo$er-priced model is "#2. "#2 $ill retail for 326/ and resellers take the same markup percentages on price as they do $ith "#1, so the markup chain is, ;etail price, minus retail margin %3/7', ;etailer)s costA$holesaler)s price, minus $holesaler)s margin %2/7', Bholesaler)s costA"#)s price 326/ 3 E6 31E6 3 36 310/

6. C.

E. =.

"#1Ns unit contribution is about 336 %31C= 3132.E2'. ;ecall that price and unit variable costs $ere determined in previous analyses. "#2Ns variable costs are estimated to be 312/, $hich gives a unit contribution of 32/ %310/ 312/'. a' Thus, for every unit that "#2 cannibali(es from "#1, the company $ill lose 316 in contribution to$ard fi ed costs and profit. b' The original estimate for ne t year)s sales of "#1 $as C//,/// units. Dut $ith the introduction of "#2, it is estimated that 2//,/// of those sales $ill be cannibali(ed by "#2. This results in a loss of contribution of 33 million %2//,/// units %316' per cannibali(ed unit'. c' &t is estimated that "#2 $ill generate an additional 6//,/// unit sales, resulting in an additional contribution of 31/ million %6//,/// units 32/ per unit'. The net effect is that "# $ill gain 3E million in total contribution by introducing "#2. This can be seen by comparing the total contribution $ith and $ithout the introduction of "#2,

6#1 &n"y
"#1 contribution "#2 contribution C//,/// units 336 4 321,///,/// /

6#1 and 6#2

0//,/// units 336 4 310,///,/// E//,/// units 32/ 4 310,///,///

2C

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Total Contribution

321,///,///

32=,///,///

9.

"# should introduce "#2, but only if additional fi ed costs do not e ceed 3E million.

$. 3.1.

Marketing by the Numbers $xercise 1et )hree

1*lliance, &nc. sells gas lamps to consumers through retail outlets. Total industry sales for *lliance)s relevant market last year $ere 31// million, $ith *lliance)s sales representing 67 of that total. Contribution margin is 267. *lliance)s sales force calls on retail outlets and each sales rep earns 36/,/// per year plus 17 commission on all sales. ;etailers receive a 0/7 margin on selling price and generate average revenue of 31/,/// per outlet for *lliance. a. The marketing manager has suggested increasing consumer advertising by 32//,///. Dy ho$ much $ould dollar sales have to increase to break even on this e penditureF Bhat increase in overall market share does this representF b. *nother suggestion is to hire t$o more sales representatives to gain ne$ consumer retail accounts. "o$ many ne$ retail outlets $ould be necessary to break even on the increased cost of adding three sales repsF c. * final suggestion is a make a 1/7 across-the-board price reduction. Dy ho$ much $ould dollar sales have to increase to maintain *lliance)s current contributionF %?ee endnote 13 to calculate the ne$ contribution margin.' d. Bhich suggestion do you think *lliance should implementF E plain your recommendation.

-nswer: a.0 *ncrease advertising by 7233 3338 *n increase in advertising of 32//,/// represents an increase in fi ed costs by that amount. Therefore, the increase in sales necessary to breakeven on this increase in fi ed costs can be calculated by dividing by the contribution margin, increase in fi ed costs 32//,/// &ncrease in sales 4 !!!!!!!!!!! 4 !!!!!! 4 3=//,/// contribution margin /.26 1 share point 4 17 of total market sales. ?o 17 of 31//,///,/// 4 31,///,///. *lliance $ould have to reali(e a /.= share point increase in market share %i.e., 3=//,/// increase in sales 31,///,/// per point 4 /.= share points', resulting in a market share of 6.=7 re+uired. *nother $ay to determine this,

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2E

increase in sales 3=//,/// &ncrease in share points 4 !!!!!!!!!!! 4 !!!!! 4 /.//= total market sales 31//,///,/// Thus, *lliance $ould need to increase market share /.= percentage points %i.e., increase from 67 market share to 6.=7 market share'. ?till another $ay to determine this, ne$ sales 36,=//,/// -e$ market share 4 !!!!!!!! 4 !!!!! 4 /./6= 4 6.=7 total market sales 31//,///,/// ?o the increase is /.= percentage points %from 67 to 6.=7 market share'. b.0 Add tw& sa"es representatives8 Each sales rep earns 36/,/// in salary, so the increase in fi ed cost 4 31//,/// %i.e., 2 reps 36/,///'. *s $e did in part a $ith the increase in advertising e penditure, the 31//,/// is an increase in fi ed costs. Therefore, $e can determine the increase in sales necessary to break even on this increase in fi ed cost by dividing by the contribution margin, increase in fi ed costs 31//,/// &ncrease in sales 4 !!!!!!!!!!! 4 !!!!!! 4 30//,/// contribution margin /.26 ;etail outlets generate average revenue of 31/,/// per outlet for *lliance, so the number of outlets necessary to break even on the increased cost of adding three sales reps can be determined by, increase in sales 30//,/// &ncrease in outlets 4 !!!!!!!!!!! 4 !!!! 4 0/ outlets revenue per outlet 31/,/// Therefore, *lliance must obtain distribution through 0/ more outlets to break even on this recommendation.

