Segmental, Productivity & Ratio Analysis

Learning Objectives : 1) Understand how cost analysis can be applied to market segments 2) Appreciate role of marketing experimentation in improving the allocation of marketing effort 3) Recognize the value of segmental productivity analysis 4) Critically perceive how ratio analysis can be used to understand the current position 5) Appreciate the relevance of strategic benchmarking How are resources utilized and with what returns needs to be understood by all companies – “Where are we now ? For doing this consider the company as a bundle of projects or activities , for example ? Reformulation and relaunch of product X ? Continued market service Y ? Successful development and launch of project Z Projects and activities can be further defined in terms of missions and this mix of projects and missions will be constantly changing with resource implications and profit consequences. Which to add and which to delete ? Ration available resources among competing activities. Establish the cost of each activity of the company to start with.

Cost Categories need to be defined. Traditional focus puts product costing as the centre of costing systems. This could impede the ability to recognize the patterns of consumer preference and competitive positioning by market segment. Attributes of market segments are different from attributes of production processes – Direct costs are traceable to Labor, Material, and salary but Indirect Costs cannot be directly traced to cost objects. The assigning of a ‘fair share’ of indirect costs, along with direct costs, is the heart of Absorption Costing (Full Costing).

Deciding the full cost of a cost object in every company is thus worked out by adding an allowance usually on hourly rate for use of all indirect factors (power, equipment, rent, insurance, salaries of reception/supervisory/staff etc. ) MARKETING COST ANALYSIS Most companies do not know what part of their total marketing outlay is spent on each product, sales territory , or customer group is because they do not have a refined system of cost analysis. Vagueness of costs like packaging – is it a promotional, production, or a distribution expense ?

Need exists for planning and control techniques to indicate levels of performance required and achieved, as well as outcome of shifting marketing efforts from one segment to another. Cost Data could be inaccurate for some of the following reasons :- • Marketing costs on products, territories being allocated on the basis of sales value or sales volume instead of causal factors like order-getting marketing expenditure thus missing out on the concept of opportunity cost of alternatives • Indirect and administrative costs are arbitrarily allocated to segments on the basis of sales volume • Some costs are not identified clearly

Marketing Cost Analysis overcomes these problems and aims to ? Analyze costs incurred in order-getting and order-filling aspects so that overall profits can be determined after combining with product cost data ? Determine Profit by product line ? Costs involved in serving different classes of customers, territories and other segments to find the relative profit performance ? Compute figures like cost per sales call, cost per order, cost to acquire new customer, cost of holding inventory for a year etc. Evaluate managers as per their actual controllable cost responsibilities ? Evaluate alternate strategies or plans with full cost Marketing segments may be one or a combination of the following ? Product line or range ? Channel of distribution ? Sales representative or territory ? Customer or Industry group ? Size of order When selecting the segment of interest, the approach to costing should be selected from alternatives such as (a) Absorption (Full ) costing (b) Variable ( Direct or Marginal ) costing.

Profit Analysis by channel can be done by comparing the net profit figures or can by Variable costing method be done by comparing the marketing contribution ( Variable contribution less Fixed direct marketing costs ). Customer Profitability Analysis Implementation of CPA can be done by following steps 1) Define customer groups and market segments by distinguishing their needs of each 2) Identify the factors which cause variations in the costs of servicing those customers. This can be done by identifying the key elements of the marketing mix used for each different group or segment ) Analyze the ways in which service offerings are differentiated between customer groups e. g. terms of trade could vary between home-based and overseas customers, between large and small customers, speed of delivery , to key accounts 4) Identify the resources that have been used for each group or segment – including personnel, warehouse facilities, administrative back-up, etc. 5) Ways in which the costs of resources (step 4) can be attributed to the customer groups 6) Relate revenues and costs to each group, with profit emerging as the difference

