442 Evaluating Sales Performance
At this point in our performance evaluation, we have completed the what happened stage. The next step is to determine why the results are as shown in Figure 15-5. As mentioned earlier, it is extremely difficult to answer this question. In the midwestern region, for example, the sales force obtained only about two-thirds as many orders as in the eastern region (2,500 versus 3,800). Was this because Colorado did about half as much advertising in the Midwest as in the East? Or does the reason he in poor selling ability or poor sales training in the Midwest? Or is competition simply much stronger in the Midwest?
After a profitability analysis has determined why the regional results came out as they did, management can move to the third stage in its performance evaluation process. That final stage is to determine what management should do about the situation. We shall discuss this third stage briefly after we have reviewed some major problem areas in marketing cost analysis.
Problems in Marketing Cost Analysis
Marketing cost analyses can be expensive in time, money, and personnel. Today, however, the use of computerized information systems enables management to generate data that are more current, more detailed, and lower in cost than was true in the past. But even the computers so far have not overcome the problems related to cost allocation and the contribution-margin versus full-cost controversy.
Allocating Costs
As a foundation for our discussion of cost allocation, let's first distinguish between direct and indirect expenses.
Direct versus Indirect Expenses
Direct costs are incurred in connection with a single unit of sales operations. Therefore, they can readily be allocated in total to a specific marketing unit, whether it is a territory, product, or customer group. If the company dropped a given territory or product, all direct expenses tied to that marketing unit would be eliminated. These are expenses that can be separated from other costs. Indirect costs are those shared by more than one market segment. In general, most marketing costs are totally or partially indirect.
Whether a given cost is classed as common or separable depends on the market segment being analyzed. The cost never remains permanently in one or the other category. Assume that each salesperson in a company has a separate territory, is paid a straight salary, and sells the entire line of products. Sales force salaries would be a direct expense if the cost analysis were being made by territories. But the salary expense would be an indirect cost if the cost were being studied for each product. They cannot be separated by product. Sales force travel expenses would be a direct territorial cost but an indirect product cost.
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The term ove.
442 Evaluating Sales PerformanceAt this point in our p.docx
1. 442 Evaluating Sales Performance
At this point in our performance evaluation, we have completed
the what happened stage. The next step is to determine why the
results are as shown in Figure 15-5. As mentioned earlier, it is
extremely difficult to answer this question. In the midwestern
region, for example, the sales force obtained only about two-
thirds as many orders as in the eastern region (2,500 versus
3,800). Was this because Colorado did about half as much
advertising in the Midwest as in the East? Or does the reason he
in poor selling ability or poor sales training in the Midwest? Or
is competition simply much stronger in the Midwest?
After a profitability analysis has determined why the regional
results came out as they did, management can move to the third
stage in its performance evaluation process. That final stage is
to determine what management should do about the situation.
We shall discuss this third stage briefly after we have reviewed
some major problem areas in marketing cost analysis.
Problems in Marketing Cost Analysis
Marketing cost analyses can be expensive in time, money, and
personnel. Today, however, the use of computerized information
systems enables management to generate data that are more
current, more detailed, and lower in cost than was true in the
past. But even the computers so far have not overcome the
problems related to cost allocation and the contribution-margin
versus full-cost controversy.
Allocating Costs
As a foundation for our discussion of cost allocation, let's first
distinguish between direct and indirect expenses.
2. Direct versus Indirect Expenses
Direct costs are incurred in connection with a single unit of
sales operations. Therefore, they can readily be allocated in
total to a specific marketing unit, whether it is a territory,
product, or customer group. If the company dropped a given
territory or product, all direct expenses tied to that marketing
unit would be eliminated. These are expenses that can be
separated from other costs. Indirect costs are those shared by
more than one market segment. In general, most marketing costs
are totally or partially indirect.
Whether a given cost is classed as common or separable
depends on the market segment being analyzed. The cost never
remains permanently in one or the other category. Assume that
each salesperson in a company has a separate territory, is paid a
straight salary, and sells the entire line of products. Sales force
salaries would be a direct expense if the cost analysis were
being made by territories. But the salary expense would be an
indirect cost if the cost were being studied for each product.