c.0 #ecrease price by 1348 Be must determine the current total contribution and the ne$ contribution margin. Ono$ing that *lliance)s market share is 67 of the total 31// million, therefore, Current sales 4 /./6 31// million 4 36 million

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Therefore, Current total contribution 4 contribution margin sales 4 /.26 36 million 4 31.26 million Though $e do not kno$ prices, $e can base our analyses on 1//7 or price 4 31.//. Decause $e kno$ the current contribution margin is 267, the unit contribution $ill e+ual 3/.26 and unit variable costs $ill e+ual 3/.E6. Thus, $e can see the effect on unit contribution and contribution margin $hen price is decreased to 3/.=/,

1rice 2nit variable cost 4 2nit contribution Contribution margin

O"d 31.// 3/.E6 3/.26 3/.26A31.// 4 /.26 or 267

New /reduced 134 0 3/.9/ 3/.E6 3/.16 3/.16A3/.9/ 4 /.1CCE or 1C.CE 7

*s can be seen, a 1/7 reduction in price resulted in a decrease of the contribution margin from 267 to 1C.CE7. To determine the level of sales necessary to break even on this price reduction, $e calculate the level of sales that must be attained at the ne$ contribution margin to achieve the same original total contribution of 31.26 million, -e$ contribution margin ne$ sales level 4 original total contribution ?o, original contribution 31,26/,/// -e$ sales level 4 !!!!!!!!!!! 4 !!!!!! ne$ contribution margin /.1CCE 4 3E,09=,6//.3/

Thus, the absolute increase in sales to merely break even on a 1/7 reduction in price e+uals 32,09=,6//.3/ %i.e., 3E,09=,6//.3/ 36 million'. d.' ?tudents) recommendations $ill vary. "o$ever, it appears that the suggestion to reduce price by 1/7 is the least attractive alternative. 1epsiCo sells its soft drinks in appro imately 0//,/// retail establishments, such as supermarkets, discount stores, and convenience stores. ?ales representatives call on each retail account $eekly, $hich means each account is called on by a sales rep 62 times per year. The average length of a sales call is E6 minutes %or 1.26 hours'. *n average salesperson $orks 2,/// hours per year %6/ $eeks per year 0/ hours per $eek', but spends ten hours a $eek on nonselling activities, such as administrative tasks and travel. "o$ many sales people does 1epsiCo needF

3.2.

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-nswer: The number of salespeople can be determined by using the $orkload method, -C :C MC 4 !!!!!!!! T*

-?

$here, -? 4 number of salespeople -C 4 number of customers %0//,///' :C 4 fre+uency of customer calls %62' MC 4 length of customer call %1.26' T* 4 time an average salesperson has available for selling per year %6/ $eeks 3/ hours per $eek 4 1,6// hours'

-?

0//,/// 62 1.26 4 !!!!!!!! 4 1E,333 1,6//

Thus, 1epsiCo needs 1E,333 salespeople to carry out the selling function.

3.3.

"air Pone 1manufactures a brand of hair styling gel. &t is considering adding a modified version of the product!a foam that provides stronger hold. "air Pone)s variable costs and prices to $holesalers are, Current hair gel 2nit selling price 2nit variable costs 2.// .=6 -e$ foam product 2.26 1.26

"air Pone e pects to sell 1 million units of the ne$ styling foam in the first year after introduction, but it e pects that C/7 of those sales $ill come from buyers $ho normally purchase "air Pone)s styling gel. "air Pone estimates that it $ould sell 1.6 million units of the gel if it did not introduce the foam. &f the fi ed cost of launching the ne$ foam $ill be 31//,/// during the first year, should "air Pone add the ne$ product to its lineF Bhy or $hy notF