Interpretation of Data The danger of absorption-based segmental analysis is that “bottom line” could be taken as the basis for action. This should not be the approach. The aim should be to take net profit as the criterion for investigation. Segmental productivity analysis would reveal % contribution to total profits by each product , and also % total time of available selling time. This could show that a high % of selling time is being devoted to low or unprofitable products. Questions which can then arise are Increasing net profits proportionately more than the marketing budget can increase marketing productivity ? ? Increase net profits without marketing outlays ? ? Increase net profits with decrease in marketing costs ? ? Decreasing net profits but with proportionately greater decrease in marketing costs ? Marketing Experimentation Studies of marketing costs can be the basis of experiments to identify all controllable independent factors that affect a particular dependant variable. This can answer the questions such as If marketing outlay is raised , how much would the net profit contribution of most profitable product be increased and how will that affect strategy of competitors in terms of stability and market share ? o By how much would the net losses of unprofitable products be reduced if some decrease was made in specific marketing outlays ? o By how much would the profit contribution of profitable products be affected by a change in the marketing effort on unprofitable products ( and vice versa ) and its effect on total marketing system ? By how much will total profit contribution be improved if some marketing efforts are diverted to profitable territories or customer groups from unprofitable ones ? o By how much will the net profit contribution be increased if there is change in method of distribution to small unprofitable accounts, or if these accounts were dropped ? Nature of Productivity Productivity can be at macro level ( entire industry or whole economies ) or at micro level ( particular company or activities in a company ). Our focus would be at the micro level , and marketing productivity can be expressed as

Marketing Outputs / Marketing inputs Sevin has defined it “ as ratio of sales or net profits to marketing costs for a specific segment of the business”. The inflationary and monetary factors need to be considered when comparing value of sales in different periods of time. To consider a particular productivity index from distribution domain. Productivity index = no. of orders shipped / no. of labor hours worked Such indexes are meaningful only when compared to some meaningful figures such as ? Internal Comparisons – figures from previous periods to do trend analysis.

Figures representing efficient or desired performance, for budgetary control ? External Comparisons – with other organizations within same markets Use of Ratios Their value lies in the relative measures and not absolute measures. Discretion is needed in choosing the ratios that are useful. Seasonal sales need to have different method for collecting and comparing data and the ultimate financial measure of short-term efficiency is the relationship between Net Profit and Capital Employed or ROI Net Profit / Capital employed X 100 = ROI

Always be sure of the definition of numerators and denominators e. g. is net profit pre-tax or post-tax ? Is capital employed based on historic cost or replacement cost figures ? Primary Ratio Net Profit / Capital Employed Secondary Ratio Net Profit / Sales revenue Sales revenue / Capital employed Tertiary Ratios are those that constitute the secondary ratios and general cause of deviation from ROI target rate is found by computing profit ratio and the capital turnover ratio first. Before corrective action the 4 simple tertiary ratios need to be done 1.

Gross Profit / Sales Revenue 2. Sales Revenue / Operating Costs 3. Sales Revenue / Fixed assets 4. Sales Revenue / Working Capital The many other levels of ratio pyramid ( page 100 of Wilson & Gilligan ) can be identified and used for finding the reasons for overall outcomes. Analyzing Ratios and Trends Declining ROI can be thought to be prima facie due to falling net profit to sales revenue but it also can be linked to particular quantity of capital investment. From published accounts it is possible to see Primary, Secondary and Tertiary ratios of competing companies.

Major cause of divergence between results of two companies can be found in their different accounting techniques and definitions e. g. two companies buy the same asset at the same time but one company chooses to depreciate asset over 4 years whereas the other takes 100% depreciation allowance in the first year. Profit Impact of Market Strategy ( PIMS ) has done research on 3000 SBUs and what drives profits for 25 years and have their results suggest that business performance can be grouped into 4 major categories : Market Attractiveness – customer bargaining power, market complexity, market growth, innovation etc. ? Competitive Strength – market share position, customer preference relative to competitors’ offerings, market coverage, product range have all contributions ? Value Added Structure – investment intensity, fixed/working capital split, employee productivity, make vs buy, capacity use, and vertical integration ? People and Organization – Lean organization, participative culture, Incentives, Training, Insiders Vs. Outsiders

The various ‘weak’ and ‘strong’ profiles are chosen from all the variables and PIMS findings were startling. Weaker profit business would make 6% ROS or 10% ROCE whereas the strong-profile business would make 11% ROS or 30% ROCE over a 4 year period. Both Ratio analysis and Productivity analysis can help in establishing the pattern of resource utilization and its productivity. This analysis would reveal the need to do Segmental reallocation to improve segments’ productivity. Ratio analysis and other such techniques can only indicate “where we are now” but cannot answer what to do next.