They cannot be separated by product. Sales force travel
expenses would be a direct territorial cost but an indirect
product cost.
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The term overhead costs is frequently used to describe a body of
3. expenses that cannot be identified solely with individual
product lines, territories, or other market segments. Sometimes,
overhead costs are referred to as fixed costs. However, it is
preferable to think of these items as indirect rather than fixed
expenses. They are fixed only in the sense that they are not
directly allocable among territories, product lines, or some
other group of market segments. The point is that these costs
cannot be attached solely to individual market units.
Difficulty of Allocating Costs
A major problem in a marketing cost analysis is that of
allocating marketing costs to individual territories, products, or
whatever segment of the market is being studied. Actually, the
problem of prorating arises at two levels: (1) when accounting
ledger expenses are being allocated to activity groups and (2)
when the resultant activity costs are apportioned to the separate
territories, products, or markets.
A direct cost can be allocated in its entirety to the market
segment being analyzed. This phase of allocation is reasonably
simple. For example, assume that a territorial cost analysis is
being made and each salesperson has a territory. Then all of a
given rep's expenses—salary, commission, travel, supplies, and
so on—can be prorated directly to that rep's territory. Some of
the advertising expense, such as the cost of ads in local
newspapers and the expense of point-of-purchase advertising
materials, also can be charged directly to a given territory.
However, the majority of costs are common (indirect) rather
than separable, and real allocation problems occur with these
expenses. For some costs, the basis of allocation may be the
same regardless of the type of analysis made. Billing expenses
are often allocated on the basis of number of "invoice lines,"
whether the cost analysis is by territory, product, or customer
group. An invoice line is one item (six dozen widgets, model
1412, for example) listed on the bill (invoice) sent to a
customer. Assume that 22 percent of all invoice lines last year
related to orders billed to customers in territory A. Then 22
4. percent of total billing costs would be allocated to that territory.
A cost analysis by product line or customer group would use
this same allocation basis—number of invoice lines—when
apportioning billing costs.
For other costs, however, the basis of allocation would vary
according to whether a firm analyzes its costs by territory,
product, or customer group. Consider sales force salaries as an
example. In a territorial cost study, these salaries may be
allocated directly to the district where the people work. In a
product cost analysis, the expense probably is prorated on the
proportionate amount of working hours a rep spends with each
product. In a cost analysis by customer classes, the salaries may
be apportioned in relation to the number of sales calls on each
customer group.
Allocating Totally Indirect Costs
The last big allocation problem discussed here concerns costs
that are totally indirect. Within the broad category of indirect
expenses, some costs are
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444
Evaluating Sales Performance
partially
indirect and some are
totally
indirect. Many expenses do carry some degree of direct
relationship to the territory or other marketing unit being
analyzed. Order-filling and shipping expenses, for example, are
par
tially indirect costs. They would
decrease
5. to some extent if a territory
or product were ehminated. They would
increase
if new products or territories were added.
However, other cost items, such as sales administrative or
general ad
ministrative expenses, are
totally
indirect costs. The cost of maintaining the chief sales execu
tive (salary, staff, and office) remains about the same, whether
or not the number of territories or products changes.
Many administrators question whether it is reasonably possible
to al
locate totally indirect costs. Consider, for example, the problem
of
allocat
ing general sales manager Cruz's expense to territories. Part of
the year, Cruz travels in these districts. The costs of
transportation, food, and lodg
ing on the road probably can be allocated directly to the
territory in
volved. However, how sho
uld Cruz's salary and office expenses be apportioned among
sales districts? If Cruz spends a month in territory A and two
months in B, then presumably one-twelfth of these expenses
may be allocated to A and one-sixth to B. At the same time, this
method may
be unfair to territory A. During the month's stay in A, Cruz
spent much time on the telephone discussing unforeseen
difficulties in territory F. More
over, how would the company apportion the expenses incurred
while Cruz is in the home office and not deal
ing with the affairs of any one particular territory?
Three methods frequently used to allocate indirect costs are
shown in Figure 15-6. Each method reflects a different
philosophy and each has obvious drawbacks.