3/

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-nswer: This is a cannibali(ation problem. To analy(e this problem, $e need to determine unit contributions, 2nit contribution 4 price unit variable costs 2nit contribution for the gel product 4 32.// 3/.=6 4 31.16 2nit contribution for the foam product 4 32.26 31.26 4 31.// <ne $ay to analy(e this is to assess the incremental contribution gained %or lost' by adding the ne$ product. "air Pone estimates that ne t year)s sales of the ne$ foam product $ould be 1 million units, but C//,/// %C/7 of 1 million' $ill be cannibali(ed from the original gel product Thus, "air Pone $ill lose 3/.16 in contribution for every unit cannibali(ed, Contribution lost due to cannibali(ation 4 C//,/// units %3/.16' 4 39/,/// "o$ever, it is estimated that the foam product $ill generate an additional 0//,/// unit sales %1 million units C//,/// cannibali(ed units'. Thus, Contribution due to net ne$ volume 4 0//,/// units 31 per unit 4 30//,/// The net effect is that "air Pone $ill gain 331/,/// in contribution by introducing the foam product %incremental contribution 4 30//,/// 39/,/// 4 331/,///'. This increase in total contribution is greater than the 31//,/// increase in fi ed costs to introduce this product, so "air Pone should consider this option favorably.

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*nother $ay to see this is to compare "air Pone)s total contribution $ith and $ithout the introduction of the ne$ product, ge" &n"y
gel contribution foam contribution Total Contribution 1,6//,/// units 31.16 4 31,E26,/// / 31,E26,///

ge" and %&am

9//,/// units 31.16 4 31,/36,/// 1,///,/// units 31.// 4 31,///,/// 32,/36,///

-otice that the difference in the total contribution is a net gain of 331/,/// %32,/36,/// 31,E26,/// 4 331/,///', $hich $e found using the incremental method. *gain, because the increase in total contribution is greater than the increase in fi ed cost, "air Pone should go ahead $ith this product introduction.

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)ab"e A2.1
Pro Forma Pr&%it-and-L&ss 1tatement %&r the 12-M&nth Peri&d $nded #ecember '1 231'

-et ?ales Cost of goods sold Jross 8argin 8arketing E penses ?ales e penses 1romotion e penses :reight Jeneral and *dministrative E penses 8anagerial salaries and e penses &ndirect overhead -et profit before income ta 31E,6//,/// 16,///,/// 12,6//,/// 32,///,/// 3,///,///

3126,///,/// C2,6//,/// 3 C2,6//,///

7 of sales 1//7 6/7 6/7

06,///,///

3C7

6,///,/// 312,6//,///

07 1/7

)ab"e A2.2
Pr&%it-and-L&ss 1tatement %&r the 12-M&nth Peri&d $nded #ecember '1 231'

-et ?ales Cost of goods sold Jross 8argin 8arketing E penses ?ales e penses 1romotion e penses :reight Jeneral and *dministrative E penses 8anagerial salaries and e penses &ndirect overhead -et profit before income ta 316,///,/// 10,///,/// 1/,///,/// 32,///,/// 6,///,///

31//,///,/// 66,///,/// 3 06,///,///

7 of sales 1//7 667 067

39,///,///

397

E,///,/// %31,///,///'

E7 -17

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1preadsheet A2.1
Pro Forma Pr&%it-and-L&ss 1tatement %&r the 12-M&nth Peri&d $nded #ecember '1 231'
% of sales Net Sales Cost of Goods Sold Gross Margin $ $ $ 125,000,000 62,500,000 62,500,000 100% 50% 50%

Marketing Expenses Sales Expenses ro!otion Expenses "eig#t

$ $ $

17,500,000 15,000,000 12,500,000

$5,000,000

%6%

General and &d!inistration Expenses Managerial salaries and expenses 'ndire(t )*er#ead Net rofit

$ $

2,000,000 %,000,000

$ $

5,000,000 12,500,000

$% 10%

Teaching Note: /ote that the absolute amount for the cost of goods sold was entered in that cell because the percentage of sales that cost of goods sold represents was estimated to represent 5 % of sales when developing the pro forma statement, but it represented 55% of actual sales. :ither one of these spreadsheets can be used to develop the spreadsheets for "uantitative e#ercise 2.2, but students will have to change e"uations in the cells to calculate the correct e#penses. 1preadsheet A2.2
Pr&%it-and-L&ss 1tatement %&r the 12-M&nth Peri&d $nded #ecember '1 231'
% of sales Net Sales Cost of Goods Sold Gross Margin $ $ $ 100,000,000 55,000,000 $5,000,000 100% 55% $5%

Marketing Expenses Sales Expenses ro!otion Expenses "eig#t

$ $ $

15,000,000 1$,000,000 10,000,000

%+,000,000

%+%

General and &d!inistration Expenses Managerial salaries and expenses 'ndire(t )*er#ead Net rofit

$ $

2,000,000 5,000,000

7,000,000 ,1,000,000-

7% .1%

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Additi&na" 9uantitative $xercises

