Description
Cost-Revenue-Investment Framework in marketing, Parameters for developing marketing budgets, evaluation of salesman's performance, meaning and significance of marketing audit.
MARKETING FINANCE INTERFACE 1. Introduction, 2. Marketing Finance Independence, 3. Marketing Finance Interdependence, 4. Cost-Revenue-Investment Framework in marketing. 1. INTRODUCTION The preceding two chapters conveyed a general idea about the nature and purpose of marketing on the one hand and the role and functions of finance on the other, besides a bird’s-eye view of the various subfunctions broadly covered under both marketing and finance functions in an organization. This Chapter will endeavor to synthesize these ideas and examine to what extent these two important functions are independent and also interdependent. An attempt will also be made to highlight how the success of an enterprise would, to a great extent, depend upon the closest possible coordination between marketing and finance. There has been a tendency, for a long time now, to treat marketing and finance as two completely different functions and separate them into water-tight compartments. Unfortunately, this tendency has been more evident among typical Indian enterprises. Marketing people have tended to create an impression that they are the money – spinners and accounting and finance, just as many other functions, is unproductive staff – parasites living on their (i.e. marketing peoples) earnings and with no contribution of their own. Finance people, on the other hand, with rigorous professional qualifications in most cases, have tried to find faults with marketing people and despised their lack of knowledge of finance and even sometimes condemned openly their high-handed attitude or frittering away the company’s precious financial resources. There is, however, a welcome sign of such tendencies steadily yielding place to an attitude of co-operation and co-ordination with a view to fulfilling the overall corporate objectives. body fight with one another the By now they might have health suffers and learnt the moral of the time-honoured fable that if the limbs of the overall consequently all the limbs, too. Yet, some conflict does exit between marketing functions and finance functions in most of today’s organizations. The marketing manager is unhappy with the accountant when the latter tightly controls the marketing staff’s traveling expenses or the sales promotion budges. An accountant’s financial wizardry of keeping the company’s interest cost low is frustrated by the marketing manager’s expertise at extending credit to the valued customers or holding more stocks at
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distribution points.
The attempt of the management accountant to
prepare a realistic budget for the company is seriously hampered by the marketing manager’s highly optimistic or highly pessimistic predictions. different. At the end of the year the actual sales are very much When they are below the prediction level, the marketing
manager is sure to produce his ‘Magna Carta’ of reasons to justify the dismal results which had it not been for him, would have been even more dismal. And next year once again come the unrealistic predictions which the marketing manager insists are realistic and there begins the management accountant’s predicament. 2. MARKETING FINANCE INDEPENDENCE. Let us first examine to what extent marketing and finance functions are independent of each other. If you analyze the nature of these functions, you will find that there exists a great deal of independence. Marketing functions by and large lie outside the organization. On the one side, there is the marketplace and on the other, there is the organization. In the marketplace there are customers, negative The marketplace is customers and neutral or potential customers. political and social changes.
always in a state of flux. It is also continuously affected by economic, Such changes are again of a very complex and interdependent nature. All such changes and forces and interactions at the marketplace are transmitted to the organization through one important function of marketing, viz. market research. Based on such factors and forces the organization takes certain decisions which are again reflected in the marketplace. Finance function by its very nature is internal to the organization. An important part of the finance function, i.e. statutory accounting or custodian accounting, is responsible to outsiders, viz., shareholders, Government authorities, auditors etc. But all other functions under finance do not owe any allegiance to outsiders and the degree of dependence, too, is little. Financial management, particularly to the extent it relates to making available financial resources from outside, is influenced rather widely by external factors, especially capital market situations. But this influence is significantly different both in character and quality from the influences that market forces constantly exert on the marketing functions. These points would lead us to believe that the nature of marketing is completely different from that of finance. And these two functions have to be discharged more or less in an isolated manner. Also these two functions require completely different types of technical and
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human skills.
This would be evidence from the fact that a very
successful salesman often turns out to be an utter failure as an accounts assistant just as a very efficient accounts man may make a mess of sales if he is asked to handle this. 3. MARKETING FINANCE INTERDEPNDENCE A general tendency to treat marketing and finance as two different functions and separating them into water-tight compartments is happily yielding place to the coming together (of these two functions) with an attitude of mutual co-operation and coordination. This welcome change may be traced to two reasons. First, these two sets of people have generally realized that they are working for a common cause in order to fulfill common corporate objectives of survival, profitability and growth. Second, there are quite a few important areas where marketing and finance specializations tend to overlap. Some of these are: i. ii. iii. iv. Product planning including product selection, retention and abandonment as well as dilution in product portfolio; Product pricing including both short-range and long-range pricing policies and strategies. Evaluation of marketing performance – both general and specific marketing functions like product profitability analysis. Functional Cost Analysis to achieve cost effectiveness and also for v. vi. vii. exercising a systematic and meaningful control over marketing costs and expenses; Introduction and operation of an effective budgetary control system in marketing; Control of marketing operation – both the employment of funds and the cost of inputs; and Marketing investment decisions including monitoring their implementation. Then there are several commercial and fiscal issues (also under the domain of Finance) that should be addressed jointly by Finance and Marketing people: Some of these – illustrative and by no means exhaustive – are: i. ii. iii. iv. Sale on consignment basis, sale on approval or sales or return type of transactions. Leasing and hire purchase transactions. Interest element on credit granted and the related concept called average due date. Bills of exchange and hundies.
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v.
Recovery of excise duty through invoicing and keeping the said duty undisturbed even when the sale is made at a discount.
vi.
Recovery of sales taxes-both Central and State – through invoicing and collection of sales tax declaration forms (Forms C & D, as the case may be)
Some progressive companies in India have therefore set up Marketing Finance Cell on the same lines as Market Research Cells. A Marketing Finance Cell is staffed by personnel possessing expertise in both finance and marketing, so that they can provide staff assistance to marketing management at all levels in all the important areas listed above, as and when necessary. 4. COST – REVENUE – INVESTMENT FRAMEWORK IN MARKETING This is a perspective view of marketing finance, comprising three components. The term cost has a broad meaning here and covers in its ambit all costs of setting up as well as running a marketing organization. Some of these costs are of one – time nature – “the capital costs” in accounting terminology. Other costs are “revenue” or of recurring nature. But even those one-time capital costs become a part and parcel of the recurring costs through the process of depreciation or amortization, so that in the end all costs get absorbed or recovered through operations. Revenue is what the organizations earn by selling its products and/or services to customers outside the organization. The sum-total of all revenues is matched against the sum-total of all costs, both direct and indirect and the difference is worked out. When the difference is on the positive side (i.e. total revenue exceeds total cost), it means a positive surplus or profit. The negative difference means a loss. To keep the recurring operations going in marketing there has to be some investments. These are broadly of two types viz. investments on capital assets (e.g. motor cars, warehouses, office equipment, etc) and those on working capital (e.g. inventory, accounts receivable, etc.). The recurring costs of such investments have to be absorbed as stated above, along with the direct costs, by revenues earned through marketing efforts. (a) Depreciation etc. Recurring cost due to investments in marketing or diminution in respect of capital assets, usually takes any or both the following forms: inventory, value of amounts to be collected from customers,
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(b)
Financing or interest charges (actual or notional) covering all investments both in fixed assets and in working capital.
The cost revenge-investment inter-relationship discussed above is succinctly represented by a financial ratio called the Return on Investment (ROI). This ratio has broadly two components, viz., Return on Sales (ROS) or Margin Ratio and the Turnover of Capital Employed (Times). Return on Investment improves or deteriorates margin percentage on sales. Even with the same margin percentage, ROI can improve or deteriorate drastically through efficiency or otherwise in the deployment of funds or capital employed in marketing operations. In fact it is quite possible to improve ROI percentage by dramatically improving the rate of capital turnover (times), margin percentage remaining the same. This is what is called “Turn and Earn”. 2. PROCESS OF BUDGET SETTING There are important issues that need to be examined and sorted out before starting the detailed budget setting exercise: i) Corporate Objectives – Companies having systematic and organized long range planning (LRP) process will always have before them such long-term objectives, spelt out clearly and quantified. The companies which do not have a LRP system should also develop broad outline about its objectives on a longterm basis, at least for two or three years. The objectives should be set specially in two respects, growth and profitability. Preferably these should be broken up into present products and lines of activities on the one hand, and proposed new products and new lines of activities on the other. ii) Corporate Profit Planning – Profit planning and budgeting are two different things. They are rather interdependent and Profit planning more precisely, complementary to each other.
should precede the detailed budgeting exercise. Basically, profit planning provides a general blue – print of the expected profit and the broad elements through which this can be achieved during a particular budget period. By its very nature, it is a summary plan, not backed by a detailed action plan. From the practical point of view it is always convenient to develop a broad profit plan and get it approved by the top management before detailed budgeting exercise is taken up. budgeting exercise. This will obviate confusion and back and forth referrals which are common in a
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iii) Nature of Markets - By nature of markets, we mean the buyers’ market and sellers’ market. exclusively in the sellers’ market. Rarely is it found that a If that be so, then the company is operating exclusively in the buyers’ market or budgeting exercise would be relatively a simple one. More often than not, a company will be found to operate under a combination of these two types of markets – some of its products being in the buyers’ market and some others enjoying the privilege of being in the sellers’ market. This combination has to be broadly determined since it has a bearing on the marketing budgets. iv) Principal Budget Factor – This is also called a key factor, limiting factor, critical factor or governing factor. It is defined as the factor, the extent of whose influence must first be assessed to ensure that the functional budges are reasonably capable of fulfillment. areas, warehouse restrictions); Limiting factor may be in any of the operational sales activity (demand, sales efficiency, space, space); labour plant capacity (machine hour, namely
bottlenecks in key process); raw materials (shortage, import (general shortage, shortage of skilled labour); management (technical knowhow, efficient and effective executive) and capital (fixed capital, working capital). Key factor may be of an enduring nature or of a purely temporary nature (that is those which may be overcome by suitable management actions). But an adequate consideration of the magnitude or impact of such factors in existence during the budge year is a must in realistic budget – setting. v) Sales Forecasting – Since more often than not sales is the limiting factor, preparation of sales budget is generally the starting point in the budgeting exercise. Sales estimate or sales forecast is the basis of sales budget. Here is a list of the various factors to be considered in arriving at sales estimate or sales forecast : a) Analysis of the past sales to understand the trends of sales and also forecast the future trends. b) Demand Analysis and market analysis to ascertain market potential, market growth, the company’s share of the market, emergence of competition, competitors’ strategy, product design, pricing trends, customers, habits and preferences, etc.
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c) Analysis of reports by salesmen as to expected sales – first hand and fresh from the field reports. d) Examination of general business conditions. e) Examination of special business conditions. f) Production capacity sturdy (or availability study, in case of a pure trading concern. g) Profitability analysis through sales mixes planning to ensure that the profit objective is fulfilled by the proposed sales forecast. vi) Spending for the future – There could be quite a few items of spending for the future like training and development of people, new product development and launch, developing an infrastructure for providing marketing intelligence and undertaking marketing research, etc. Such expenses may not
contribute directly to profit during the budget year and may often bring down the profitability, sometimes significantly. It is therefore, necessary to segregate such expenses from pure operational expenses, at least for the purpose of understanding the budget – year performance and profitability in the right perspective. Management may still commit such expenses on long – term considerations knowing fully well the extent to which this would reduce the profit for the budget year. After having thoroughly evaluated the above issues and prepared some basic inputs as a sequel, one might go about developing the detailed budgets. Efforts should be made of course to direct the entire budget setting activities along a systematic and logical approach, vide a schematic presentation given on page 138. 3. PARAMETERS FOR DEVELOPING MARKETING BUDGETS. Budgeting essentially involves developing a chart, a map or integrated and well – knit plan of action – as much detailed as possible – for a definite period of time to achieve some definite objectives. Budges are nothing but specific estimates of future events and situations. All such estimates have to be based upon some logic, some chain of reasoning, a set of assumptions and a number of parameters. Good budgeting practice requires that all such assumptions and parameters should be laid down in precise terms with quantification wherever possible. If this condition is not fulfilled, the credibility of budgetary controls system or objective evaluation of performance and effective control of operations. The subsidiary or support budget mentioned in the table
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does provide some basic data and worksheets, including some important norms, and assumptions, in support of the principal budgets. Besides these, there could be a number of other assumptions and parameters of varied types. We give below only few such important parameters which would lie behind the framing of the market budgets. i) Distribution Plan: The existing distribution system and any proposed changes in it during the budget year (e.g. change – over from distributorship to distribution through the company’s own sales depots, changeover, partial or full, from sole selling agency system to company’s own marketing, etc.) ii) Advertisement Plan: The usual advertisement through media etc., as well as any extraordinary promotional campaign envisaged during the budget year with detailed cost – benefit analysis in respect of each such plan, change over from advertisement advertisement through through agencies agencies to to the the company’s company’s own own
advertising set – up again with a suitable cost – benefit analysis in this regard, etc. iii) Salesmen’s recruitment and training scheme with its financial implications. iv) Salesmen’s and executives’ travel plans, with estimated expenses against each, showing separately inland travel and foreign travel. v) Salesmen’s incentive scheme. vi) Inventory policy and any changes therein. vii) Credit policy and any changes therein. viii) After sales service set up and basis of charging for services. ix) Import and export policy of the Government. x) Breakdown of sales plan into quota in respect of the various profit centers as well as various sales executives under each. Budgets have to be approved by the top management or the budget committee. should be A detailed review of the budgets should along with some of the important precede the approval. For review and approval, budget figures presented parameters as stated above. Also, for comparison during review, budget statements should include various other sets of figures. Each budget statement should contain at least the following sets of figures : a) b) Previous year – 1 actual; Current year latest best estimates; and
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c)
Budget year estimates. Sometimes, to gain a better idea of the trend for the purpose of budget review, previous year – 2 and even previous year – 3 actual figures are required in each budget statement. Once the annual budgets are framed, finanalised and approved, the budgets have to be broken up into shorter-period budgets are broken into monthly budgets. Some companies restrict themselves to quarterly budgets because of the special nature of their business operations, which some other companies may like to, develop fortnightly, weekly or even daily budgets.