6. ) (
FIGURE 15-6
)
3
Management of a Sales Force, 12th Edition
(
Method
)Methods Used to Allocate Indirect Costs
Evaluation
Divide cost equally among territories or Easy to do, but
inaccurate and usually
unfair to some market segments.
whatever market segments are being analyzed.
Allocate costs in proportion to sales
volume obtained from each territory
(or product or customer group).
Allocate indirect costs in same
proportion as the total direct costs. Thus if product A accounted
for 25 percent of the total direct costs, then A also would be
charged with 25 percent of the indirect expenses.
Underlying philosophy: apply cost burden where it can best be
borne. That is, charge a high-volume market segment with a
large share of the indirect cost. This method is simple and easy
to do but may be very inaccurate. Tells very little about a
segment's profitability and may even be misleading.
Again, easy to do but can be inaccurate and misleading. Falsely
7. assumes a close relationship between direct and indirect
expenses.
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An Ethi
cal Dilemma
)One of the problems typically encountered in a marketing cost
analysis is the difficulty of allocating total indirect cost. These
costs include such items as the salaries and office expense of
the top sales executives in a firm. In Figure 15-6, we noted
some commonly used methods for allocating these expenses.
One such method is to allocate indirect expenses in proportion
to the sales volume or gross margin generated in each territory.
Assume that a midwestern territory generated $1 million in
sales last year and an eastern district's Bales were $2 million.
Then the eastern territory's allocation of indirect expenses
8. would be twice that of the mid-western unit. The underlying
rationale for this expense-allocation basis is that the cost
burden should be placed where it can best be borne. That is, the
biggest volume (or gross margin) territories should absorb the
largest share of indirect costs.
The salespeople and sales managers in these big territories
understandably object to this cost-allocation system. The
objections increase especially when the reps' or the district
managers' compensation includes a profit-sharing element.
Those people also object when their performance evaluations
include a review of the district's net profitability.
Question: Is it ethical to allocate indirect expenses to territories
on the basis of where these costs can best be carried?
Use of Findings from Profitability Analysis
So far in our discussion of marketing cost analysis, we have
dealt generally with the first stage in the evaluation process.
That is, we have been finding out what happened. Now let's
look at some examples of how management might use the
combined findings from both sales volume and marketing cost
analyses—the profitability analysis.
Territorial Decisions
Once management has completed its volume and cost analyses,
it may decide to adjust territorial boundaries to match their
current potential. Possibly the district is too small. That is, the
potential volume is not adequate to support the expense of
covering the territory. Or it may be too large, forcing the
salesperson to spend too much time and expense in traveling.
Management also may consider a change in selling methods or
channels in an unprofitable area. Possibly mail or telephone
selling should be used instead of mcurring the expense of
personal-selling visits. A company that sells directly to retailers
or industrial users may consider using wholesaling
9. intermediaries instead.
A weak territory sometimes can be made profitable by an
increase in advertising and sales promotion. Possibly, the
salespeople are not getting adequate support. Or competition
may have grown so strong that management must be resigned to
a smaller market share than formerly.
The problems in poor territories may he with the activities of
the salespeople. They may need closer supervision, or perhaps
too large a percentage of their sales comes from low-margin
items. They also may simply be poor sales reps.
448 PART 5 Evaluating Sales Performance
As a last resort, it may be necessary to abandon a territory
entirely, not even using the facilities provided by mail,
telephone, or middlemen. Possibly the potential once present no
longer exists. However, before dropping a territory from its
market, a company should consider the cost repercussions. The
territory presumably has carried some share of indirect,
inescapable expenses, such as marketing and general
administrative costs. If the district is abandoned, these expenses
must be absorbed by the remaining areas.
Products
When a cost analysis by products shows significant differences
in the profitability of the product line, the executives should
determine the reasons for the differences. It may be that these
profit variations stem from factors (typical order size or
packaging requirements, for example) that are firmly set. That
is, management has very little opportunity for profit
improvement. On the other hand, many low-profit items often
do present opportunities for administrative action. A firm may
simplify its line by eliminating some models or colors for which
there is little demand. Also, simplification allows the sales
force to concentrate on fewer items and probably increases the
sales of the remaining products.