1. Chill <ut, a manufacturer of outdoor patio heaters, reali(es a cost of 3E6 for every heater it produces. Total fi ed costs e+ual 33 million. &f the company manufactures 1 million heaters, compute the follo$ing, a. unit cost b. markup price if the company desires a 167 return on sales c. ;<& price if the company desires a 2/7 return on an investment of 31/ million -nswer: a.' 2nit cost 4 variable cost 5 fi ed costs 33,///,/// !!!!!! 4 3E6 5 !!!!! 4 3E= unit sales 1,///,///

unit cost 3E= b.' 8arkup price 4 !!!!!!!!!!!!! 4 !!! 4 391.EC %l desired return on sales' l /.16

c.' ;<& price 4 unit cost 5

;<& investment %/.2/ 31/,///,///' !!!!!!! 4 3E= 5 !!!!!! 4 3=/.// unit sales 1,///,///

2. * $omen)s apparel retailer purchases items to sell in the store. &f the retailer purchases a blouse for 33/ and sells it for 306, determine the follo$ing, a. dollar markup b. markup percentage on cost c. markup percentage on selling price -nswer: a.' #ollar markup 4 selling price cost 4 306 33/ 4 316 dollar markup 316 b.' 8arkup percentage on cost 4 !!!!!!! 4 !!! 4 /.6 4 6/7 cost 33/ dollar markup 316 c.' 8arkup percentage on price 4 !!!!!!! 4 !!! 4 /.333 4 33.37 price 306

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3. * consumer purchases a la$n mo$er from "ome #epot for 3226. "ome #epot)s markup is 3/7, and the $holesaler)s is 2/7, both based on selling price. :or $hat price does the manufacturer sell the product to the $holesalerF -nswer: price cost 8arkup percentage on price 4 !!!!!! price so, Cost at each level 4 price %price markup7'

"ome #epot)s cost 4 3226 %3226 /.3/' 4 316E.6/, $hich is the price the $holesaler sells it to "ome #epot. The $holesaler)s cost 4 316E.6/ %316E.6/ /.2/' 4 312C, $hich is the price the manufacturer sells the product to the $holesaler. *nother $ay to compute this is, ;etail price, 3226.// minus retail margin %3/7', 3 CE.6/ ;etailer)s costA$holesaler)s price, 316E.6/ minus $holesale margin %2/7', 3 31.6/ Bholesaler)s costAmanufacturer)s price 3 12C.// 0. * bicycle manufacturer has a unit cost of 3E6 and $ishes to achieve a margin of 0/7 based on selling price. &f the manufacturer sells directly to a retailer $ho then adds a set margin of 3/7 based on selling price, determine the retail price charged to consumers. -nswer: price cost 8arkup percentage on price 4 !!!!!! price ?o, at any level in the chain, cost price 4 !!!!! %1 markup' cost 3E6 8anufacturer)s price 4 !!!!! 4 !!!!! 4 3126

3C

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%1 markup'

%1 /.0'

cost 3126 ;etailer)s price 4 !!!!! 4 !!!!! 4 31E=.6E %1 markup' %1 /.3' 6. Complete the blanks in the follo$ing markup chain. *ll markup percentages are based on selling prices. 3 7 ;etail selling price ;etail markup ;etail cost Bholesale selling price Bholesale markup Bholesale cost 8anufacturer)s selling price 8anufacturer)s markup 8anufacturer)s cost -nswer: To complete this chain, students need the follo$ing e+uations, #ollar markup 4 selling price cost price cost 8arkup percentage on price 4 !!!!!! price so, Cost at each level 4 price %price markup7' 30.// QQQQQQQQQQQQ QQQQQQQQQQQQ QQQQQQQQQQQQ QQQQQQQQQQQQ QQQQQQQQQQQQ QQQQQQQQQQQQ QQQQQQQQQQQQ 3/.0= C/7 QQQQQQQQQQ 6/7

price cost 8arkup percentage on price 4 !!!!!!

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price ?o, at any level in the chain, cost price 4 !!!!! %1 markup7' To fill in the blanks on this chain, students can begin either at the top or the bottom. &f beginning at the top, they can determine the retail dollar markup, follo$ed by the retail cost, $hich is the $holesale selling price. There is not enough information at that point to continue do$n the chain, so they $ill have to $ork from the bottom to determine the $holesale cost. Borking from the bottom, they can first determine the manufacturer)s selling price from the information given, and the difference bet$een the price and the cost is the dollar markup. The manufacturer)s price is the $holesale cost, so no$ they can $ork from the top to determine the $holesale selling price %$hich they $ould have gotten to if starting at the top'. <nce these t$o figures are determined, they can subtract the $holesale cost from the $holesale price to determine the $holesale dollar markup. The only unkno$n, then, is the percentage $holesale markup, $hich can be determined by dividing the $holesale dollar markup by the $holesale price. 3 ;etail selling price ;etail markup ;etail cost Bholesale selling price Bholesale markup Bholesale cost 8anufacturer)s selling price 8anufacturer)s markup 8anufacturer)s cost 30.// ;;;'2. ;;;'2. ;;;'2. QQQQ QQQQ QQQQ QQ, %QQQ 6/7 7