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4. FLEXIBLE BUDGETING While fixed budgets portray a more or less rigid plan based on one set of conditions and one level of activity, flexible budgeting system attempts to develop a series of budgets for various levels of activity and under varying sets of assumptions. Conventionally, flexible budgeting system is associated with production budgets. But there is no reason why this concept should not apply to the marketing budgets also. Infract, marketing budgets could be framed on a more realistic basis and their control made more meaningful and effective with the help of the concept. The expense behavior analysis suggested earlier should form the bedrock of flexible budgeting in marketing, especially for marketing expense budgets. For example, we give here a summary of the marketing expenses broken up into the four functions and indicating the behavior of expenses: Illustration: Flexible Budgeting. The marketing expenses of P. Ltd. have been budged at Rs. 100 lakhs for the current year and their functional allocation is shown below: Functional Allocation of Budgeted Expenses: (Rs. In lakhs) Direct selling Distribution Promotion Other marketing Fixed 10 15 5 10 40 Variable 30 20 10 60 Total 40 35 15 10 100
The sales were budgeted at Rs.1000 lakhs and the quarterly break – up of the budgeted sales is, Quarter I Rs. 160 lakhs
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II III IV
Rs. 240 lakhs Rs. 280 lakhs Rs. 320 lakhs
The actual sales during the I and II quarters were Rs.200 lakhs and Rs. 180 lakhs respectively and the actual marketing expenses were quarter I – Rs.26 lakhs and quarter II – Rs. 23.5 lakhs. A. Fixed Budgeting Under fixed budgeting, no distinction will be made between fixed and variable marketing costs and the total budgeted marketing costs of Rs.100 lakhs would be assumed to be incurred uniformly throughout the year. So quarterly budgets for marketing costs would be Rs.25 lakhs for each quarter. The report on sales and marketing costs would be as given below: (Rs. In lakhs) Quarter I Budget Actual Sales Marketin g expenses (F) Favourable (A) Adverse. B. Flexible Budgeting If a flexible budgeting is followed, the fixed marketing costs of Rs.40 lakhs would be assumed to be incurred uniformly throughout the year. The variable marketing costs would vary with the sales value in each quarter. Since Rs. 60 lakhs of variable costs represent 6% of budgeted sales, the budgeted marketing costs would be as follows: (Rs. In lakhs Fixed expenses Variable expenses 100.00 19.60 24.40 26.80 29.20 Total 40.00 60.00 Qtr.I 10.00 9.60 Qtr.II 10.00 12.40 Qtr.III 10.00 16.80 Qtr.IV 10.00 19.20 160 25 200 26 Quarter II Budget Actual 240 25 180 23.5
Varianc e 40(F) 1(A)
Varianc e 60(A) 1.5 (F)
When actual expenses are to be compared with the budget, the budgeted variable expenses will have to be flexed for the actual sales volume achieved to work out the variances. Marketing Expenses Allowed for Sales Achieved.
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(Rs. In lakhs) Quarter I Fixed expenses 10 Variable expenses 12 (6% of actual sales) Total 22 Quarter II 10 10.8 20.8
The control report under flexible budgeting would be as follows: Quarter I Budget Actual Sales Marketin g expenses During the first quarter, the adverse expenses variance is only Rs.1 lakh under the fixed budgeting method. being higher than budgeted. It will be easy for the marketing department to justify this increase on the ground of sales Similarly, in the second quarter, the However, when we apply the The marketing department will be complimented for showing a favourable expenses variance of Rs.1.5 lakhs. flexible budgeting concept, the position changes significantly. 160 22 200 26 Quarter II Budget Actual 240 20.8 180 23.5
Varianc e 40(F) 4A)
Varianc e 60 (A) 2.7 (A)
adverse variance in the first quarter is Rs.4 lakhs and not Rs.1 lakh. Similarly during the second quarter there is again an adverse variance of Rs.2.7 lakhs and not a favourable variance of Rs.1.5 lakhs. In order to judge expense variance in the right perspective, the flexible budgeting approach would obviously be the correct one. For more effective control of expenses – the same approach or arriving at the revised budgeted expenses figures – the expenses should be allowed with references to the actual activity – can be extended to each functional area. And for this purpose, the budget should also be broken up department – wise as shown at the beginning. Further, to introduce more intensive control, the technique can be adopted on a monthly basis instead of quarterly as shown here. working will however, remain the same. 5. ADMINISTRATION OF BUDGETARY CONTROL SYSTEM Many organizations in India have a reasonably good budgeting system, but the budgetary control system is either non-existent or ill-structured or haphazardly implemented by them. In fact, no matter how systematically it is done, budgeting loses much of its significance and utility unless a budgetary control system is operated in The mode of
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proper perspective. i) ii)
This comprises several important steps that
need to be taken up in a logical sequence, as follows: Developing the budgets as well as breaking these up into department/section wise details and also for shorter period; Continuous comparison a regular periodic intervals, say, monthly or quarterly, between the budgeted figures and the corresponding actual, using suitably designed formats; iii) As a sequent to (ii) above, location of divergences between the budgeted figures and actual figures and pinpointing those that are adverse in nature and higher in magnitude; iv) v) Analyzing the reasons for the divergences so pinpointed; Initiating remedial measures, again through the active involvement of the operating people, in order to correct the adverse divergences in the immediate next time – period; and vi) If any major divergence, whether favourable or adverse, is found to be beyond control during the budget period, then working out a rational basis for revising the budget itself. It is important to use suitably designed formats for presentation of budget actual comparison. suggested to this end: Budget TM (This Month) Budget YTD (Year –to-date) (Year-to date last year) Variance TM Variance YTD Variance YTD LY. Actual TM Actual YTD Actual YTD LY It should provide preferably a multiple frame of comparison and the following column-heads may be
Review and comparison between budgets and actual on a regular and continuing basis and generating budgetary control statements form only one part of the story. off control actions. actions. shoulder But the other part, perhaps the more important part, is the process through which these statements trigger The most vital requirement for this is that somebody has to take up the responsibility of initiating the corrective More often than not it is found that people do not like to the responsibility for taking corrective measures and The reason for the above may be
budgetary control ends there.
attributed to the human factor in budgetary control system, or in any other control system for that matter. People have been found to be a bit too sensitive to adverse variance confronted with the same; they start building up defense mechanisms in their own mind, rather than thinking constructively how to correct
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the situation.
They start finding scapegoats alibis and excuses to
justify non-performance. An atmosphere of mutual faith and confidence has, therefore, to be created in the organization whereby people will look upon variance analyses not as fault – finding or witch hunting exercises, but engage themselves, in a genuine and constructive manner, in coordinated efforts so as to correct the adverse variances. This is of paramount importance, otherwise budgets and standards will continue to go wrong and the entire control mechanism will degenerate into mechanistic rituals with nothing coming out of these. 6. PROFABILITY CONCENT IN BUDGETING Budgeting in marketing area can be rendered more meaningful if the elementary concepts of statistical probability theory are introduced in the budgeting system. This may be explained with reference to a simple budgeting situation as indicated below: Profit Budget for the year 19x5 (Rs. Lakh) Pessimistic Sales at Rs.10 500 per unit Variable costs : Manufacturing Marketing Rs.0.50 per unit Marginal Cost Marginal Moderate 700 per Optimistic 800 unit Rs. 4.80 per unit 384. 40 424 376
Rs.5.10 per unit Rs.5 255 25 280 220 350 35 385 315
Contribution Fixed cost Manufacturing 100 Marketing 20 Administrative 10 Net Income before tax Tax at 50
130 90 45 45
100 20 10
130 185 92.5 92.5
100 20 10
130 246 123 123
percent Net Income after tax
In this case, the two important variables in the budget are the volume of sales and the estimate of variable expenses. We may assign probabilities to the pessimistic, moderate and optimistic estimates on the basis of our past experience and future expectations. Suppose, according to our judgment, the probabilities assigned to the pessimistic, moderate and optimistic sales estimates are 0.3, 0.5 and
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0.2, respectively.
Similarly, let us assume that the probabilities
assigned to the pessimistic, moderate and optimistic estimates of variable costs are 0.2, 0.6 and 0.2 respectively. In the circumstances, we can have 3 further probable estimates of profits under each of the categories, pessimistic, moderate and optimistic, as indicated below: (Rs. Lakh) 1. 2. Sales @ 500 P=0.3 255 250 700 P=0.5 240 357 350 800 P=0.2 336 408 400 384 Rs.10 each) Variables costs Manufacturi ng x (Volume Rs.5.10 or P= 0.2 25 280 P= 0.6 25 275 P= 0.2 25 265 P= 0.2. 35 392 P= 0.6 35 385 P= 0.2 35 371 P= 0.2 40 448 P= 0.6 40 440 P= 0.2 40 424 376 130 246 123 123 0.0 4 4.9 2
Rs.5.00 Rs.4.80) 3. 4. 5. 6. 7. 8. 9. 10 . 11 . Marketing Marginal cost Marginal
220 225
235 308 315 130 130 130 105 178 185 89 89 0.1 0 8.9 0 92.5 92.5 0.30 27.7 5
329 352 360 130 130 130 199 222 230 99. 5 99. 5 0.1 0 9.9 5 111 115 111 115 0.0 4 4.4 4 0.12 13.8 0
contribution Fixed costs 130 130 Net income 90 95 before tax Tax at 50 45 percent Net income 45 after tax Joint 0.0
47.5 52. 5 47.5 52. . 5 0.18 0.0 6 8.55 3.1 5
probability 6 Net income 2.7 after tax x 0 joint probability (9 x 10)
Expected value of income after tax: Rs. 84.16 lakh It may be observed that the absolute estimates incorporated in the budget give rise to a variation of the net income after tax form Rs.45 lakh to Rs. 123 lakh and as such can provide us with an unstable base for future projections. A much better quantification of the future expected income after tax is possible if we incorporate probabilities of a few key variables in our analysis.
