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Marketing finance[1]


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Marketing finance[1]

  1. 1. Unit I Introduction to Marketing Finance This subject introduces the way in which financial analysis can be used in marketing, and gives a brief overview of the areas in marketing where knowledge of finance can be very useful, particularly in helping marketers gauge how well strategy is working, in evaluating marketing research alternatives, developing future plans and in marketing control. Financial skills are critical in today's environment. Marketing professionals need to have the ability to analyze the projected Return on Invest (ROI) of a marketing endeavor to corporate decision makers. The understanding and Evaluate the cost/benefit trade off or a new project, this would include discounting back net present values of future projected cash inflows, and comparing the (NPV) to the marketing project's budgeted expenditure. The multiple channel options of advertising, public relations, digital media, and live events, there are endless means of creating connections and touch-points with customers. Unfortunately, a lack of communication between marketing and finance often stands in the way of maximizing the results of an integrated marketing strategy. Finance and Marketing can (and should) collaborate to drive higher bottom-line performance. Marketing and Finance Integration Marketing and finance departments in a company are generally at odds with each other due to their opposing orientations. But their qualities, when integrated, can be productive and greatly enhance value of the corporation. Financial input in marketing can create shareholder value and demonstrate how to achieve the required integration of the finance function with marketing for the successful modern business. The functions of these departments are as follows. Marketing function-To generate sales (revenue, income) to be used by finance department to meet costs, capital expenditure, service capital, strengthen firm’s financial position Finance Function-To ensure that a firm remains financially strong, solvent, liquid and profitable by employing its resources (raised/generated) efficiently, productively and profitably. Finance department is responsible for overall management of the finances of the company. It is concerned with budgeting, costing, risk diversification etc. Finance department has to see that money is being distributed properly. On the other hand, marketing department is responsible for realizing the wishes of the customers and then designing a product according to these needs so that customers are satisfied. Quite often, these functions run into problems and are unable to work to their full potential because of inherent relationship issues. The lack of co-operation soon becomes apparent when the team
  2. 2. members work at cross purposes. Some of the conflicts that arise between these functions are addressed here. Objectives for learning marketing Finance Financial analysis can be used to serve many purposes in an organisation but in the area of marketing it has four main functions: a) to gauge how well marketing strategy is working (situation analysis) b) to evaluate marketing decision alternatives c) to develop plans for the future d) to control activities on a short term or-day to-day basis. Importance of marketing finance knowledge to marketer For marketer it becomes necessary to coordinate their plans with functional areas like sales forecast, budgeting and estimating return from market initiative. It helps to understand rate of return on marketing investment & capital investment require to earn profit ROI Definition of 'Return On Investment - ROI' A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. The return on investment formula: For example, a marketer may compare two different products by dividing the gross profit that each product has generated by its respective marketing expenses. A financial analyst, however, may compare the same two products using an entirely different ROI calculation, perhaps by dividing the net income of an investment by the total value of all resources that have been employed to make and sell the product. In the above formula "gains from investment", refers to the proceeds obtained from selling the investment of interest. Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken.