;;;' .< QQQQ ;;;'(.2 QQQQ ;;;'(.2 QQQQ ;;;' .=2QQQQ 3/.0=

C/7

C. Note: 2nl- $se this exercise i( the e3$ations gi!en in the teaching note 4ere co!ered. ?uppose a retailer uses a markup of 0/7 based on price and found that his competitor $as using a markup of 6/7 percent based on cost and $anted to kno$ $hat this $ould be as a percentage of selling price. *re these e+uivalentF

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-nswer: The e+uations given in the teaching note are,

markup percentage on cost 1//7 5 markup percentage on cost

8arkup percentage on selling price 4

8arkup percentage on cost 4

markup percentage on selling price 1//7 - markup percentage on selling price

The calculation is,

6/7 6/7 4 4 33.37 1//7 5 6/7 16/7

These are not e+uivalent as the first retailer is using a 0/7 markup based on price, but the competitor is using a lo$er markup based on price %33.37'. E. 1?easons, &nc. manufactures holiday $reaths and sells them directly to retailers for 36.//. The manufacturer)s cost information is as follo$s, Gariable cost 33.36A$reath *dvertising and promotion 33//,/// <verhead 3E//,/// Calculate the follo$ing, a. contribution per unit and contribution margin for the manufacturer b. break-even volume in units and dollars c. volume in units and dollar sales necessary if ?easons)s profit goal is 36//,/// d. net profit if C million $reaths are sold -nswer: a.' 2nit contribution 4 selling price unit variable cost Therefore, the contribution per unit 4 36 33.36 4 31.C6

unit contribution 31.C6 Contribution margin 4 !!!!!!!! 4 !!!! 4 /.33 or 337 price 36

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fi ed costs 31,///,/// b.' Dreakeven volume 4 !!!!!!!! 4 !!!! 4 C/C,/C1 units unit contribution 31.C6 Dreakeven sales 4 breakeven volume price 4 C/C,/C1 units 36 4 33,/3/,3/6 or fi ed costs 31,///,/// Dreakeven sales 4 !!!!!!!! 4 !!!! 4 33,/3/,3/3 contribution margin /.33 The difference bet$een the t$o calculations for breakeven sales is due to rounding. fi ed costs 5 profit goal c.' 2nit volume 4 !!!!!!!!!!! price variable cost 31,///,/// 5 36//,/// 4 !!!!!!!!!! 4 9/9,/91 units 36 33.36 ?ales necessary 4 9/9,/91 units or 36 4 30,606,066

fi ed costs 5 profit goal 31,6//,/// Dreakeven sales 4 !!!!!!!! 4 !!!! 4 30,606,066 contribution margin /.33

d.' -et profit 4 total revenue total costs Total revenue if C million units are sold 4 C,///,/// 36 4 33/ million Total cost is e+ual to T:C 5 TGC, so if C million units are sold, Total cost 4 31,///,/// 5 %33.36 C,///,///' 4 321,1//,/// -et profit 4 33/,///,/// 321,1//,/// 4 3=,9//,/// %-ote, ?tudents may merely subtract the fi ed costs from the total contribution, %31.C6 C,///,/// units' 31,///,/// 4 3=,9//,///.'

0/

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=. * company sells its products for 3=.6/. &t has variable costs of 32.6/, and fi ed costs total 326/,///. Bhat must its dollar sales be to break evenF "o$ many units must it sell to earn a 2/7 return on its investment of 31//,///F -nswer: Dreakeven volume fi ed costs 326/,/// 4 !!!!!!!! 4 !!!! 4 01,CCE units unit contribution 3C.//

$here unit contribution 4 price variable cost 4 3=.6/ 32.6/ 4 3C.// Dreakeven sales 4 breakeven volume price 4 01,CCE units 3=.6/ 4 3360,1C9.6/ or fi ed costs 326/,/// Dreakeven sales 4 !!!!!!!! 4 !!!! 4 3362,113 contribution margin /.E1 $here unit contribution 3C.// Contribution margin 4 !!!!!!!! 4 !!!! 4 /.E/69 or E17 price 3=.6/ price 3=.6/ The difference bet$een the t$o calculations for breakeven sales is due to rounding. To determine the unit volume necessary to earn a 2/7 return on an investment of 31//,///, $e must first determine the absolute amount of the profit goal. The profit goal is 2/7 of 31//,///, or 32/,/// %/.2 31//,///'. so fi ed costs 5 profit goal 2nit volume 4 !!!!!!!!!!! unit contribution 326/,/// 5 32/,/// 4 !!!!!!!!!! 4 06,/// units 3C.// 9. #etermine the market potential for a product that has = million prospective buyers $ho purchase an average of 2 per year and price averages 36/.