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1. Marginal Costing – Basic Concepts; 2. Optimsing Product mix ; 3. The Break Even Concept; 4. The Break-Even Chart; 5. Cost Volume Profit Analysis; 6. Break Even Analysis in a Multi-Product Situation; 7. Conclusion. 1. MARGINAL COSTING – BASIC CONCEPTS Marginal costing is the technique of segregating fixed and variable costs and thereafter arriving at the cost which would vary in proportion to the volume of production or sales. Total costing or absorption costing is the opposite of marginal costing. In the western countries, the expression direct costing and direct cost are treated to be synonymous with marginal costing and marginal cost, correct. We should, therefore, consider only variable cost as the same as marginal cost is to isolate the cost that can be saved when one less unit is produced over a given level. Fixed costs are costs that tend to be unaffected by variations in the volume of output. The important words here are ‘tend to be unaffected’ that is, fixed cost does not necessarily remain fixed for good. But it is assumed to be so under certain set of circumstances and within a particular range of activities and for a specified period. Variable costs are those that tend to vary directly in relation to the volume of output. Usually direct material, directly chargeable expenses and a part of the overheads constitute the total variable cost per unit. It is interesting to note here that, judged from the angle of a unit of product, fixed costs are the only variable costs and variable costs are the costs that remain fixed. This is because fixed costs are fixed in quantum but variable costs are fixed in rate per unit of product. A distinction should be made between marginal or variable cost of production and marginal cost of sales – the latter should include the
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post – manufacturing variable costs, mainly for selling and distribution activities, while the former will obviously take into account the variable costs related to manufacturing operations only. There is some controversy as regards treatment of direct labour in marginal costing. This is due to its general treatment in the western countries as variable cost and accordingly shown as such in the publications of these countries. While it may be correct from their point of view, it is erroneous in the context or developing countries like India, where direct labour, for that matter, all labour costs, are by and large fixed in nature. Some exceptions are wages paid under piece work system (cases are rather few), part of the overtime pay, wages paid to purely casual workers engaged occasionally for handling extraordinary volume of work, etc. On a realistic assessment, the amounts, involved in these are not significant; and these components of labour cost may be considered as variable. countries like India. There are two more categories of costs, namely, semi-fixed and semivariable costs. Semi-fixed costs increase in steps up to a certain Examples are extent; thereafter they remain fixed at that level. But the rest bulk of labour cost should be treated only as fixed cost, under the situations obtaining in the
supervision, depreciation on shift operations, etc. Semi-variable costs are those that vary but not in proportion to production or sales- the variation may be at a lower rate or at a higher rate. Examples of such costs are power, telephone and telex changes etc. For marginal costing, these semi-fixed and semi-variable costs should be subsequently segregated into fixed and variable elements, taking into account the degree of fixity and variability of such costs, so that ultimately we are left with only two categories of costs, fixed costs and variable costs. Contribution is the difference between sales volume and marginal cost of sales (that is, total variable cost). profit. This is called contribution, because it represents the amount contributed towards fixed cost and Thus profit is arrived at after deducting fixed cost from contribution. Symbolically, C = SV – MC (C = Contribution, SV – Sales Value and MC = Marginal Cost) OR, C + MC = SV. Also: C = P + F (where P = Profit, F = Fixed Cost)
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Or C – P = F or, C -F = P The cost identification and profit build – up in Marginal Costing is illustrated below, under one product assumption and with hypothetical figures: Cost & Profit under Marginal Costing (i) (ii) (iii) (iv) Direct materials Variable cost of Direct Labour Direct Expenses (Variable) Variable Overheads : Factory Office & Administration (v) (vi) (vii 3 1 9 55 100 45 Cost per unit (Rs) 40 3 3
Selling & Distribution 5 Marginal cost of sales – (i) to (iv) Selling Price Contribution per unit – (vi) – (v)
) Rs. In lakh Total contribution on 1 lakh units sold Total Fixed Costs Total Profit 45 25 20
The proponents of marginal costing technique strongly maintain that products do not earn profits – what they offer is only contribution. Fixed costs are not directly related to the products – they are only ‘period costs’ and should be related to the business as such. But the total fixed cost of the business has to be deducted from the total contribution earned by all the products and the result will be the total profit of the business. Marginal costing technique, therefore, precludes any apportionment of fixed costs among products – fixed costs as the period costs of the business are considered separately in arriving at profits of the business. Let us assume that Company X Ltd. deals in three products, A, B and C. The hypothetical profit built-up would be as follows: Illustration – (i) Month: M Units A sold 1 B 2 20 40 C 3 30 90
(lakhs) Contribution per 45 unit (Rs) Total Contribution (Rs. Lakhs) Contribution 45
175 18
fund
of
the (Rs. 75
business
Lakhs) Total fixed cost of the business (Rs. Lakhs) Total profit the (Rs. Lakhs) of
100
business
Note: ‘Contribution fund’ is the total contribution earned by all the products. Assume that the total production capacity (interchangeable between the products) is limited to 6 lakh units per month. It is interesting to examine how total profit of the business will change, merely because of a change in the sales – mix, whilst all other factors (viz. product – wise unit contribution and total fixed cost of the business) remain unchanged. Illustration – (ii) Month: M Units A sold 3 B 1 20 20 C 2 30 60
(lakhs) Contribution per 45 unit (Rs) Total Contribution fund of the business Rs/Lakhs Total fixed cost of the business (Rs. Lakhs) Total profit the (Rs. Lakhs) of 135
215
75
business 140
Illustration – (iii) Month: M Units A sold 1 B 4 20 C 1 30
(lakhs) Contribution per 45
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unit (Rs) Total Contribution (Rs./lakhs) Contribution fund of the (Rs. business
45
80
30
155
Lakhs) Total fixed cost of the business (Rs/Lakhs) Total profit the (Rs. Lakhs) of
75
80
business
The total profit of the business improves from Rs.100 lakhs to Rs.140 lakhs because of a more favourable sales – mix in Illustration – (ii), then comes down to Rs.80 lakhs in Illustration – (iii) when sales-mix becomes relatively unfavourable. And for all such changes in overall profits, the total fixed cost of the business has no role to pay whatsoever. This substantiates further why fixed cost is to be considered as a ‘period cost’ and not ‘product cost’ as emphasized under Marginal Costing technique. We may now introduce the concept of Contribution to Sales ratio. This measured in terms of either unit or total, was earlier called P/V ratio, usually expressed as a percentage. The expanded form of P/V ratio is Profit Volume Ratio which is unfortunately confusing, perhaps a misnomer. The ratio is not profit to volume, but contribution to sales, therefore C/S ratio. Assuming sale price to be Rs.100 and contribution Rs. 40, the C/S ratio would be: Contribution/sales or 40/100 or 0.4 or 40 per cent. We may now introduce the C/S Ratios, (i.e. ratios of contribution to sales) respectively inventing some additional figures, in the above illustrations: (Rs. /unit) Sale Price Marginal Cost Contribution C/S Ratio A 100 55 45 45% B 40 20 20 50% C 90 60 30 33 1/3%
Product wise profitability and therefore, product preference from Sales – mix point of view may now be summarized as follows:Criterion Order of preference
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i)
Contribution A
C
B
per unit (when unit sale is a constraint) ii) C/S Ratio B (when constraint) Contribution C/S Ratio sale price/value is a 45 45% 20 50% 30 33 1/3% A C
2. OPTMISING PRODUCT – MIX. According to management accounting principles, a product mix that maximizes the total contribution earned would be the optimum one. Also, the key factor or limiting factor which imposes a constraint on the volume of output should be identified so that the contribution per unit of the limiting factor could be worked out for the various products. This would help in the ranking of the products, and the product which yields the highest contribution per unit of limiting factor would be produced, subject to other constraints, to the maximum and thus the profit maximized. Such ranking of the products, in addition to highlighting the most profitable products, would also ensure allocation of available resources in such a manner that a proper product – mix can be chosen, given a set of constraints. Even when the firm may have the option of increasing prices of products to improve profits or may find that it would have to produce certain quantity of an unprofitable product as its demand is interrelated to that of some highly profitable product, or it may not be practicable for the firm to increase the costs on sales promotion, cost analysis techniques may be used to identify the more profitable alternatives so that a “what if” analysis can be made in respect of other options available and a proper product-mix chosen. Let us envisage a situation where more than one product is manufactured by the same types of machines, using the same basic raw materials but yielding varying rates of contribution per unit. There may be constraints in one or more of the different machine-hours, availability of raw material and/or say, demand. The marginal costing techniques (for example, study of contribution per unit of limiting factor) can be brought to bear upon the problem of determining the optimum product – mix in such a situation. Illustration The following particulars are extracted from the records of a company
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Details Sales Consumption material Material Cost Direct wages (assumed to
Per unit Product A Rs.100 of 2 kg. Rs.10 cost Rs.15 be Rs.5 3 Rs. 5 Rs.15
Product B Rs.120 3 kg. Rs.15 Rs.10
variable) Direct expenses Machine hours used Overhead expenses Fixed Variable
Rs.6 2 Rs.10 Rs.20
(A) Comment on profitability of each product (both are the same raw material) when * * * * Total sales potential in units is limited Total sales potential in value is limited Raw material is in short supply. Production capacity (in terms of machine hours) Is the limiting factor. (B) Assuming raw material as the key factor, availability of which is 10,000 kg, and maximum sales potential of each product 3,500 units, find the product – mix which will yield the maximum profit. Working/Solutions Product A Direct materials 10 Direct wages 15 Direct expenses 5 Variable overhead 15 Marginal cost 45 Sales 100 Contribution 55 C/S Ratio 0.55 Contribution per kg. of Rs.27.50 material Contribution machine hour Thus the profitability of each product will be determined on the basis of the principle: the higher the contribution per unit of limiting factor, the more profitable is the product. Accordingly a statement of profitability under different conditions may be prepared. Limiting Factor i) Sales volume Ranking of Products BA Ranking based ib Unit contribution 22 per Rs.18.33 Per Unit Product B 15 10 6 29 51 120 69 0.575 Rs.23.00 Rs.34.50
ii)
Sales
value/Sale BA AB
C/S ratio Contribution per kg. of material Contribution machine hour. per
Price iii) Raw Material iv) capacity hours)
Production BA (machine
Under the situation, in part (B), the product preference will be in the same order as (iii) above subject to the conditions that maximum demand for each of the two products is 3,500 units. In other words, 3,500 units of more profitable product will be produced firs. The balance of available raw materials will then be utilized for the production of the less profitable product. Thus, the optimum product – mix would be as follows
roduct Units Raw materials Total materials required (Kg) 7,000 3,000 10,000 raw per Unit (Kg) A B 3,500 1,000 2 3
* (10,000 – 7,000)/3KG = 1,000 UNITS. The technique as illustrated above has, however, limited applicability. It can give us the desired result in all cases where the principal limiting factor or constraint is only one and in a view cases only where the constraints are two in number. And in many other cases of two constraints an in all cases where constraints are more than two (which is most akin to reality, needless to say) optimum product or sales-mix can be determined by the application of Linear Programming technique. 3. THE BREAK-EVEN CONCEPT. In marginal costing technique, contribution (c) is understood as contribution towards fixed cost (F) and profit (P). In other words, C = F + P or C-F = P or C – P = F Accordingly, if P=O then C must be equal to F only. This situation is called break-even point, which indicates a noprofit-no-loss situation. At this point, the total contribution (C) earned is equal to what would be necessary to meet only the total fixed expenses (F) of the business. Sales below break even point means incurring loss (a part of fixed expenses remaining unrecovered) and sales above this point would enable the business to earn profit. It is
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also important to note that once the break even point is reached, all earned (since total fixed cost stands already recovered at the breakeven point itself). The difference between the break-even sales or activity and actual (or projected) sales or activity is called margin of safety. The higher the margin of safety, the greater is the capacity of the enterprise to withstand fluctuations in actual activity due to internal or external reasons. It may be noted also that margin or safety and break-even point, related as proportions or percentages to sales, are If the complementary – both will together equal 1 to 100 per cent. per cent), of the sale value and vice versa. The break – even (BE) point may be worked out by different methods The simplest one is: Total fixed cost __________________ Unit contribution Assuming total fixed cost to be Rs.20 lakhs, the BE point at Rs.40 contribution per unit will be: Rs. 20 lakhs _______________ Rs.40 With the help of C/S ratio also, the same result can be obtained in terms of sales value: B.E. Sales Value = Total Fixed cost C/S ratio Total fixed cost Variable cost 1 - _________________ Sales Rs.20 lakhs = = ______________ 40% Rs.50 lakhs = = Rs.20 lakhs ____________ 1-60/100 Rs.50 lakhs __________________ Or __________________ = 50,000 units.
margin of safety is 0.4 (40 per cent), then break even must be 0.6 (60
Let us take some illustrations at this stage. 1. Data Period (quarter) I Sales Rs. Lakhs 30 Net Profit Rs. Lakhs 2
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II Required i) ii) iii) iv) v) vi) C.S. Ratio
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6
Fixed cost per quarter B.E. Sales value per quarter Margin of safety as on quarter II sales. Sales required in quarter III to earn a profit of Rs.10 lakhs. Profit expected during quarter IV, given the sales forecast for the period, Rs.45 lakhs.
Workings i) The crucial stage is to find the C/S ratio. It may be noted that, as per the given date, there have been net profits in both the quarters. This means that the total fixed cost per quarter has It may also be been covered fully in each of the two quarters.
recalled that all post break –even contributions are actually net profits, fixed costs having been already covered at the break-even point itself. Therefore, the additional net profit of Rs.4 lakhs (6-2) is actually the additional contribution earned on the additional sales of Rs. 10 lakhs (40-30). Thus the C/S ratio would be 4/10 = 0.4 or 40%.
ii)
Total contribution = 40% of Rs.30 lakhs = Rs.12 lakhs = Rs.12 in quarter I Therefore, cost Or Total contribution in quarter II Therefore, fixed cost = 40% on 40 lakhs = Rs.16 lakhs = Rs. 16 lakhs – Rs. 6 lakhs (net profit) Rs.10 lakhs fixed lakhs – 2 lakhs (net profit) Rs. 10 lakhs.
(Note: Fixed cost per quarter has to be the same.) iii) B.E. Sales value Fixed cost per quarter per quarter = __________________________ C/S ratio = Rs. 25 lakhs
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iv) Quarter II sales B.E. Sales
= Rs.40 lakhs = Rs. 25 lakhs
M/S as percentage of quarter II sales = 15 on 40 = 37.5% (Therefore, B.E. = 62.5% of the sales) v) Contribution required to each a profit of Rs.10 lakhs = Rs.20 lakhs (fixed cost Rs.10 lakhs + profit Rs.10 lakhs) Contribution required Sales required ______________________ C.S. Ratio Rs. 20 lakhs _____________ 40% = Rs.50 lakhs Alternatively, sales required = B.E. Sales + additional sales Required for a contribution of Rs.10 lakhs Rs.10 lakhs = Rs.25 lakhs + _______________ 40% vi) Contribution to be earned on Rs.45 lakhs sales = 40% of Rs.45 lakhs = Rs.18 lakhs. Therefore, net profit = Rs.18 lakhs – Rs.10 lakhs (fixed cost) = Rs. 8 lakhs. 2. Summarized Profit/Loss Account for the year ended on 31.12.19x8. Rs. Lakhs Sale ( 4 lakhs units @ Rs.100 400 each) Variable cost of sales Contribution margin Total fixed cost Profit before tax (PBT) Tax @ 60% Profit after tax (PAT) 300 100 50 50 30 20 = Rs.50 lakhs
For the year 19x9 (i.e. 1-1-19x9 to 31-12-19x9) the company has projected its operations as follows: i) ii) iii) i) ii) iii) Sales: 5 lakhs units @ Rs.100 each. Proportion of variable cost of sales to sales: unchanged. Total fixed expenses : to go up to Rs.55 lakhs The break-even sales (units and value) for 19x8 The break-even sales (units and value) for 19x9 Why is there a difference in the break even sales between the two years?
Required.
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iv)
What would the revised C/S ratio be if the company was to achieve in 19x9 a break even situation at the same break even sales value as 19x8?
v) vi)
To achieve the revised C/S ratio as per (iv) above through price revision, what would be revised price in 19x9? To achieve the revised C/S ratio as per (iv) above through changes in variable cost of sales what would be the revised variable cost of sales per unit in 19x9?
Working: Rs.50 lakhs (total fixed cost) i) B.E. Sales: 19 x 8 – units: _____________________________ Rs.25 (contribution/unit) = 2 lakhs. Rs.50 lakhs (total fixed cost) Value = _____________________________ Rs.25% (C/S Ratio) = Rs. 200 lakhs. Rs.55 ii) B.E. Sales: 19 x 9 – units: __________ = 2.2 lakhs Rs.25 Rs.55 lakhs) Value = _______________ 25% iii) Since there is no change in C/S ratio, the only person for the difference in the B.E. Sales between the two years is the increase in total fixed expenses by Rs.5 lakhs in 19 x9 over than in 19x8. Rs.5 lakhs) Check: _______________ Rs. 25 Rs. 5 lakhs Or _______________ 25% iv) To achieve B.E. at a sale of Rs.200 lakhs, with Rs.55 lakhs of total fixed expenses, the revised C/S ratio would be: = Rs. 20 lakhs = 20,000 Units ) ) Addition ) to original ) B.E. Level = Rs.220 lakhs.