  3. 3. Marketing not only influence the firms profit but it also affect the investment function. Decisions of new plant and equipment, inventories, account receivables are the categories of investment that can be affected by marketing decisions. Before investment decision marketer should understand the position of their company and the returns expected .ROI is often compared with expected rate of return on capital investment Return on investment (ROI) is tool that management can use in evaluating sales performance and in making marketing decisions. This is most commonly used ratio both for interpretation of publish accounts and also for control of internal operation. It is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. A variation of the ROI concept is, return on assets managed (ROAM). The ROAM concept is especially useful for evaluating the performance of field sales managers. Importance of Measuring ROI Creates the ability to understand and communicate the return on your marketing investment Helps to better evaluate which programs are the most effective and which need to be modified or eliminated Assists in getting the resources you need Allows you to have an intelligent conversation regarding your marketing budget Advantages of ROI Challenges for measuring ROI
  4. 4. Problem on Marketing ROI 1. XYZ company annual revenue is Rs. 40, 00,000 using various channels of marketing. Company’s current spending on each channel is Rs. 64000. Total number of transaction during a period by all channels is 4000. Number of customers visited to company is 500 customers. 2. Calculate number of customer require by company for positive ROI if net profit contribution of company is 20%. 3. By considering following information calculate ROI of different channels. Tradeshows Advertisement Direct Mail Tele -Marketing Lead Generated 50 255 800 450 Closed Sales 30 51 40 45 Ans:1. Average Sale = Annual Revenue/Total transaction = 40, 00,000/4000 = Rs. 1000 Average transaction/ customer = Total Transaction / Number of customer = 4000/500 = 8 Transaction Customer Equity = Average Sale * Average transaction = = Customer Net Profit 1000*8 Rs. 8000 = Customer Equity* Net Profit Calculation = 8000*20% = Rs. 1600 Customers Needed to Breakeven = Channel Marketing Investment/ Customer Net Profit = 64,000/1600 = 40 customers Since XYZ company spending 64,000/channel . Each channel need to produce 40 customers to reach breakeven. Producing less than 40 customer is Negetive ROI and more is positive ROI. 2. ROI of Different Channels: Tradeshows Advertisement Direct Mail Tele -Marketing Marketing Investment 64,000 64,000 64,000 64,000 Lead Generated 50 255 800 450 Closed Sales 30 51 40 45 Conversion Rate 6% 20% 5% 10% Life time Net Revenue 48,000 81,600 64000 72000 Marketing ROI -25% 27.5% 0% 12.5% Life time net revenue of Channel = closed sales of that channel * Net profit per customer
  5. 5. ROI = Sales Revenue- Marketing Investment Marketing Investment Evaluation: 1.Advertisement participation is a highly profitable channel; XYZ Company should devote additional resources to this channel. 2. Trade shows are highly unprofitable; XYZ Company needs to reevaluate continuing within this channel. 3. Direct Mail efforts are breaking even; XYZ Company should reevaluate continuing within this channel and/or revamping its current execution. 4. Telemarketing is a profitable channel; XYZ Company should consider devoting more resources to this channel. (Please note, however, one channel can impact the success of another channel and any assessments should try and understand the relationship(s) between channels.) Exercise Problem: Annual Revenue of Surekha Enterprises is Rs. 20,00,000. Company is using different promotional channels for marketing its product . Current spending on each channel is Rs. 1,80,000 .Net profit from each customer is 5000. By using following details evaluate the profitability of each channels. Channels Industry Expo T.V./Newspaper Social Media Direct Marketing Advertisements Enquiry Generated 350 500 75 700 Closed sales 37 42 18 55 Ans: Industry Expo T.V./Newspaper Social Media Direct Marketing Advertisements Marketing Investment 1,80,000 1,80,000 1,80,000 1,80,000 Lead Generated 350 500 75 700 Closed Sales 37 42 18 55 1,85,000 2,10,000 90,000 2,75,000 Conversion Rate Life time Net Revenue Marketing ROI Note : Life time net revenue of Channel = closed sales of that channel * Net profit per customer Evaluation: 1.Direct Marketing & Advertisement participation is a highly profitable channel, company should devote additional resources to this channel. 2. Social Media are highly unprofitable; company needs to reevaluate continuing within this channel. 3. Industry Expo is near to break even; company should reevaluate continuing within this channel