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-nswer: .4n"p $here . 4 total market demand n 4 number of buyers in the market " 4 +uantity purchased by an average buyer per year p 4 price of an average unit The upper limit of market demand is called market potential. &t)s a straightfor$ard calculation, L 4 =,///,/// buyers 2 units per buyer 36/ per unit 4 3=// million 1/. ?mithsborough, &nc. had the follo$ing profit and loss statement for the year ending 2//9, ?ales Cost of goods sold Jross 8argin 8arketing E penses ?ales e penses 1romotion e penses Jeneral and *dministrative E penses 8anagerial salaries and e penses for the marketing function &ndirect overhead -et profit before income ta 31/,///,/// 0,///,/// 36/,///,/// 1/,///,/// 30/,///,///

10,///,///

31,///,/// C,///,///

E,///,/// 319,///,///

#etermine the follo$ing ratios, a. gross margin percentage b. net profit percentage c. operating e pense percentage d. net marketing contribution e. marketing return on sales %marketing ;<?' f. marketing return on investment %marketing ;<&' g. &s ?mithsborough doing $ellF E plain your ans$er. -nswer: a.' Jross margin percentage4 gross margin 30/,///,/// !!!!!!! 4 !!!!!! 4 /.=/ 4 =/7 net sales 36/,///,///

02

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net profit 319,///,/// b.' -et profit percentage 4 !!!!!!! 4 !!!!!! 4 /.3= 4 3=7 net sales 36/,///,/// total e penses 321,///,/// 4 !!!!!!! 4 !!!!! 4 /.02 4 027 net sales 36/,///,///

c.' <perating e pense percentage

d.' -8C 4 net sales cost of goods sold marketing e penses $here, marketing e penses 4 selling e penses 5 promotion 5 managerial salaries and e penses for the marketing function 4 31/,///,/// 5 30,///,/// 5 31,///,/// 4 316,///,/// so, -8C 4 36/,///,/// 31/,///,/// 316,///,/// 4 326,///,/// net marketing contribution 326,///,/// e.' 8arketing ;<? 4 !!!!!!!!!!! 4 !!!!!! net sales 36/,///,/// 4 /.6/ 4 6/7

net marketing contribution 326,///,/// f.' 8arketing ;<& 4 !!!!!!!!!!! 4 !!!!!! 4 1.CE 4 1CE7 marketing e penses 316,///,/// This is not a mistake. 8arketing ;<& can be greater than 1//7, $hich indicates that the company is efficient $ith its marketing e penditures. &n this case, each dollar spent on marketing is generating 31.CE to$ard general fi ed costs and profit. g.' ?tudents) responses $ill vary on this +uestion, but most students $ill agree that ?mithsborough is doing $ell. "o$ever, it should be noted that these ratios should be compared to previous ratios for the division, other divisions of the company, competitors, and industry averages. 11. Jiven the follo$ing cost structure, calculate 1Dlendco, &nc.)s breakeven dollar sales,

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Cost of goods sold e+ual to 6/7 of sales ?ales salaries totaling 31,///,/// plus 1/7 commission on each sale *dvertising e penditures of 36//,/// :reight e penses e+ual 1/7 of sales 8arketing staff costs e+ual 326/,/// per year &ndirect overhead e+uals 3C//,/// -nswer: Dreakeven sales can be determined by,

fi ed costs Dreak-even sales 4 !!!!!!!!!! contribution margin Total fi ed costs 4 sales salaries 5 advertising 5 managerial salaries and e penses 5 indirect overhead 4 31,///,/// 5 36//,/// 5 326/,/// 5 3C//,/// 4 32,36/,///

Gariable costs make up E/7 of sales %i.e., C<J? 4 6/7, commissions 4 1/7, and freight 4 1/7 of sales'. ?o, Contribution margin 4 1 /.E/ 4 /.3/ Therefore, fi ed costs 32,36/,/// Dreak-even sales 4 !!!!!!!!!!! 4 !!!!!! contribution margin /.3/ 4 3E,=33,333

12. #rake,1 &nc. manufactures electric $elders that it sells to other manufacturers, and sales last year $ere 306 million. #rake has a 367 contribution margin. The marketing manager has suggested increasing the number of sales representatives by