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Rs.55 lakhs ______________ X X = 27.5% v) Let the revised price be P Then P – 75 = 27.5% of P P = Rs.103.44 (app) vi) The revised variable cost of sales per unit would be 100 – 27.5 = Rs.72.5. = Rs.200 lakhs (X = C/S ratio)
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30
31
32
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CHAPTER 18 EVALUATION OF SALESMAN’S PERFORMANCE 1. Clearing the Ground; 2. Problems in Salesman’s Performance Evaluation; 3. Evaluation Parameters and Criteria; 4. Salesman’s Compensation and Incentive Schemes; 5. Concluding Observations, 1. CLEARING THE GROUND Every one of us in our own sphere is a salesman. Even as a child is born it has to adopt the selling technique may be by crying, to persuade its mother to give it food. different sphere and under Throughout out life we have situations. Salesmanship likewise to sell ourselves and therefore adopt selling techniques in different therefore is not something uncommon or unusual. However, when we think of a salesman in a commercial or industrial enterprise, this thought of ours is immediately associated with certain specific qualities, the qualities that go to make a salesman. More important among these are attitude, knowledge (of the product, market and people), habits and selling skills. Selling skills again are broadly determined by one’s ability of aggressiveness or submissiveness depending upon the situation. The purpose of this Chapter is to discuss broadly two important issues, one logically leading to the other, viz. evaluation of salesman’s performance, and to develop a rational compensation package for the sales force. However, as an integral part of these two interrelated aspects, it will be necessary at the outset to focus on the need for performance evaluation and the various problems that may be encountered, especially when quantitative approach is attempted. The need any purpose of designing and implementing an adequate method of measuring a salesman’s performance in any marketing organization can hardly be exaggerated. Broadly and essentially this would help the marketing or sales manager to evaluate his sales force and improve its efficiency. It would help the manager in the task of creating, directing and stimulating a sales force to effectively respond to new challenges in the market situation. useful in. a) Developing Salesmanship as an inter-personal influence process. b) Motivation of salesman and supervisory leadership. Besides this, in more specific terms, a good performance evaluation system could be very
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c) Making decisions regarding selection, induction, training, award, promotion, transfer etc. d) Identifying the need for continuous training and development of sales force. e) Improving marketing, marketing aids, strategies and tools (e.g. working documents, demonstration materials etc.) f) Determining and restructuring salesman’s territories and work assignments. g) Improving sales planning e.g. Planning call cycles, routes and visits, job preparation, distribution centers etc. h) Introducing sound compensation and incentive systems supported by a ration evaluation scheme. The concept of productivity of salesman is relevant in this context. A salesman is considered to be productive only when the results achieved by him would not only offset the cost of efforts expanded on him by the company but also leave some surplus thereafter, which would satisfy the company’s predetermined norms of expectation from him. These norms could be expressed in the form of certain ratios, viz. sales per salesman, gross margin per productivity
salesman, contribution per salesman, net marketing margin per salesman, etc. cost should be looked upon from two angles, viz. direct costs and indirect or associated costs. Direct costs are actually the compensation package including commission, if any; the company has to offer to the salesman. The indirect or associated costs, mostly of a hidden nature, represent the costs that have to be incurred to equip the salesman to do his job, and to provide the necessary facilities and services to enable him to sell. Examples of such costs are traveling expenses entertainment expenses, promotional literature, samples, other selling aids used by the salesman etc. It was estimated sometimes ago by a pharmaceutical company that it cost Rs.25,000/per year to maintain even a newly appointed medical representative, though his basic salary would be only around Rs.500/- per month. This total cost of Rs.25, 000/- Takes care of both the direct and indirect elements. The question that necessarily follows is what should the company expect in monetary terms from the salesman before taking a decision to appoint him and commit itself to this cost of Rs.25,000/and more importantly, what sort of checks and balances or evaluation and control systems the company should operate to achieve it. 2. PROBLEMS IN SALESMAN’S PERFORMACE EVALUATION
35
Now, we come to certain problems that are inherent in any salesman’s performance evaluation system, which might affect and distort the results of quantitative evaluation. enumerated below: a) First is the problem arising out of evaluation based on qualitative judgment Vis – Vis quantitative data. Needless to say, in any qualitative evaluation are always the possibility of personal bias and subjective value judgment vitiating the evaluation. Similarly, if evaluation is based entirely on statistical data, the results may not be always correct, particularly because certain important qualities, of a salesman can only assessed, not quantitatively established. persuade situation. b) Next is the problem of comparison between salesmen based on the results of evaluation. Such comparison can never be on apples to apples basis, since a great deal of human element is involved and different salesman have to work under different geographical and environmental peculiarities and constraints, in addition to the difference in the features and problems of the different products they handle. c) Third is the problem of determining standard or bench marks. Evaluation should always be based on such predetermined standards of performance or norms. If the standards or norms are not realistically set, evaluation will be vitiated. d) Fourth is the problem involved in determining the periodicity of evaluation. Evaluation based on very short-term results may be correct and it could sometimes be damaging in consequence. Similarly, evaluation based on very long-term results is not desirable because, if the results are not satisfactory, it will have a great impact on the operating results of the company for a longer period. Besides these, promotion, resignation, retirement and transfer of salesman create several problems in deciding upon the periodicity of evaluation. e) Sometimes salesman’s performance evaluation based on quantitative data may throw up certain discoveries and, intriguing question. For samples, all salesmen in all other regions have surpassed their respective sales quota by 20 percent, but those in Region A have failed to reach 80 percent people and as well as an alteration depending These are between upon the broadly determined by one’s ability to impress, influence or aggressiveness submissiveness Some of these problems are
36
of the quota; sales volume for the company as a whole has increased by 20 percent but contribution falls short of the target by 5 percent and so on. f) Next is the problem of comparing variation in sales activity of different groups in the sales force and comparing relevant parts of job for each salesman within each sales group. g) The last problems in the list refer to the accounting system or the data base records are not adequate to provide precise comparison of salesman or sales-group performance. For example, difficulty will arise in evaluating an improvement in gross sales volume achieved by a group against the profitability of the mix of products another group has sold. Similar would be the difficulty in comparing the performance of a man in one sales group with that of a man in another group when the makeup of the job is different in each group. It can be appreciated that unless the issues stated above, are properly analyzed thoroughly, evaluation based on primary results along might be not only erroneous but also misleading. The above problems also indicate the need for developing a scheme of evaluation with multiple measures criteria to make dissimilar data more comparable. 3. EVALUATION PARAMETERS AND CRITERIA. A brief survey of existing literature shows that efforts have not wanted in developing suitable evaluation schemes to tackle such a multivariety situation and provide a handy tool to the sales manager. The techniques developed so far range from the accounting system after introducing some necessary minor modifications. A systematic and rather practicable approach has been suggested by James C. Cotham III and David Cravens*. According to them copying with dissimilar performance data is not a simple task, but by using the standard deviation personal selling influences are observed. The standard deviation adjusts seem in fly incomparable performance data so that measurement can be made against the same yardstick, thus allowing sales managers to make direct comparisons of dissimilar sales efforts. The technique, called a Z score or standard Score, can be utilized to place different measures of performance on the same scale. The formula for calculating the Z score is: P-M Z score = _________
37
S.D. Where P = A raw performance measure for salesman, M = Mean (average) raw performance for the sales group; S.D. = Standard deviation of raw performance measure for the sales group. Consider a sales job with two performance measures, of volume and profitability. Assume that salesman Joseph produces Rs.2,000/- in volume in excess of his work target; the average for his sales group on the volume dimension is Rs.1,000/- and the standard deviation for the group is Rs.2,000/- Joseph’s Z score on the volume dimension is 2,000/1,000/- divided by 2,000/- which is equal to 0.50. If this Z score on the profitability dimension is 1.32 computed in the same fashion, then his composite performance (assuming equal importance of both dimensions) is 1.82 (o.50 plus 1.32) After a performance score has been adjusted to a common measuring scale using the Z score technique, it can be added to one or more additional standardized measure for a particular salesman to obtain a composite measure of his performance. This method provides a mode of examining salesman’s performances of specific dimensions. It also furnishes sales managers a composite measurement of any number of combinations of quantitative and qualitative measures of performance for men in a sale group. Simultaneously, this technique eliminates the need for devising a single overall performance measure, which is generally difficult to deal with. Cotham and Cravens have extended their model to measure inter-group performance as well. We will now discuss an alternative approach that can be more easily put into practice. The simple model delineated here has already been successfully tries in at least two companies, one engaged in consumer marketing and the other in industrial marketing. While applying this model, however, some suitable modifications would be needed, depending on the situations obtaining and specific purpose or purposes in view. At the outset, it should be stressed that our evaluation scheme like any other requires that the sales manager should. a) Organize sales activities into appropriate sales groups (such as industry, customer or product) and/or sales territories; b) Delineate the salesman’s job in each group or territories; c) Set benchmarks or standards of performance for each part of the job; and d) Establish specific methods of evaluation and the criteria and techniques to be adapted to this end.
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Out suggested approach provides, in the first place a check list of 20 parameters or criteria that could be used for the purpose of evaluation of salesman’s performance. While the list is only indicative and by no means exhaustive, it is neither desirable nor practicable for any company to adopt all these criteria – only a few say, four to sis may be chosen. It is also important to assign suitable weight ages to the criteria chosen, since all these may not be of equal importance. The criteria in the list are orientated towards an evaluation only of quantitative or financial nature. Now the list with a rational grouping, follows; A. Sales Achieved 1. Market Share 2. Sales Quantity 3. Sales Value B. Activity & Productivity 4. Number of calls. 5. Number of orders. 6. Value of orders booked 7. Value of orders per call (batting average) 8. Ratio of order value booked to the total value (Hit Ratio) C. Financial Performance 9. Contribution and C/S Ratio. 10. Direct selling expenses ratio. 11. Direct Sales margin. D. Working Capital Management. 12. Average inventory 13. Average outstanding receivables. 14. Average working capital locked up. E. V ital Performance Index. 15. Marketing Return on Investment (ROI) F Others 16. New Product Performance 17. Number of accounts obtained. 18. Number of accounts lost. 19. Number of customer companies. 20. Information about competitors, plan and strategies. In respect of each of the above criteria there should be some predetermined standards or norms expecting for those where such norms cannot be easily established (e.g. item nos. 19 and 20). Also
39
the above criteria have to be adopted for evaluating the results of as a particular period, say a week, a fortnight, month or a quarter; and this period should be used uniformly, regularly and without discrimination for all salesmen in the organization. Based on a hypothetical situation and data and using a few of the criteria chosen from the above list, a comparative evaluation of three salesmen has been made and this is shown in Tables I and II. 4. SALESMAN’S COMPENSATION AND INCENTIVE SCHEME. It is almost an accepted practice that a salesman’s compensation package should not be a fixed one, regardless of his performance or achievement. Incentive scheme in some form or the other should be initiated to provide his productivity and at the same time enable the organization to share a part of the results arising out of the organized producing. The reverse is also true. If a salesman does not perform well, his total compensation package should get reduced to reflect, to some extent at least, the effect of his poor performance. does not pay back to is as per its norms. The organization also is not obliged to protect his pay packet as long as he The provision of such negative incentive would also act as a positive motivation to all salesmen. Accordingly, many companies have developed a scheme for compensating their salesman based on two broad elements viz fixed remuneration (Salary D.A. etc.) and incentive payments (commission, bonus awards etc.) As regards the fixed element of a salesman’s compensation packet, it should be ensured that the amount is not too low for him to meet his basic requirements but should not be, at the same time, too high to dissuade him from putting in extra efforts required to earn some incentives. Coming to the second element of the compensation. Viz. incentives, it is to be noted that there cannot be any straight – jacket scheme applicable to all companies or even to all salesman of a particular company marketing diverse, products and services. Every company has, therefore, to develop the scheme or schemes which suit it most. In developing a nature of the markets, area potential, seasonality in sales and a financial evaluation of the type of benefit – cost-analysis under various alternative situations that could be envisaged under the scheme. In developing a suitable incentive scheme for salesman the parameters and criteria of performance evaluation indicated earlier, may be effectively made use of. In that case, it would be advisable to choose a few criteria, say only five or six of them, which are considered to be the most important to the company. In respect of each such criterion chosen, suitable norms or standards have to be established. Further,
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appropriate weightage should also be given to those criteria, since not all of them could be equally important. Again, in respect of each of the criteria so chosen, a suitable system of reward and penalty should be built into the incentive scheme to take care of the performance, higher or lower than the norm. To elaborate these points let us take the hypothetical illustration, as outlined in Tables I, II and III. 5. CONCLUDING OBSERVATIONS Any scheme for the evaluation of salesman’s performance and the financial incentives following from it should have adequate provisions for the following inter alia: a) Experimentation with changes through lateral transfers should be encouraged. This is often useful since a particular salesman attached to a particular produce or territory for a relatively long period might tent to take things for granted. b) Personal evaluation through a good judgment system can never be replaced by quantitative analysis, however, detailed and scientific it may be. In fact, a judicious combination of personal evaluation and quantitative evaluation should be the right answer. c) While evaluation based on short-term results are required to operate the schemes, similar analysis and evaluation for a longer term is also necessary to develop long-range marketing strategies. d) Each sales manager has to develop his own method of performance evaluation and update it with changes over time. e) Marketing information system has to be sufficiently geared to meet the requirements for developing and successfully operating the evaluation and compensation scheme. We will discuss this aspect in detail in the last section of the book, viz. marketing control. AN ILLUSTRATION OF A MULTIPLE – CRITERIA EVALUATION CUM COMPENSATION SCHEME. TABLE I S.No. THE PLAN PRODUCT_____________ Evaluation Weightage Criteria Norms Basis score :maximum 12 for each (6 points for achieving of
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norm + or – for deviation as 1. Market share 30 25% shown below + (-) 1 for increase (decrease) every 5% or 2. Value orders 3. Batting average 4. Sales Value 10 Rs.10 lakhs 10 Rs.25,000 of 15 Rs.10 lakhs part. -doby
every Rs. 1 lakh or part. -Doby every Rs.5, 000 of part. -doby every Rs.1 lakh or part. -doby every 5% or part -do- -do-
5.
C/S Ratio
15
40%
6.
Marketing ROI20
20
20%
TABLE EVALUATION PRODUCT MONTH (Based on the Plan in Table I) P ZONE M DATE Salesman –A Figures Scor e Market 35% 8 Z ________
SR.No Criteria . 1. 2. 3. 4. 5. 6.