  6. 6. Sales Revenue Analysis Definition of Sales Analysis – a detailed examination of a company's sales data, involving assimilating, classifying comparing, and drawing conclusions. Control is one of the most critical functions performed by a sales manager as it measures the performance of the system and helps the manager take corrective action if the performance of the system is not in agreement with the formulated plans. The present day dynamic marketplace has forced sales managers to shift their focus in sales control from sales volume alone and to lay equal emphasis on costs incurred in implementing the sales effort. The objective of sales control is to ensure that the company's sales efforts are in tune with its sales plan by taking necessary measures in case of deviations. The sales control function measures the performance of the sales force and identifies the problems and opportunities that the firm is exposed to. The process of sales control involves setting goals, comparing actual with the targets, and taking up corrective action if necessary. The sales efforts of a company can be studied through a sales analysis that involves gathering, classifying, comparing, and studying the sales data of the company. A typical sales analysis involves deciding on the purpose of evaluation, comparing the sales figures with some standards and processing the data to generate reports. An analysis of volume of sales by categories is very helpful in identifying the root causes of the problems in the sales activities of the firm. Though a sales analysis helps identify the problems associated with the sales activities of the firm. It is also bound by a few limitations like dependency on accounting records, inability to reflect the profitability of sales, etc. Significance of Sales Revenue Analysis 1. To get valuable information for proper decision making 2. For allocation of marketing budget 3. For cost optimization 4. To channelize the activity 5. Strategy formulation 6. Evaluation of existing strategy Uses of sales analysis Several major broad applications of sales analysis follow: 1. Establishment of the sales forecasting system. 2. Development of sales performance measures. 3. Evaluation of market position. 4. Production planning and inventory control. 5. Maintaining appropriate product mixes. 6. Modifying the sales territory structures. 7. Planning sales force activities. 8. Evaluation of salespeople's performance. 9. Measuring the effect of advertising and other sales promotional activities.
  7. 7. 10. Modifying channels of distribution. 11. Evaluating channels of distribution. Analysis of Sales Revenue The most common procedure of sales by some appropriate groupings such as: 1. geographic regions or territories 2. product, package size 3. market, class of customer 4. method of sale 5. size of order 6. financial arrangements Product wise of Sales Revenue Analysis An analysis of company sales requires that the data be disaggregated by product line. Sales of each product must be studied by comparing them to industry sales. Sales analysis involves analyzing the sales volume or the total sales of the company. It includes the total sales of the company by territory, customer, and product category. A sales audit is periodically taken up by the sales management to examine the entire selling operations of the firm. An analysis of company sales requires that the data be disaggregated by product line. Sales of each product must be studied by comparing them to industry sales. The analysis involves four steps. First, the past sales pattern reveals growth rate and degree of instability. Second, company sales are compared with industry. Third, the impact of economic trends and cycles is incorporated. Finally, corporate strategies indicate if past patterns will remain or change. Measurement of product wise profit can be attempted by comparing the sales revenue of each product with cost associated with its production, selling & distribution Product wise profitability analysis will be more complicated for large companies having diversified product range and operating through a large number of sales and distribution set ups Product wise profitability analysis helps in – 1. Identifying most profitable product so that more sale of that product could be encouraged 2. Allocating funds available for future investment among various product division 3. Maintaining the close control over cost The analysis involves four steps. 1. The past sales pattern reveals growth rate and degree of instability. 2. Company sales are compared with industry. 3. The impact of economic trends and cycles is incorporated. 4. Corporate strategies indicate if past patterns will remain or change.