10. Sometimes a product's profitability can be increased by
redesigning or repackaging the item. Packaging the product in
multiple rather than single units may increase the average order
size. This will cut the unit costs of order filling, shipping, and
packaging. Another possibility is to alter (increase or decrease)
the amount of advertising and other promotional help
appropriated for the product. Possibly, a change in sales force
compensation is needed to (1) increase the sales of profitable
items or (2) discourage the sales of low-margin goods.
A low-volume item cannot always be dropped from the line. Nor
can a company always drop an item even though it shows an
irreducible net loss. The product may be necessary to round out
a line, and the customers may expect the seller to carry it. Thus,
eliminating the products might damage the firm's relationships
with important clients.2
Customer/Size of Order
As suggested in Chapter 14 by the 80-20 principle, some
customers are much more important to the firm than other
customers. In fact, a profitability analysis can reveal that
selling to and servicing certain customers actually loses money
for the sales organization. In such an analysis, Georgia-Pacific's
(GFs) supply chain team found that it was losing money
providing expedited transportation and distribution services to a
major customer. After seeing this information, the customer was
willing to work more collaboratively with GP in order to lower
costs and raise profits. Surprisingly, many companies never
bother to do such an analysis and thus have no clue about the
relative profitability of their customers.3
A key step in this regard is to calculate how much money is
spent to get the orders of each customer. A common situation
plaguing many companies is the small-order problem. That is,
often orders are so small that they result in a loss to the
company. Many costs such as direct selling or billing are often
the
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same for each order, whether it is for $10 or $10,000. A cost
analysis by customer groups is closely related to an analysis by
order size. Frequently, a customer class that generates a below-
average profit also presents a small-order problem. Sometimes
large-volume purchasers build up their volume by giving the
seller many small individual orders. Management should review
both their customer and order-size analyses before making
policy decisions in these areas.
Some firms find that certain customers are costing them too
much, and thus they end the business relationship.4 Firing
unprofitable customers, however, is not always the right choice.
Management first should determine why the accounts are
unprofitable and why the average orders are small, and then
consider ways to improve these situations. Several reasons may
account for a customer's small orders or unprofitableness. For
instance:
· An account buys a large amount in total over a period of a
year, but the customer buys in small amounts from several
suppliers.
· A company buys a large amount in total and all from one
supplier. But this customer purchases frequently, so the average
order is small. The increasingly popular just-in-time (JIT)
inventory control systems typically involve the frequent
delivery of small orders. However, a JIT delivery system is
usually a part of a profitable, long-term purchasing
commitment. Consequently, both the buyer and seller can
benefit from a JIT inventory control strategy.
· An account is small but growing, and a seller caters to it in
12. hope of future benefits.
· A customer is small and, as far as can be projected into the
future, will remain small.
There are many practical suggestions for increasing the average
size of an order or for reducing the marketing costs of small
orders. See Figure 15-8 for examples.
flGURt 15-8
Ways to Increase Ord?F Size and 8 Educate customers who
buy from several different suppliers. Stress the Reduce Small-
Order Marketing advantages of purchasing from one
supplier.
Ql^ • For customers who purchase large total quantities in
frequent small orders,
stress the advantages of ordering once a month instead of once a
week. Point out that the buyer eliminates all handling, billing,
and accounting expenses connected with three of the four
orders. Note further that the buyer writes only one check and
one purchase order. In addition, stress that there will be only
one bill to process and one shipment to put into inventory
instead of three or four.
· Educate the Bales force as well as customers. In fact, it may
be necessary to change the compensation plan to discourage
acceptance of smaller orders.
· Substitute direct mail or telephone selling for sales calls on
unprofitable or small-order accounts. Or continue to call on
these accounts, but less frequently.
a Shift an account to a wholesaler or some other type of
intermediary rather than
dealing directly, even by mail or telephone. " Drop a mass-
distribution policy and adopt a selective one. This new policy
may
actually increase sales because sales reps can spend more time
with profitable
accounts.
· Establish a minimum order size.
· Establish a minimum charge or a service charge to combat