Weight ed Score 240 60 70 50 75 140
Salesman – B Figures Scor e 20% Rs.11 lacs Rs.22,00 0 Rs.10 lacs 30% 12% 5 7 5 6 4 4
Weight ed Score 150 105 50 60 60 80
Share Value of Rs.8 lacs 4 orders Batting average Sales Value C/S Ratio Marketin g Rs.27,00 7
0 Rs.9 lacs 5 35% 22% 5 7
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635 Weighted Average Score (Max. 6.35 12) * HYPOTHETICAL TABLE III COMPENSATION PLAN (Minimum Basic Salary Per Month Rs.2, 000 (ASSUMED) Score Upto 6 6.1 to 6.5 6.6 to 7.0 7.1. to 7.5 Compensation A. B. NOTE: Basic Rs. 2,000 2,000 2,000 2,000 Basic Rs. 2,000 2,000 Incentive Rs. 500 1,000 1,500 Incentive Rs. 500
505 5.05
Total Earning Rs. 2,000 2,500 3,000 3,500 Total Rs. 2,500 2,000
1. the award to a salesman for high scoring say 10 or above in a month may be, in addition to the usual monetary award, a nonmonetary one e.g. declaring him as an outstanding salesman of the month, giving a rolling trophy, awarding a merit certificate etc. 2. Payment of incentives may be effected only after 2/4 weeks from the end of the relative month, since some time is required for generating the basic data and working out the scores as per Table II. The basic pay however may be given at the end of the each month in the usual manner. The model illustrated above is based on hypothetical situations and data. But this being a simple one, any marketing organisation may adopt this with suitable modifications as may be required.
1. Preview, 2. Meaning and Significance of Marketing Audit, 3. Methodology, 4. Inferences and Recommendations, 5. Concluding Observations. 1. PREVIEW In the foregoing chapter of this book conscious attempts have been made to highlight the salient f features of marketing management process vis-a-vis the various factors and forces that at continuously at
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play in the market place.
It has been stressed that the essence of Market-oriented culture is a
marketing lies in “market orientation” as distinct from “product orientation”, or any other orientation. necessity in today’s increasingly competitive world. In market-oriented environment a company gears the efforts needed to produce what the market demands. service. Marketing process is an amalgam of a host of variables, e.g. objectives, strategies, tactics, etc. and these are subject to rapid obsolescence in the fast changing marketing environment. Marketing executives being engaged in continuous analysis, planning and control can hardly find time to suit back and examine what they have been doing and how they could improve their effectiveness in the context of the only unchanging thing that the “change” Marketing audit is an effective tool for assessing critically the need for such change and identifying key area for enhancing the sectoral as well as overall marketing effectiveness. Market leadership is established by creating customer satisfaction through produce innovation and customer
2. MEANING AND SIGNIFICANCE OF MARKETING AUDIT. Marketing Audit a sub-system or component part of Management Audit. While Management audit has a very broad and all pervasive scope, Marketing Audit can stand on its own feet and may be conducted either as a part and parcel or independent of Management Audit. “Marketing Audit is a comprehensive, systematic, independent and periodic examination of company’s or business unit’s marketing environment, objectives, strategies and activities with a view to determining problem area and opportunities and recommending plan of action to improve the company’s marketing Kolter) The above definition clearly spells out the following characteristics: Comprehensiveness Systematic Covers all the major activities of the company. There should be structured audit performance.” (Prof.
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programmed to be followed in proper Independent sequence for timely be The completion of the audit. Marketing audit can by outside consultants. for obvious reasons. Marketing audit should intervals. Normal practice of conducting an audit takes a narrow view. In this connection, Prof. Shuchmen says: “The marketing audit is a tool that can be of tremendous value not only to the less successful, crisisridden company but also to the highly successful and profitable industry leader. Even best can be made better. In fact, even the best must be better, for few if any marketing operations can remain successful over the years by maintaining status quo” It appears that marketing audit is more important in successful companies simply because they have a tendency to breed complacency. Webster defines an audit as “a formal or official examination and
conducted by internal experts or second alternative is preferred Periodic be
conducted at regular periodic
verification of an account, a methodical examination and review”. This is the concept of accounting audit which is carried out according to a fixed time table and under highly standardized procedure. In marketing audit there is no such clear-cut procedure. The accounting audit is directed towards the outsiders (shareholders, creditors, public etc.) whereas in marketing audit it is intended to deal with a specific marketing problem or assessment of component of marketing effectiveness, exclusively for internal uses. In fact, the term “audit” assumes much broader connotation and import when used in the context of Management audit as well as Marketing Audit. 3. METHODOLOGY It is not possible to present a comprehensive list of all the tools and techniques that are generally used for conducting management audit as well as one of its most important components, marketing audit. This is particularly because the approach and methodology vary widely not only between one audit unit and another but also among different
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experts carrying out marketing audit even for the same or identical unit. We would briefly discuss here nevertheless some of the important and well-accepted tools and techniques that generally form part of the methodology. It needs to be emphasized that one has to adopt a judicious blend of these tools and techniques, having regard to the nature of the audit-unit and the purpose of the marketing audit. i. Pre-Audit Briefing: It is described that there should be a pre-audit discussion with the company officials to agree upon the broad audit areas such as: a) Objective and purpose – general/specific, b) Coverage, c) Depth of study, d) Time schedule, and e) Expected specific outcome. ii) Basic Instruments: There are two accepted instruments for reviewing the overall marketing effectiveness: a) Marketing effectiveness rating review, and b) Marketing audit, as a sequent to (a) a) Marketing Effectiveness Rating Review Structured questionnaires are prepared to cover the major attributes of marketing orientation namely, customer philosophy, marketing and organization, marketing information, strategic orientation
operational efficiently. b) Marketing Audit: The major components required attention of a marketing auditor are: Marketing Environment Audit, Marketing Strategy Audit, Marketing Organisation Audit, Marketing Systems Audit, Marketing Productivity Audit and Marketing Function Audit typical questionnaires related to these areas have been given at the end.
iii) Swot Analysis: Swot Analysis is an almost universally accepted tool for auditing marketing operation. Swot (as mentioned earlier also) is the abbreviated version of strengths (S), Weaknesses (W), Opportunities (O) and Threats (T). The S & W parts of SWOT are actually
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Organizational Analysis (internal) and the O & T comprise Environment Scanning (external). SWOT analysis can be conducted through questionnaire technique or brain-storming sessions. As an illustration, we are giving below only a few of the SWOT’s listed during a brain-storming session of senior marketing executive of a leading instrumentation company, while a marketing audit was being carried out: Strengths: i. ii. iii. Wide range of products, thereby offering better business potential. Efficient after-sales service provided by the company. Availability cases. Weaknesses: i. ii. iii. Poor Government liaison and public relation. Inadequate efforts on a continuing basis for development of new markets. Technological obsolescence in respect of some of the products manufactured and/or marketed by the company. Opportunities: i. ii. Fast growing and varied markets offered by the Indian Economy for the products of the company. Increased markets for the company’s products arising out of Government legislations re-pollution control, stricter adherence to quality standards, etc. iii. Scope for introduction of new products with latest technology opportunities, Threats: i. Changing customer behaviour evident from unethical practices which the company is not willing to indulge into. ii. iii. Social-political instability in some regions causing retardation in industrial activities. Scarcity in foreign exchange leading to conservative import policy. and due thus to exploring the market gap technology of both indigenous and imported instrumentation equipment as alternatives, in some
prevailing in India.
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iv. Data Generation and Analysis: Data collection is an integral part of the marketing audit and for satisfactory result, interfacing with company officials and file references are a pre-requisite. A cursory glance over the questionnaire given at the end will corroborate that apart from statistical data due emphasis is placed on the personal views obtained through interactions – both one to one basis and at times in groups. Because of this, an effective communication with all levels of management is needed. For generating necessary data and information, different types of questionnaires may have to be designed and administered, depending again on the purpose and scope of the marketing audit. In course of conducting a fairly comprehensive marketing audit of a large engineering conglomerate (a multi-national unit with diversified produce portfolio), as many as six questionnaires were designed and used respectively for: Company’s Executives (senior-level-all etc.) functions), Customers (direct), Customers (indirect-agents
Principals/Suppliers and Competitors. v. Brain –Storming : The expression was first coined by Alex Osborn. This involves collaboration of personnel to “storm” a problem. It is in fact a creative conference aiming to generate a host of ideas-good, bad or indifferent. In a brain storming exercise, quantitative and qualitative facts and figures are usually available to facilitate marketing audit, provided the brain-storming session comprises participants well-informed in the reference subject. 4. INFERENCES AND RECOMMENDATIONS This is the concluding part of marketing audit. The effectiveness of the audit is directly related to the auditors skill and professional expertise and of course objectivity with which the analysis of data (derived from pre-set questionnaires) are made, inferences are drawn from the analyzed data (identifying for example areas where immediate corrective actions might be needed) and appropriate recommendations are incorporated in the audit report. Much as the reader would like us to present some case studies on marketing audit in keeping with the age-old adage. “Examples are
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better than precepts.” It would not be practicable for us to do so here. We are nonetheless giving below a few interesting outcomes that were included in the respective marketing audit reports, by way of illustrations only. i) Audit Unit – large consumer products – based chemical company in a neighboring country: a. Immediate formation of a task force for expansion of the
product-range by introducing at least ten new products in certain identified field like. b. Establishing appropriate methods for evaluation of promotion and advertisement activities with a view to ensuring cost effective promotion. C. conducting an attitude survey of marketing and sales personnel and simultaneously generating pertinent data rather counterparts in the industry, in order to restructure their compensation and incentive package. ii) Audit Unit – an old established foundry in the Eastern India: a) The order – shipping – billing – cycle time (worked out at around 78 days for a new order and about 68 days for a repeat order) being very high, given the industry norms, needs to be cut down by the least 25% in each case within one year. b) The present success rate against enquires or “Hit Ratio” of 1:8 can be improved to 2:8 or 1 : 4 given the proper organization and support system in marketing operations, in order to double the capacity utilization (from the meager 20% at present) as well as the turnover level. c) Taking a hard took at and revamping as necessary, the pricing policy and strategy of the company in order that demand and state of completion etc. are built into the pricing system, rather than allowing the same to be entirely cost-based as existing now. d) Introducing an effective market – research function in the company not only for regular market share or hit ratio analysis but also for undertaking researches on the changing pattern buying behaviour with respect to the company’s products. 5. CONCLUDING OBSERVATIONS It is the consensus opinion that the marketing audit should be conducted by outside consultants in order to have an independent look
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of the market orientation – present and future- and to submit an unbiased report free from push and pull of various interested groups. After all outside experts would not have any axe to grind, score to settle or corporate ladder to climb! The marketing auditor is to determine what is being done, appraise what is being done and recommend what should be done. It is essential that the audit should be conducted and completed within an agreed time frame so that the data forming the background of the audit do not become outdated and thus nullify some inferences and recommendations. Also important is the auditor getting familiarized with the company’s background including extend of professionalism, work culture, breadth of experience, result-orientation, cost-consciousness and recommendations. The ultimate object of marketing audit is improving the marketing effectiveness and market-orientation and in no way should it be a tool of assessing individual competence. In other words, Marketing Audit should never be allowed to degenerate into a faultfinding or witch-hunting exercise. Once these are ensured, progressive organizations will no longer shy away from getting marketing audits conducted. Thus, the prevailing apprehension or mistrust in this area could also be set at reset. MARKETING AUDIT INSTRUMENT QUESTIONNAIRE. (Please indicate your rating by a ?mark against each criterion under the *5 Point Rating Scale for I to V. briefly under VI). I. Marketing Environment: The extent to which you are conversant _______________________________ with the changes in the environment A Macro Environment i) Economic. ii) Financial and fiscal. iii) Social. iv) Political. B. Task Environment i) Market segments ii) Customer iii) Competitor. 1 2 3 4 5 Please put your observations
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iv) Substitutes of products v) product/process technology II. Marketing Objectives and Goal: i) The degree of clarity of corporate objectives and how they lead logically to the marketing objectives, ii) The degree of clarity in the marketing objectives. iii) Clarity in priority ranking between different marketing objectives (e.g. market leadership, market shares, volume sales growth, rupee sales growth, marketing profitability etc.) iv) The extend to which the marketing objectives are qualified. _______________________________________________________________________ _ *1 = very Poor, 2 = Below Average, 3 = Average, 4 = Good and 5 = Excellent. III. Marketing Organisation: i) Degree of effectiveness in the ____________________________ Existing marketing organization 1 executives iii) Extent of smooth interaction between marketing and other departments. IV) Marketing Mix. Indicate your rating of effectiveness against each of the following elements of the Marketing Mix/functions. i) Product (range, packaging, performance, quality, after sales service, etc.) ii) Price (including financial terms) iii) Promotion (mode, channels, medial etc) iv) Placement (distribution channels and network – both coverage and cost effectiveness) V. Marketing Systems: Indicate your rating of effectiveness against each of the following areas under marketing systems i) Marketing MIS (state of business monitoring and development) ii) Marketing budgets and business plans iii) Marketing long range plans iv) Cash flow in marketing Operations v) Product line profitability 2 3 4 5 ii) Degree of clarity of authority and responsibility of marketing
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vi) Marketing intelligence (including market researches and surveys) vii) Sales analysis (from different angles) viii) Market share analysis (overall as well as for different market segments) ix) Sales force – recruitment and training. x) Marketing performance evaluation. VI. Marketing Strategies : i) Does your company have long-range strategy in respect of your product group? If so, what methodology is adopted? ii) Is the long-range strategy supplemented by short range strategies and tactics? If so, how are they linked and determined from each other? iii) What is your perception of the degree of clarity in communication of strategies developed or when strategies are changed? iv) What methodologies are adopted in monitoring the implementation of these strategies? What and to what is their effectiveness? v) Does the Company have a contingency planning methodology for your product group? If so, what and to whom extent? vi) Extent of use of sophisticated techniques (e.g. Product Life Cycle concept, Boston Consulting Group model etc.) that are adopted in developing marketing strategies. (Note: Adequate space to be provided below each question) Remarks or Additional Comments, if any ______________________________________________________________________ Name: ___________________________ Signature: ________________________ Designation ______________________ Date: ____________________________ Location: ____________________________________________________________ Responsibility Area: _________________________________________________ (Business Centre/ Products/Territory, etc.)______________________________________________
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Marketing Finance Interface Towards Organizational Integration and Effectiveness In the manufacturing sector, companies are leveraging technology to gain competitive advantage. In the service sector, supply chain management and merchandizing are in sharp focus, while in the knowledge management domain, data mining and data warehousing continue to dominate knowledge based unit. The bottom line is that irrespective of the nature of business, to survive in this market, a company has to provide excellent products or services at the most competitive rates. The changing business scenario and the infallibility of some basic truths about marketing management and financial management have brought into sharp focus the critical need of marketing finance interface for competitive growth. The Cover Story focuses on the areas of marketing finance interface, like financial aspects of brand management, strategic cost management, cost analysis in marketing decisions, pricing policies appraisal and control of marketing performance, etc. Marketing Finance Independence Marketing functions by and large lie outside the organization. On the one side there is the market and on the other there is the organization. In the marketplace there are positive customers, negative customers, neutral potential customers and non-customers. Markets are always in a state of flux. They are also continuously affected by economic, Such changes are again of a very political, and social changes. and decisions,
complex and interdependent nature. All such changes and forces and interactions at the marketplace are transmitted to the organization through one important function of marketing-market research. Based on such factors and forces the organization takes certain decisions which are again reflected in the marketplace. The finance function by its very nature is internal to the organization. An important part of the finance function, i.e. statutory accounting is responsible to outsiders, viz. shareholders, government authorities, auditors, etc. But the other functions under finance do not owe any allegiance to outsiders and the degree of dependence too is little. Financial management, particularly to the extent it relates to making available financial resources from outside, is influenced rather widely by external factors, especially capital market situates. But this influence is significantly different both in character and quality from
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the influence that market forces constantly exert on the marketing functions. Marketing Finance Interdependence Behind these apparent elements of diversity, there is an element of inherent unity in the two functions, marketing and finance. This unit or point of contact is to be traced to the fact that both these sets of professions are working for a common cause and endeavoring to reach a common destination for the organization, viz. its survival, growth and profitability, on the course might be different. The magnitude and complexity of finance function will keep on increasing at a geometric rate if the organization can ensure highly dynamic marketing function. The number and more importantly, the type of people required for efficient discharge of finance functions depends, to a large extent, on the nature and degree of success in the marketing function. If marketing fails, finance, and for that matter all other functions in the organization, will have to come to a grinding halt. Similarly, marketing also depends, heavily on finance. In the first place the finance function has to provide necessary support in a continuous manner to marketing so that it can become effective and successful. This is especially important in respect of working capital for marketing operations. Besides this, it has been seen on a number of occasions how wrong decisions in the marketing area could be stalled by timely interference of efficient finance people. There are also instances to prove how a dynamic marketing move has been halted because of unimaginative and unwarranted intervention from finance people who are incapable of understanding or appreciating marketing issues. In today’s environment, marketing and finance functions work hand in hand to enable companies achieve competitive edge. There are quite a few important areas where the marketing and finance functions overlap. Some of these are: (i) Introduction and operation of an effective budgetary control system in marketing. (ii) Product planning including product selection, retention and abandonment as well as dilution in product portfolio. (iii) Product pricing including both short-range and long-range pricing policies and strategies.