  8. 8. 1) - Past rate of growth To determine the trend of each product sales, the two or three years of results reported in annual reports is not sufficient. There are two cases where that would not be true.  First, for a product that has a very stable and steady market (e.g. a basic consumer item such as milk), sales are increasing from year to year by the same rate (e.g. population growth); but, naturally, that is also the case where there is little to analyze.  Second, in the case of new products or company restructuring, only very recent sales are relevant. Consolidated sales data is usually given for several years (five or ten), but sales by major segments of activity go only back one or two years. This means that several annual reports must be obtained. A monthly break-down is imperative to study seasonal variations and to make projections for less than one year. Monthly sales would only be available to an analyst inside the firm. For long term lending or investment decisions monthly data is not necessary. For seasonal lines of credit, loan officer would require monthly sales along with a cash budget. Once an adequate data set is put together (i.e. a minimum of ten years), an analyst must decide whether to use the actual numbers or adjust them for inflation. If data series are in current currency, an adjustment is not needed. If real data series are used, such as demographic statistics, then sales should first be deflated (i.e. divided by an index of inflation appropriately chosen for the product in question) so that the amounts in dollars correspond better to actual quantities sold. Then, a time-series analysis is used to determine the long term trend in sales growth. In general, calculation of a growth rate statistic is needed to decide whether the product has a high, low or moderate growth. To determine if a sales growth is high, one would compare it to the average aggregate real rate of growth of personal consumption expenditure for consumer products, or gross domestic investment for equipment and machinery. If the sale growth rate is higher than the aggregate, that indicates that the product life cycle is still in an early stage, otherwise the product is beyond its maturity. Next, the level of sales instability can be measured by calculating the standard deviation and comparing it to standard deviation of output of the sector, and of other companies in the same industry. Note that aggregate series are by their nature more stable than their constituent components, and it is not very useful to compare their variability with that of a single company. It is normally expected that instability and growth go together. If there is no growth but significant instability, that suggests that demand is unstable for this product. This may be caused by large clients placing occasional large orders (e.g. such as those for Airbus and Boeing), or strategies of competitors taking away customers. The emphasis must therefore be placed on an analysis of demand and competitors. Especially, a technological forecast would show whether potential new products are likely to wipe out all hope of sales recovery. If that is the case, further analytical work is pointless. Otherwise, a temporary slump has to be explained.
  9. 9. If, on the contrary, growth is healthy but very steady, that may suggest that sales are not affected as much by demand as by production. Although that is a desirable situation for the company, an analyst may question whether some demand remains unsatisfied, and that unsatisfied demand may attract new competitors. In this case, it is the constraint existing in production (or legislation) that must be investigated. In addition, market research can reveal the magnitude of the actual demand. If growth and instability are both high, analysis is difficult. It is possible that if sales are growing very rapidly but by jumps, this may indicate that growth has been generated by acquisitions of other companies. Growth through acquisition is naturally a very good sign of financial strength and market dominance for the acquiring company. But acquisitions must also be digested, and have occasionally gone sour. Moreover, there is a finite number of firms that can be acquired. Lastly, earlier and subsequent comments about conglomerates suggest that conglomerates are incapable of a continued indefinite growth that is healthy. For all the cases in between (i.e. neither excessive nor non-existent instability), the next step is to correlate the sales pattern to economic patterns. 2) - Relation of sales to economic trends Economic patterns are either cyclical or long term. This analysis is most accurately conducted with regression or sensitivity analysis, at industry level. A quicker and less formal approach relies on graphs of plotted sales and aggregate economic data. A first observation should tell whether company sales vary more, less or to the same extent as the reference business cycle. Sales of very few products move in opposite direction to the business cycle; they are, thereby, labeled counter-cyclical. Attorneys specializing in bankruptcies may be one example. Less rare are products that are little affected by the business cycle. These are basic items of personal use such as toothpaste, health products and numerous food items. An extreme example is that of funeral parlors. For each of these types of products, linking sales to the underlying demand variable is sufficient. Most product sales are pro-cyclical, but the sales may precede or lag the pattern of spending in the overall economy. When conducting the regression analysis, one must always test for the presence of a lag or anticipation in company sales pattern relative to the reference cycle. For instance, industries that are affected by cost of capital will precede the business cycle, while industries affected by changes in aggregate output will lag the cycle. If a close fit exists between sales and cycle (lagged or not) it shows that other elements (i.e. industry and long term trends) have only minor influence. If sales are growing well, but do not coincide with the cycle, there must be some other influence. This influence can be one or a combination of long term changing social patterns. Sales sensitivity to these patterns needs to be tested. If none give a reasonable explanation, then sales growth must be attributed to company unique strategy and to conditions in the industry.