00

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five, $hich $ould cause fi ed costs to increase by 326/,///. *nother suggestion is to reduce price by 1/7. a. Bhat incremental dollar volume $ould be necessary to break even on the suggestion to hire five additional sales repsF b. Bhat absolute increase in dollar sales volume $ould be necessary to maintain #rake)s current contribution if price $as reduced by 1/7F c. Bhich suggestion do you think #rake should implementF E plain your recommendation. -nswer: a.0 Add %ive sa"es representatives8 *dding five sale reps $ould increase fi ed cost by 326/,///. Be can determine the increase in sales necessary to break even on this increase in fi ed cost by dividing by the contribution margin, increase in fi ed costs 326/,/// &ncrease in sales 4 !!!!!!!!!!! 4 !!!!!! 4 3E10,2=C contribution margin /.36 b.0 #ecrease price by 1348 Be must determine the current total contribution $ith sales of 306 million and the ne$ contribution margin after price is reduced by 1/7. Therefore, Current total contribution 4 contribution margin sales 4 /.36 306 million 4 316,E6/,/// Though $e do not kno$ prices, $e can base our analyses on 1//7 or price 4 31.//. Decause $e kno$ the current contribution margin is 367, the unit contribution $ill e+ual 3/.36 and unit variable costs $ill e+ual 3/.C6. Thus, $e can see the effect on unit contribution and contribution margin $hen price is decreased to 3/.9/,

1rice 2nit variable cost 4 2nit contribution Contribution margin

O"d 31.// 3/.C6 3/.36 3/.36A31.// 4 /.36 or 367

New /reduced 134 0 3/.9/ 3/.C6 3/.26 3/.26A3/.9/ 4 /.2E= or 2E.= 7

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*s can be seen, a 1/7 reduction in price resulted in a decrease of the contribution margin from 367 to 2E.=7. To determine the level of sales necessary to break even on this price reduction, $e calculate the level of sales that must be attained at the ne$ contribution margin to achieve the same original total contribution of 316,E6/,///, -e$ contribution margin ne$ sales level 4 original total contribution ?o, original contribution 316,E6/,/// -e$ sales level 4 !!!!!!!!!!! 4 !!!!!! ne$ contribution margin /.2E= 4 36C,C60,CEC

Thus, the absolute increase in sales to merely break even on a 1/7 reduction in price e+uals 311,C60,CEC %i.e., 36C,C60,CEC 306,///,///'. c.0 ?tudents) recommendations $ill vary. "o$ever, it appears that the suggestion to reduce price by 1/7 is the least attractive alternative.

13. *rtco sells framed art$ork in appro imately 6,/// home decorating stores. ?ales representatives call on each store 6 times per year. The average length of a sales call is one hour. Bhile an average salesperson $orks 2,/// hours per year %i.e., 6/ $eeks per year 0/ hours per $eek', each spends ten hours a $eek on nonselling activities, such as administrative tasks and travel. "o$ many sales people does *rtco needF *ns$er, The number of salespeople can be determined by using the $orkload method, -C :C MC 4 !!!!!!!! T*

-? $here,

-? 4 number of salespeople -C 4 number of customers %6,/// stores' :C 4 fre+uency of customer calls %6 time per year' MC 4 length of customer call %1 hour'

0C

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T* 4 time an average salesperson has available for selling per year %6/ $eeks 3/ hours per $eek 4 1,6// hours'

-?

6,/// 6 1 4 !!!!!!!! 4 1C.CE or 1E salespeople 1,6//

10. *vian Electronics, &nc. 1manufactures a model of portable music players that can play music do$nloaded from the &nternet. &t is considering adding a more advanced model of the product that can also do$nload and play video files as $ell as music files. *vian)s variable costs and prices to $holesalers are,
+urrent Audi& m&de" New Audi&:,ide& m&de"

2nit selling price 2nit variable costs

316/.// 3C/.//

326/.// 312/.//

The company e pects to sell 2 million units of the ne$ audioAvideo model in the first year after introduction, but it e pects that half of those sales $ill come from buyers $ho $ould have purchased *vian)s current audio model. *vian estimates that it $ould sell 2.6 million units of the current audio model if it did not introduce the audioAvideo model. &f the fi ed cost of launching the ne$ audioAvideo model $ill be 3=//,/// during the first year, should *vian add the ne$ modelF Bhy or $hy notF -nswer: This is a cannibali(ation problem. To analy(e this problem, $e need to determine unit contributions, 2nit contribution 4 price unit variable costs 2nit contribution for the audio model 4 316/ 3C/ 4 39/ 2nit contribution for the audioAvideo model 4 326/ 312/ 4 313/ Decause the audioAvideo model has a higher contribution than the audio model, any cannibali(ed volume $ill positively impact total contribution. That is, *vian $ill e perience a gain in contribution of 30/ for every unit cannibali(ed from the audio model %313/ 39/ 4 30/'. "o$ever, $e must determine the contribution gained by adding the ne$ model to ensure that it is higher than the 3=//,/// increase in fi ed costs associated $ith the introduction of the ne$ model. Contribution gained due to cannibali(ation 4 1 million units 30/ 4 30/,///,///