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(iv)
Marketing
investment
decisions
including
monitoring
their
implementation with suitable feed-back-oriented control systems. (v) Evaluation of marketing performance, including both general and special marketing functions (vi) Control of marketing operations – both the employment of funds and the cost of inputs. (vii) Functional Cost Analysis to achieve cost effectiveness and also for exercising a systematic and meaningful control over marketing costs and expenses. (viii) Valuation of Brands and brand risk analysis. Interface and integration Finance and marketing cannot and should not work in isolation. There exists the need for a highest degree of coordination between these two functions so that the organization as a whole could achieve sustainable growth. There cannot be meaningful co-operation, far less any coordination, between two sets of people if they do not understand each other. Such back of understanding might lead to a situation when each will abdicate to the other. This may not be damaging when the going is good. But during a period of rough sailing, each will develop hostility towards the other. This is true of finance and marketing people in Needless to say, no organization can many Indian Organizations.
afford to allow such hostility except at its own peril. Obviously the only way to avoid such a situation is to develop a better understanding by each of the other’s discipline and sphere of operation. Any functional management, and marketing cannot be an exception, includes planning, organization, and control in the first place, and taking decisions and evaluating the results of such decisions at the end. There are also such things as direction and motivation which are important to marketing. But all such functions of marketing management must have some relevance to finance. Sometimes such relevance could be direct and sometime indirect or a little contrived. But any management function which does not take into account the finance implication involved, would mean nothing but groping in the dark with consequent uncertainty of success. This would be more so for marketing because the results of all marketing operations have ultimately to reflect in the Balance Sheet of the organization through its Profit and Loss Account.
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The above observations apply particularly to marketing decisions. Some management professionals believe that there are only two people in the organization who take decisions – the managing director and the marketing director. In fact, everybody right from the marketing executive up to the topmost person in charge of marketing operations has to take decisions day in and day out. Such decisions could be short-term or long-term, repetitive (programmed) or singleshort (unprogrammed). However, one basic requirement of each and every decision, to make it a right decision and at the right time is that the decision-maker should be above to envisage clearly, even before he takes the decision, its effects on the company’s bottom line and balance sheet. It has to be appreciated that the develop such a faculty is not an easy job. This requires a substantial exposure to accounting, finance and management accounting concepts. While nobody expects that a marketing man having acquired such expertise will change his role and join the finance function of the organization, it is highly desirable that he/she should require and develop such expertise even to meet the challenges of his/her marketing function. In complicated situations involving hard-core financial implications, he/she can always draw upon the greater degree of expertise available in the finance department of the organization and sometimes even outside the organization. But he/she must have the ability to understand when he/she should seek such assistance. Otherwise ignorance must have the ability to understand when he/she should seek such assistance. Otherwise ignorance will not be bliss to the individual, especially in the long run. In ordinary situations he has to often take quick decisions, otherwise he may lose a business opportunity. And in such cases he cannot afford to waste time by referring the matter to the finance department. He himself has to take the decision on the spot and it has to be the right one from the financial point of view. An example in view is the decision regarding pricing and terms of payment, especially while negotiating a big tender or an export order. It is equally important to note that the finance professionals will also have to play an effective role in this area. They in particular should: (a) Have a reasonably good exposure to some of the basic concepts of marketing.
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(b) Develop an appreciation of the uncertain and competitive environment under which marketing people have to operate and, therefore, develop the need to adopt a flexible attitude towards their plans, programs and activities; and (c) Endeavor to replace accounting control through conventional budgeting system, particularly of marketing costs and expenses, by a more purposeful managerial control based on a profit-centered approach. Marketing objectives should be logically derived from and be an integral part of the corporate planning process. Peter Drucker in The Practice at Management sets out seven distinct marketing objectives that are necessary in most businesses. These are: 1. The desired standing of existing products in their present market. This may be expressed in sales value as well as in percentage market shares, measured against both direct and indirect competition. 2. The desired standing of existing products in new markets, measured in the same way. 3. The existing products that should be abandoned, for technological reasons, because of market trends, to improve the product mix, or as a result of management’s decision concerning what is business should be. 4. The new products needed in existing markets, defined in number of products, their properties, sales value and projected market share. 5. The new markets that new products should develop in sales revenue and percentage market share. 6. The distributive organization needed to accomplish the marketing of goods and the pricing policy appropriate to them. 7. A service objective measuring how well the customer should be supplied with what he considers value by the company, its products, its sales, and service organization. One of the principle areas of marketing finance interface relates to marketing budgets. Companies having a systematic and organized Long-Range Planning process (LRP) will always have clearly spelt out long-term objectives. The companies which do not have an LRP system should also develop a broad outline about its objectives on a long-term basis, at least for two to three years. The objectives should be especially in two respects. Viz. growth and profitability. Preferably these should be broken up into present products and line of activities on the one hand and proposed new products and new lines of activities, on the other. An attempt should be made at the outset to ensure that the annual marketing budges under preparation broadly
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conforms and contributes to the company’s growth and profitability objectives for the next few years. Next, companies have to deal with the problem of achieving “goal congruence”. It is often seen that some products could be marketed or some lines of activities could be developed with relatively less marketing efforts. While the marketing department would try to put higher budget figures for such products or activities, at the expenses of others, this might not be in conformity with the corporate goals and objectives, especially from a long-term point of view. It could so happen that the Profit Volume Ratio (Contribution/Selling Price) of such products may be low. There are several instances when products with low PV Ration have been suffered the lack of focus and consequently lower volumes. Such cases completely disturb the cost volume profit relationship and are against the long-term interests of companies. Similar problems might also arise in the case of a company engaged in marketing both its own manufactures and, also of others as selling agents. In the process, the long-range corporate goals and objectives should predominate. The next issue concerns, “corporate profit planning” and the marketing department’s responsibility in this regard. In the first place, a broad profit plan prepared in advance and duly approved by the management, results in confusion and repletion in the budget exercise and consequently delays i8ts finalization. solely responsible for achievement or Secondly, even though cause improvement, or marketing has the major role in achieving the profit target, it is not deterioration in the profit position. Production could be more efficient and economic or less so that what is envisaged would straight away reflect in the cost of products, non-marketing administrative expenses can go up or come down even substantially, due to efficient or inefficient handling of finance, the incidence of interest could be much lower or higher than envisaged and so on. And all these will directly affect profitability. Therefore, it is necessary at the outset to establish, specify and quantify, as far as practicable, the responsibility of the marketing department viz-vis other departments in achieving the profit targets. The last basic issue we shall discuss here is “spending for the future” as against spending for the present. Too many companies still reward executives for short-term profits. Very often a manager will not spend
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money on the future, and with luck he will get promoted out of his job, or retire from it before the future arrives. Some others have to live with the consequences. There could be quite a few items of spending for the future in the marketing area, viz. launch of a new profit, an advertisement popularizing infrastructure campaign new for uses for of penetration existing marketing into new markets or an products, developing
providing
intelligence,
undertaking
marketing research, etc.