  10. 10. 3) - Industry considerations Industry sales are studied in a similar sequence to that of a company: growth, instability, cyclicality and sensitivity to long term social-economic patterns An analyst would indeed want to compare the industry sales behavior with that of the company. This would tell if the company is falling behind, or not, and if sales are affected by similar processes. A shortcut that avoids this extensive investigation, is to calculate the market share of the company over the period of years studied. If the market share has remained steady, it shows that industry and company sales have moved in parallel, that the market is not subject to aggressive strategies of competitor, and that demand is not much disturbed by changing social patterns. This also suggests that an aggressive company strategy may be a waste of efforts. If the company market share has been going up, that has to be a good sign. Reasons must be traced to company strategy. If the investigation does not reveal that. Then one must find out why competitors are pulling out of the market. If the company is losing market share, the causes are of major concern. An analyst must find out what strategies are used by competitors: price, technology, convenience, location, or other. If the investigation does not give definitive answers, then changing socio-economic patterns must be looked at again with greater attention. This would also justify a market research for an analyst inside the company. 4) - Market research A market research can be expensive and lengthy. Clearly, it is recommended only if the sales analysis using available statistical and historical information does not give adequate answers. Market research uses a variety of techniques such as surveys, interviews, panels, market tests and expert opinions. It is intended to reveal customer preferences: i.e. the reasons why customers buy certain products, and therefore do not buy others. For the company, a market research is indispensable for strategy formulation, and is conducted periodically. For an outside analyst, a market research on a product is inconceivable unless the decision at hand is a purchase of the company. 5) - Foreign market considerations Sales in foreign markets are studied in the same manner as domestic sales, with the exception that tastes, socio-economic patterns, business practices, legislation and other market conditions, are different and less well understood by the analyst than domestic ones. In addition, statistical data in almost all foreign markets is deficient. On a more positive note, sales growth in foreign markets usually follows by a few years that of the domestic market. In today's increasing global economy, one would want not to make a distinction between domestic and foreign markets. But, except for a few countries that are very close culturally and economically to one's own country, the distinction is still warranted. 6) - Company strategy After accounting for all external factors (except possibly luck), i.e. business cycle, socio-economic changes, competitors' strategies, consumer preferences and foreign market conditions, what remains are
  11. 11. internal reasons for sales variations. One would want to think that company sales are the result of carefully planned and deliberate management decisions in aspects of product, price, place and promotion (also known as the four P's of marketing). Consequently, any change in market share ought to be reflected by a prior marketing strategy, or lack thereof. An analyst must also investigate that the company does not suffer from: defective purchasing or production (i.e. two other P's). If exceptional sales growth is most certainly attributable to a wise company strategy, an analyst must give management recognition, and take this into account in sales projections. If, on the contrary, sales have been erratic or slumping, suggesting a history of marketing mistakes that the company is correcting in the current plan, that still justifies an analyst's confidence. But no such redemption is warranted if neglect is apparent in company approach to its market Territory wise of Sales Revenue Analysis  Measurement of Territory wise profit can be attempted by comparing the sales revenue of each Territory with cost associated with its production , selling & distribution  Territory wise analysis helps in 1. Identify the selling expenses incurred by each territory 2. Requirement of the promotion expenses to increase sales revenue 3. Cost of credit incurred by each territory Channel wise of Sales Revenue Analysis  Analysis of marketing method and channel type helps in 1. To take decision of selling method i. e. Direct to customer, or through wholesaler or retailer, or commission agent. 2. Order size and order handling cost to the firm. 3. To analyze the performance of salesman; cost of sales calls, cost of orders booked, order to call ratio etc. 4. For discount classification; cost incurred at each price category. Sales Revenue Analysis of Revenue by Customer order 1. To evaluate the profitability as per customer type 2. An order size of customers purchases 3. The proportion of cash and credit sales in each customer type. 4. The mode/manner of delivery taken by customers