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-o further calculations are necessary because the gain in contribution due to cannibali(ation alone far e ceeds the increase in fi ed cost. *vian should introduce the ne$ model. %"o$ever, if students did calculate the total incremental contribution, they must determine the contribution generated by the other 1 million units of the audioAvideo model that are not cannibali(ed sales, 1 million units 313/ 4 313/ million. *dd that to the contribution due to the cannibali(ed sales, and $e get a total increase in contribution of 31E/ million.' *nother $ay students might do this problem is to e amine the total contributions $ith and $ithout the ne$ model,
Audi& m&de" &n"y 2,6//,/// units 39/ 4 3226,///,/// / 3226,///,/// Audi& and Audi&:,ide& m&de"s 1,6//,/// units 39/ 4 3136,///,/// 2,///,/// units 313/ 4 32C/,///,/// 3396,///,///

audio contribution audioAvideo contribution Total Contribution

The difference in the total contribution is a net gain of 31E/ million %3396 million 3226 million 4 31E/ million', $hich is greater than the 3=//,/// increase in fi ed costs. 16. 11erfam is a manufacturer of fragrances for $omen. &t currently sells t$o brands, one called *llure, $hich is sold to $holesalers for 30/, and another called Deauty, $hich is sold to $holesalers for 32/. &t is considering adding a mid-priced brand called Classy for 33/. 1erfam)s variable costs and prices to $holesalers for si ounce bottles are,

A""ure 2nit selling price 2nit variable costs 30/.// 32/.//

!eauty 32/.// 31/.//

+"assy /new brand0 33/.// 316.//

1erfam e pects to sell 1/,/// bottles of the ne$ Classy brand, but 6,/// of those sales $ill be cannibali(ed from *llure and 1,/// $ill be cannibali(ed from Deauty. Defore 1erfam considered the ne$ brand, it had e pected to sell 11,/// bottles of *llure and 1/,/// bottles of Deauty. ?hould 1erfam launch the ne$ Classy brandF -nswer: This is a cannibali(ation problem. To analy(e this problem, $e need to determine unit contributions for each brand, 2nit contribution 4 price unit variable costs 2nit contribution for *llure 4 30/ 32/ 4 32/

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2nit contribution for Deauty 4 32/ 31/ 4 31/ 2nit contribution for Classy 4 33/ 316 4 316 <ne $ay to analy(e this is to assess the incremental contribution gained %or lost' by adding the ne$ product. 1erfam estimates that ne t year)s sales of the ne$ Classy brand $ill be 1/,/// bottles, but 6,/// of those $ill be cannibali(ed from the *llure brand and 1,/// $ill be cannibali(ed from the Deauty brand. Thus, 1erfam $ill lose 36 in contribution for every bottle cannibali(ed from *llure, but it $ill gain 36 in contribution for every bottle cannibali(ed from Deauty, Contribution lost due to cannibali(ation from *llure 4 6,/// bottles %36' 4 326,/// Contribution gained due to cannibali(ation from Deauty 4 1,/// bottles 36 4 36,/// The net effect is a loss in total contribution of 32/,/// due to cannibali(ation. "o$ever, it is estimated that Classy $ill generate an additional 0,/// bottle sales. Thus, Contribution due to net ne$ volume 4 0,/// bottles 316 per unit 4 3C/,/// The net effect is that 1erfam $ill gain 30/,/// in incremental contribution by introducing the ne$ Classy brand %incremental contribution 4 3C/,/// 32/,/// 4 30/,///'. *ssuming no increases in fi ed costs, 1erfam should launch this ne$ brand. *nother $ay to see is to compare 1erfam)s total contribution $ith and $ithout the introduction of the ne$ product, A""ure and !eauty &n"y
*llure contribution Deauty contribution Classy contribution Total Contribution 11,/// bottles 32/ 4 322/,/// 1/,/// bottles 31/ 4 31//,/// / 332/,///

A"" three brands

C,/// bottles 32/ 4 312/,/// 9,/// bottles 31/ 4 39/,/// 1/,/// bottles 316 4 316/,/// 33C/,///

-otice that the difference in the total contribution is a net gain of 30/,/// %33C/,/// 332/,/// 4 30/,///', $hich $e found using the incremental method.

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