Needless to say such expenses may not
contribute directly to profits during the budget year and may often bring down the profitability, sometimes significantly. It is, therefore, necessary to segregate such expenses from pure operational Management expenses, at least for the purpose of understanding the budget- year performance and profitability in the right perspective. may still commit such expenses on long-term considerations knowing fully well the extend to which this would reduce the profit for the budget year. One of the most critical areas of marketing finance interface lies in the concept of Strategic Cost Management. Strategic Cost Management – The Paradigm Shift Traditional cost management techniques primarily relate to analysis of operating data with a view to achieving cost-effective operations and gain competitive advantage. It is in no way connected to the analysis of strategies pursued by the companies to ascertain their effectiveness in gaining competitive advantage. Strategic Cost Management relates to the integration of cost management techniques like Marginal Costing, Absorption Costing, Standard Costing and Target Costing, focus on standalone analysis to achieve cost-effective operation. Marginal Costing underscores the divergent cost behaviour of variable and fixed costs. It focuses on cost-profit-volume relationship and key areas of break-even point, margin of safety, and profit volume ratios. It is considered a very useful tool in decision – making. Absorption Costing, on the other hand, proceeds on the premise that overhead (works administrative, selling and distribution) should be absorbed over volumes for cost-effective operation. Standard Costing is a useful tool for implementing budgetary control which sets norms and analyzes variances in material, labor and overhead cost and provides for variance distribution on a global basis. actual cost against targets. Target Costing analyzes
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All these cost management techniques focus on operations rather than strategy. managers Costing was used as a control measure, to enable line keep of costs today under is control. in The rapid changing business in ushering transformation
environment
manufacturing and product management systems forcing companies to adopt a more proactive approach which would extend beyond the traditional ambit of cost and management accounting. The basic premise of strategic cost management is that a firm can gain competitive advantage through the analysis of both financial and non financial information. Financial information includes figures pertaining to sales, cash flow and stock price. Non-financial information consists of details such as market share, product quality, customer satisfaction, corporate governance and growth opportunities. Financial information indicates a firm’s current financial position, whereas non-financial information position. indicates a firm’s competitive position. Customer satisfaction is crucial to the determination of a firm’s competitive Thus, Customer Relationship, Management (CRM) has become a crucial component in this exercise. The competitive position is assessed on the basis of customer satisfaction, internal business processes and innovation and learning. Financial and non-financial measures together constitute Critical Success Factors. These factors are essential for a firm’s growth and success. A company’s journey to competitive edge gets fuelled by the culture of innovation within it. In this context, it would be pertinent to mention about two important and relevant research contributions. In “Seeing What’s Next”, Christensen, Anthony and Roth have discussed the theories of innovation that can be used to predict industry change, while in the “Blue Ocean Strategy”, Kim and Mouborgne have focused on how to create uncontested market space and make “competition irrelevant”. This is the context of Strategic Cost Management (SCM). SCM integrates three strategic management themes. are: * Value chain analysis * Cost driver analysis * Strategic positioning analysis. Value Chain Analysis Each organization has certain value creating activities. These activities start with the receipt of material inputs and extend to the ultimate realization of sales proceeds. Value chain analysis is a strategic The three themes
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analysis tool that can be used to identify area in which value can be enhanced for customers or costs can be reduced. Value chain The value analysis, thus, helps a firm gain competitive advantage. firm. The value chain of a manufacturing firm includes activities like procurement of raw materials and consumables, manufacturing, assembling, testing, packaging, warehouse, distribution, retail sales and customer service. Organizations can split operations into a Similarly, the value of a number of activities to analyze their value chain and to identify critical success factors that need improvement. service industry (say the retail sector) comprises merchandizing, supply chain management logistics, display and promotion, customer care and service. Value chain analysis is centered on a product or service and caters to all the activities taken up for delivering it. An Individual firm positions itself at some point in the value chain, depending upon the competitive advantage it can have over other firms. For example, in the software industry TCS, Infosys, Wipro and Satyam are major players in India, who occupy different positions in the value chain depending on their core competency. Value Chain Analysis Involves Three Stages. Stage 1 : Identifying value chain activities; Stage 2 : Identifying the cost driver(s) for each activity in the value chain; Stage 3 : Creating competitive advantage by reducing cost or adding value. Identifying Value Chain Activities. In the first stage of value chain analysis a firm identifies all the activities in its value chain. The value activities differ from industry to industry. In the engineering industry, procurement cost of raw materials, its yield, length of the operating cycle, the effectiveness of the manufacturing process, the efficient use of technology are in focus, whereas in the pharmacy sector, the emphasis in the present WTO dominated environment is on R & D and molecules and clinical trials. the development of new In the FMCG sector, the focus is on
chain of a manufacturing firm differs from the value chain of a services
promotion, advertising, brand management and distribution, while the
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financial services sector is focused on product innovation, wealth management and relationship marketing. Identifying Cost Drivers Cost driver is the factor that causes or “drives” specific costs that are incurred. It is the factor that explains the consumption of resources, and affects a change in the cost of an activity. For instance, productivity is the key driver in manpower cost, and yield is the key driver in material cost. In this step, those activities that have potential for cost reduction are identified and analyzed. Creating a competitive advantage by Reducing Cost or Adding Value The third stage relates to a detailed study of the value activities and cost drivers that have been identified earlier to determine the nature of existing and potential competitive advantage. This helps the firm improve its strategic positioning. In addition, analysis of value activities also enables the firm to identify areas in which the company can provide greater value. For example, Shoppers’ Stop uses high-end information technology, based on supply chain management to coordinate with its suppliers to quickly restock its stores. Similar strategies are followed by Pantaloon and Westside to strengthen the process of merchandising. This enables these retail chains to maintain optimum stocks of all products and thereby reduce inventory costs. Most manufacturing companies in India use ERP systems form either SAP or ORACLE to streamline their inventory, manufacturing, delivering systems and financial control systems. Cost driver analysis is derived from the concepts of Activity – based Costing (ABC). ABC attempts to focus on the activities performed in producing products in the manufacturing process rather than on simply allocating resource costs to products using a volume base. ABC aims to ascertain the cost of products by acknowledging that – production complexity and production diversity are factors underlined by activities that can be costly but are independent of the volume of output. In ABC systems, cost drivers for activities are used to generate product costs and are considered to be more accurate and appropriate for decision-making, pricing, performance evaluation etc. Brand Valuation
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Another Emerging Issue is Branch Valuation A full-fledged brand valuation exercise can help a company strengthen its interdepartmental communication and also develop a reliable information system. The exercise will indicate the strengths and weaknesses of the company’s brands and will be a useful tool in devising brand management strategies. The company can identify its most resourceful brands and can thus differentiate between strong brands and brands which are only glamorous and not that strong, and thereby aid in resource allocation to maximize shareholder returns. The recent trend of acquiring established brands to ensure growth amid tough competition has led to the wide acclaim of the brand valuation concept in negotiating the transaction price. Brand valuation can also help in identifying brands to be included in the portfolio A survey conducted by The Economic Times has revealed that the growth in the top line as well as bottom line of the major Indian Groups-Tatas, Birlas and Ambanis – in the past five years have been largely due to acquisitions. In these acquisitions, valuation of both the corporate brand and the product brand has played major roles. According to Arindam Bhattarcharjee and C. Prashanth: “Branch Valuation could be central theme for any brand management where the idea is to manage the asset value of the brand. In line with this perspective, valuation methods should assist brand managers in carrying out a comprehensive health check for the brand. Most prevalent methods, centered on financial number crunching, will not serve this purpose. An effective method would be one which derives its inputs from the consumers of the brands. The underlying objective in this method would be to allow consumers to say what the brand is worth. After all, the consumer’s perception of the brand ensures the reliability of the brand’s earning in the future.” Cost Analysis in Marketing Decisions Cost Analysis plays a major role in marketing decisions. Some of the major application aspects in this area are: Decisional Phenomena of a Business Decisions have to be taken in an enterprise mainly with regard planning and controlling its operations Decision making is a management prerogative. In fact, managements at different levels
have to take a wide variety of decisions. All such decisions may be grouped into two classes viz. (a) Single – short (or unprogrammed)
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decisions and (b) repetitive (or programmed) decisions. Each single – short decision is a unique decision in respect of a unique problem. All capital expenditure decisions are of this type. Repetitive decisions are those that have to be taken at periodic intervals with reference to some repetitive problems or aspects of a business. Some examples of repetitive decisions are advertisement media selection and expenditure planning, decisions regarding inventory level norms, pricing decisions, decisions, about optimum product and/or sale-mix, and so on. Any decision, whatever be its nature and type is essentially and circumstances. According to Drucker, modern management should be interested not so much in present decisions as in the “futurity of the present decisions” Though decisions are taken with an eye on the future, the past is always a never failing guide, especially in respect of repetitive decisions. A proper systematic analysis of past financial data would definitely offer a good guide to the “decisionsmaker”. A right decision at the right time cannot be taken simply on the basis of some quantitative data and information. There are nonfinancial or qualitative factors as well, which sometimes weigh more heavily than the financial or quantitative factors. In fact, a good decision-maker does have always before him an array of both financial and non-financial factors relevant to a particular decision-making problem. The skill of the decision maker lies primarily in his ability to analyze the interdependence and interaction of both these sets of factors, especially with regard to their futurity. The Concept of Cost Analysis It may be noted in this connection that the financial accounting framework of any enterprise is rigid and straight-jacketed. Even the cost accounting process is by and large of a rigid nature for two reasons, first, the recording of costs and expenses have to follow the conventional accounting pattern, and second, the costing method adopted for a particular firm has to be somewhat right, although, as we have seen depending on the nature of industries, it is possible to adopt different costing methods for cost finding. Because of the rigidity of the systems, data available from the financial accounting and cost accounting records would be more or less uniform and, as such, suit only some specific but limited purposes. But in a business enterprise, decision-making problems are varied. specific decisional problems. Therefore, there is need for varied types of analyses of the accounting and cost data to suit This is what we may all cost analysis.
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We may indicate here, certain basic features of cost analysis. These are as follows: i) The purpose of cost analysis is essentially to generate, and subsequently to provide financial and quantitative data to decisionmakers so as to aid and improve the decision-making process. ii) The scope of cost analysis is almost unlimited. iii) Cost analysis is made with reference to the data available from both accounting and cost accounting records and also various other statistical data not available directly from such accounting records. More often than not, these analyzers pertain to the costs and expenses and, only at times, to revenues. iv) The types of cost analysis are varied – as varied as the decision – making problems of an enterprise. v) Since cost analysis is intended to serve only internal purposes, viz. decision – making, the results of such analyses are not subjected to scrutiny by outside authorities, especially auditors. vi) The results of cost analysis need not be accurate. Very often in the interest of speed, even approximate results may be enough for the specific need. The degree of accuracy to be desired would depend upon the nature of the decision for which the cost analysis is made and the timing of such decision. The concepts of sensitivity analysis and statistical test of significance are relevant in his context. vii) Cost analysis is made using certain tools and techniques. These techniques vary from the simplest to the most sophisticated. Also though may of the costing techniques are applied in this area; there is no limitation on borrowing techniques from various other disciplines like statistics, engineering and operations research. Some Important Techniques of Cost Analysis i) Fixed and Variable Cost Analysis Fixed and Variable Cost Analysis is used in Marginal Costing. The cost, profit, volume analysis underscores the relationship between costs, volumes and profits. The concept of Profit Volume Ratio (Contribution /Selling Price) is used by Marketing Managers to rationalize produce mix for greater profitability. Break even Analysis is another technique of marginal costing which is frequently used by marketing managers. ii) Different Cost and Incremental Revenue Analysis Different cost relates to increase in total cost due to difference in two activity levels. Differential cost includes variable cost and also fixed
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cost, if any. When fixed cost remains unaffected to change in activity, both marginal cost and differential cost would be the same. Differential cost and incremental revenue analysis is helpful in various types of decisional problems (e.g. whether or not to accept an additional bulk order at a price lower than the existing one, whether to increase the production units in a situation when larger supply might bring down the price, etc). The decision rules to be applied while using this technique are: - Keep on increasing production/sale as long as the incremental revenue is higher than the differential cost. - Stop further increase in activity at the point where the differential cost tends to be higher than the incremental revenue. - Fix the level of activity at the optimum point where differential cost equals or approximates incremental revenue, as this is the point where maximum profit will be earned. Any activity planning below this level would mean sacrifice of profit and above this level, loss of profit. iii) Relevant Cost Analysis Through a cost relevance study an attempt is made to arrive at what is called the relevant cost, i.e. the cost (disregarding how much of it is variable and how much fixed) relevant to a particular decision. Relevant costing concept has wide application in the areas of introduction of new products dropping a product or product line, changing the production process, introducing mechanization to replace manual work, etc. For example, when we are considering a proposal to drop a product line, a part of the fixed cost in this connection might cease to exist after the line is dropped, while a part of it may still continue to be incurred and shared by other product lines. This fact should be considered in arriving at the cost relevant to that particular decisional problem. iv) Analysis This is another popular technique intended to analyze the effectiveness (in financial or even non – financial terms) of a particular cost. Cost – effectiveness analysis has two important fields of application. (a) One may be able to find the cheapest means of accomplishing a defined objective. For example, there may be a number of alternative modes of distribution, with varying cost estimates, of the same goods to reach the same customers. Obviously, that alternative will be chosen which ensures the lowest cost.
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(b) One may be interested in ensuring the maximum value out of a given expenditure in a situation where there is difficulty in exact quantification, in financial terms, of the value or the benefits. An example in view may be measuring the effectiveness of advertisement and promotional efforts, given a number of alternative media, with the same amount of expenses. Under both the approaches mentioned above, benefits cannot be quantified in strict monetary terms. But the point of difference between the two approaches is that, in the first case, the benefit is fixed but the costs are varied, while in the second case the cost is fixed but benefits are varied. v) Opportunity Costing Technique. Opportunity costing technique is used in selecting the right course of action or decision out or two mutually exclusive alternative measures. Usually the gains and losses of one such measure become the losses and gains respectively of the other measure. An attempt is made to find which of the two ensures a net positive gain, called the opportunity gain, and obviously, that particular alternative would be chosen. Sometimes a situation may arise in which there are only two alternatives quite opposite and mutually – exclusive in character – acceptance of one would necessarily – mean rejection of the other. For example, a marketer may have to decide which of the two products he would recommend to the same customer – one manufactured by his company and the other an agency product – both able to serve the particular customer’s need but having different costs, prices may be used with advantage. exclusion of the other. vi) Benefit Cost Analysis This is a simple technique applicable in situations where there are a number of alternatives, not mutually exclusive in character (unlike the situation requiring the adoption of opportunity costing techniques). Under benefit cost analysis, an attempt is made to ascertain the total cost and total benefits in respect of each of the alternative decisional problems in a given area or to meet a desired objective. In assessing the cost, both direct and indirect or associated costs are considered. Similar is the case with benefits. Thereafter, a ratio of benefit to cost and future potentials. In situations like this, opportunity costing technique The alternative which shows a net positive opportunity gain for the company should be chose to the
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is computed for each alternative.
Obviously, the alternative which
ensures the highest ratio of benefit to cost would be most acceptable. This technique may be used, say, in deciding upon priorities for allocation of limited resources or marketing efforts when there are varied and complex marketing opportunities available. vii) Engineered Costs, Committed Costs and Managed Costs Engineered costs are those elements of cost for which the right or proper amount can be estimated. Director labour, direct material and perhaps most of the costs conventionally called “variables” can be treated as engineered costs. The committed costs are the inevitable consequences of past commitments. Depreciation, executive salary, even rent, etc. are examples of committed costs. Managed costs (or discretionary costs) represent those which management wants to vary within wide limits. Research and development, advertisement, accounting and administration costs, staff fringe benefits and welfare, etc. fall under this category. The above concepts were introduced by Robert A. Antony in connection with the evaluation and control of operations under the profit center system. However, these concepts are also useful in the area of effective expenses control, especially in marketing operations. viii) Cost Analysis and Decision-making Cost Analysis has profound impact on the following decisions: a) Introduction of New Products Introduction of new products may take either of the two forms viz. - Introduction of add-on products or line extension products, and - Launching of new products or a product line. The technique to assess the profitability of line extension products is the incremental contribution estimates. Usually such incremental contribution is also the profit since there may be no addition to fixed overheads in such a case. The same technique of contribution analysis would be followed in assessing the profitability of a new product line. In this case, however, the relatable fixed cost (i.e. the fixed cost arising directly out of the introduction of the new product line) would have to be deducted from the initial contribution to arrive at the net incremental contribution from the new product line. This contribution may again be taken to be an additional profit of the business since its other general fixed costs supposedly stand recovered through the sale of other existing products.
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In any such analysis, forecasts of sales, variable costs and fixed costs have to be made realistically. Sales forecast would result from a market survey and market research. Variable cost should be forecast with reference to the existing cost structure and cost behaviour in respect of similar products in the company and/or other companies. The forecast of fixed costs is intimately lined up with the question of capacity proposed to be built up for production and marketing. Ordinarily, fixed cost will contain two elements, viz. depreciation on the additional fixed assets to be installed and interest on additional working capital requirements. b) Discontinuing a Product from the Marketing Plan The same technique as in (a) above may be used here with slight modification. The objective should be to find the net gain or loss consequent upon the discontinuance of a product or product line. Such net gain or loss would result from the loss in contribution and saving in relatable fixed expenses on the one hand and the greater impact of general fixed expenses on the serving products, on the other. The decision rules in such a situation would be as follows: I) The product should not be dropped as long as the contribution earned by it is adequate to cover the direct fixed cost relatable to the product. Therefore, if the direct fixed cost is higher than the contribution, the product should be dropped. II) General fixed costs and common expenses, which cannot be saved even after a particular product is dropped, have no role to pay in the decision – the total amount involved should be segregated and considered to be the expenses of the company as a whole whether the product is dropper or continued. c) Launching a Promotional Campaign The steps to be taken and the techniques to be adopted in the financial appraisal of such a campaign are summarized below: I) A decision – tree or a schematic diagram to identify all the decision alternatives and their interrelationship; II) Sales forecasts under each alternative as per I; III) Net contribution (after deduction of both variable costs and relatable fixed expenses) under each alternative;
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IV) Application of Discontinued Cash Flow (DCF) techniques to find from the results in (III) the Net Present Value (NPV) and/or the Internal Rate of Return (IRR) under each case, taking a uniform time horizon; V) Opportunity cost concept (e.g. opportunity loss by way of interest on money for promotional outlay, in working out (III). VI) Risk analysis in respect of (II) VII) “Roll back concept” to find the best payoff alternative under (III). Two sets of results would be available, under (III) and (IV). These have then to be studied, weighted and compared against norms (e.g. I.R.R. against the cutoff rate) to identify financially the most profitable alternative. Of course, a host of non-financial factors (e.g. marketing aspects in this case) will have to be considered before a ‘go’ or ‘no go’ decision is taken in this respect. Pricing Policies and Decisions Any business enterprise should as its primary objective, aim at optimization of profit or surplus so that it can sustain and also grow. The concept of optimization implies the existence of certain constrains some internal and some external. Efforts should be directed towards optimization of surplus against all such constraints. Profit or surplus depends on three factors primarily, viz. price, cost and volume. Price may or may not be controllable. So also is cost. Again volume may have to be restricted because of external or internal factors – some controllable and some not so. What is more important is that all these factors are intricately and intimately interdependent. This makes pricing a very difficult task. A widely varying combination of a host of factors influence, from time to time, pricing decisions both in the short run and in the long run and thereby determine the profit that an enterprise earns or would earn. The Marketer’s Dilemma More often than not problems relating to pricing baffle the marketer. And in quite a few situations he literally faces a dilemma. Let us look at some of the pricing problems that confront the management of an enterprise. 1. High-Price-Low-Volume vs Lo-Price-High-Volume While profit may be maximized under any of these situations, at least in the short run, it is extremely difficult to suggest a long term solution to this dilemma – whether to go for lower unit profit with higher volume
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or the reverse. The reason is it all depends on a number of factors, both external and internal. 2. Uniform End-Selling Price vs Discriminating Prices Both have advantages and disadvantages. of profitability through price discrimination. unidimensional approach here also. 3. “Cost Plus” Basis of Pricing This is a widely talked of concept. Moreover, in its ultimate analysis, price has to be cost-based, directly or indirectly. Price and cost cannot afford to remain unrelated to each other for long. But some pertinent questions that might arise are: What is cost? Is it historical cost, standard cost, or marginal cost? Should it include the cost of ideal capacity and of excess of capacity too? However some may argue to substantiate that “cost is a fact” within a certain range, cost is only what the cost accountant reports. 4. Price Revision Consequent upon cost escalation, imposition of special tax, duty, etc. price revision may have to be effect. Sometime, because of marketing considerations, for example, competitors’ pricing strategy, revision in existing prices, upward or downward, may be necessary. A number of problems arise in determining the quantum of any price revision, if not in a change in the pricing policy itself. Any wrong decision in this area may turn out to be suicidal. More important is the There cannot be any question of practicability in the area of operation, besides the question
Various Bases of Price Determination i) “Full cost plus” pricing ii) Marginal cost based pricing iii) ROI and cost of capital based pricing Development of Pricing Strategies Development of appropriate pricing strategies, especially from a longterm point of view, is a must for the survival and growth of any
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marketing enterprise.
The task involved has two aspects, viz., an
understanding of the price a buyer is willing or prepared to pay, and setting detailed objectives of the firm underlying its proposed pricing plan. The price a buyer is prepared to pay will depend on various factors like: (i) The position and power of the brand in the market. (ii) Value of goods to buyer – the buyer’s need of the product and his ability to do without it – nearness to situation of the need. (iii) Ability to deploy funds for the purpose – other demands on buyer-s budger. (iv) Price charged by competition – price charged for substitutes. In certain circumstances the product will be faced with a “backward leaning” demand curve, indicating that more will be bought at a higher than a lower price. This in turn may be due to snob appeal, fear of scarcity, psychological value added to the product, etc. Now we come to the second aspect viz. objectives. The age-old
objective of profit maximization suffers from a host of definitional and conceptual imprecisions as well as practical difficulties. Consequently, there is the need for considering multiple objectives and their mutual interdependence mainly from the marketing angle. In fact, pricing can ‘be a key to achieving far broader corporate objectives than those implied in the limited commercial concept of profit. Some of these objectives are : earning a target return on investment, achieving or sustaining a certain level of market share, ensuring a planned level of economic product/operations, achieving a specified rate of growth in turnover and/.or profit, meeting or beating competition, systematic product dilution and pruning and avoidance of government interference or restriction. Only upon a clear understanding of the various issues involved in both the aspects stated above, it would be necessary to design a price strategy for each product and each significant market segment separately for adoption in the short run and in the long run. Examples of some of the more common price strategies are: (i) Penetration Pricing, i.e. deliberately keeping prices low or moderate to achieve a sizable market share as quickly as possible. (ii) Price cutting – mainly to drive competitors from the market.
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(iii) “Skimming the cream” i.e. starting with a relatively high price and coming down later, if necessary, rather than following a course the other way round; (iv) Marginal pricing or contribution theory pricing – mainly to earn some contribution by using capacity otherwise unutilized. It may be mentioned in this connection that there should be some variation in pricing strategies by products or service types. weapon in the hands of the marketing manager. In the consumer group filed, for example, pricing is the most powerful But in industrial marketing, pricing may not be so powerful a tool. In the professional service sector, members usually do not knowingly compete with each other on professional charges – attempts should be made to improve upon the client’s financial results by other means, with of course each firm following a pricing strategy unique to itself. New Product Pricing Depending on the nature of the new product, suitable pricing strategy has to be developed. If the product is only anew pack or even a line extension product, pricing can be based on marginal cost and incremental contribution approach. This would ensure some distinct marketing advantage through greater competitive edge, especially during the initial period of introduction of the product. Once the product or pack get a good foothold in the market, its price may be progressively adjusted to bring in line with the other products or packs. If the product is new to the company but not new to the country, an extensive market survey and research should be conducted not only to get a feel of its market, but also to have an order of magnitude estimate of the price at which it can sell. The final price may then be determined after considering the total cost as also the marginal cost, competitors, relative prices, the special features of the product vis – vis the competitors’ and so on. Application of the technique of value analysis has been found to be highly effective in this area of pricing. In case the product is absolutely new to the consumers and there is no precedent to guide the pricing policy, the only approach left is one of trial and error with the objective of ultimately arriving at the desired price after sometime. But two factors are to be considered in such pricing decisions, namely recovery of research and development cost on the new product and cashing on the good brand image of the
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company by fixing up a relatively high price initially. In fact, this factor of brand image is taken into account in all new product pricing decisions. Some other important factors which provide some rough and ready criteria in the pricing of new products are as follows : (i) Snob Value The company may fix price for the new product if it is superior quality counterpart of an existing product, to give it the snob value it needs (ii) Product Life Considerations If the product life is shorter (for example, medicines, toys, etc.) its price should be kept high. But if the product has a longer life (for example, machine tools) undercutting of price initially may some times be necessary to penetrate into the desired market effectively. Appraisal and Control of Marketing Performance The results of business operation in general and marketing operation in particular are reflected in the annual accounts after the close of the year. It might be seen at that time that the results do not meet the expectations or the desired level established at the beginning. But by then they become historical – fait accompli! The results can, however, be favorably molded through suitable control actions only if periodic reviews of performance that: (i) Adverse situations can be controlled, to some extend at least, before they get out of hand; (ii) Uncontrollable adverse factors can be identified and quantified soon after these emerge; and (iii) Some safety valves can be provided against the possibility of efforts slackening sometime or the other during the year. There are different modes of marketing performance analysis and appraisal for the purpose of effectively controlling the operations. We have already discussed one such approach, viz. profit center system. This is considered to be a more sophisticated approach. Besides this, there are two other widely used approaches : (I) Sales analysis and sales variances analysis (ii) Comparative analysis of performance of various marketing subunits vis-a-vis reestablished norms. Sales Analysis and Sales Variance Analysis are made. Thus, the importance of performance evaluation and appraisal from time to time lies in the fact
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Sales analysis and sales variance analysis are commonly used techniques of marketing control – control exercised through comparison and application of the principle of exception. Selling and Distribution Cost Analysis Selling and distribution cost analysis is important for both cost determination and cost control. For the purpose of cost determination and distribution expenses should be grouped into two categories: (i) The direct expense which can be allocated to functions, area, division, product groups or products, salesmen, etc; (ii) The indirect or general selling and distribution expenses which cannot be so allocated and should therefore be apportioned on some suitable basis. Sales Variance Analysis The technique of variance analysis of standard costing can be used very effectively for the purpose of sales variance analysis which in turn could be used to locate precisely the reasons for divergence between budgeted or expected results and actual results. Sales variances can be calculated in two ways, viz. A. The Value Method This will show the variances in terms if sales value. Total sales value variance and then volume variance into price variance and then volume variance may be further analyzed into quantity variance and mix variance. B. The Profit Method Under this method variances are shown in terms of their effect on profit (or gross margin or contribution). This is a more improved method than the former. These variances are also called margin variances and the mode of their calculation and analysis would be the same as under (A) above, with the only difference that here sales value would be replaced by profit in each case. Product Line Profitability Analysis Profitability analysis is of different types. Since net profit is the simplest and the most easily understood criterion of performance, often it is necessary to arrive at, through preparation of comparative profit and loss statement, product or product line-wise, territory-wise, or even salesman-wise net profit figures. In preparing such statements, management accounting tools and technique are being Proper analysis of such reasons will help initiate suitable control actions as well.
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increasingly used. Specially, the technique of analysis of selling and distribution costs is of great use in any such profitability analysis. Profitability analysis of divisions or product lines or products is relatively, simple in case of small or medium-sized marketing organizations handling a few divisions and operating through a few selling establishments. But in case of a multi-product, multi-market marketing organization with highly diversified product range and operating through multiple selling and distribution establishments, division-wise and product-wise profitability analysis becomes a very complicated exercise. And in such cases, computer is often made use of. This requires a detailed systems study and suitable programming to get realistic performance results in the form of profits.
Conclusion In the foregoing paragraphs, an attempt has been made to identify some areas where marketing finance interface can help in achieving sustainable growth. Management Accounting tools like Cost Driver Analysis helps in differentiation and strategic positioning. The concept of Branch Valuation helps an organization in realizing the value of its brands in the market. There are a host of other applications which help organizations create enduring value in the marketplace. Concepts like strategic Cost Management (SCM) represent paradigm shifts in cost management. In SCM, cost management becomes a The function of strategic choice and has an acute external focus.
interface with the value chain brings external focus to the concept. The structural cost drivers and the executive cost drivers integrate managerial and technical skills towards better cost management. Cost leadership has an internal focus while differentiation focuses on strategic positioning which is the hallmark of competitive advantage. Santanu Ray Director The Icfai Business School, Kolkata, The author can be reached at santanuray @ibsindia.org.
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doc_424360465.doc
Cost-Revenue-Investment Framework in marketing, Parameters for developing marketing budgets, evaluation of salesman's performance, meaning and significance of marketing audit.
MARKETING FINANCE INTERFACE 1. Introduction, 2. Marketing Finance Independence, 3. Marketing Finance Interdependence, 4. Cost-Revenue-Investment Framework in marketing. 1. INTRODUCTION The preceding two chapters conveyed a general idea about the nature and purpose of marketing on the one hand and the role and functions of finance on the other, besides a bird’s-eye view of the various subfunctions broadly covered under both marketing and finance functions in an organization. This Chapter will endeavor to synthesize these ideas and examine to what extent these two important functions are independent and also interdependent. An attempt will also be made to highlight how the success of an enterprise would, to a great extent, depend upon the closest possible coordination between marketing and finance. There has been a tendency, for a long time now, to treat marketing and finance as two completely different functions and separate them into water-tight compartments. Unfortunately, this tendency has been more evident among typical Indian enterprises. Marketing people have tended to create an impression that they are the money – spinners and accounting and finance, just as many other functions, is unproductive staff – parasites living on their (i.e. marketing peoples) earnings and with no contribution of their own. Finance people, on the other hand, with rigorous professional qualifications in most cases, have tried to find faults with marketing people and despised their lack of knowledge of finance and even sometimes condemned openly their high-handed attitude or frittering away the company’s precious financial resources. There is, however, a welcome sign of such tendencies steadily yielding place to an attitude of co-operation and co-ordination with a view to fulfilling the overall corporate objectives. body fight with one another the By now they might have health suffers and learnt the moral of the time-honoured fable that if the limbs of the overall consequently all the limbs, too. Yet, some conflict does exit between marketing functions and finance functions in most of today’s organizations. The marketing manager is unhappy with the accountant when the latter tightly controls the marketing staff’s traveling expenses or the sales promotion budges. An accountant’s financial wizardry of keeping the company’s interest cost low is frustrated by the marketing manager’s expertise at extending credit to the valued customers or holding more stocks at
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distribution points.
The attempt of the management accountant to
prepare a realistic budget for the company is seriously hampered by the marketing manager’s highly optimistic or highly pessimistic predictions. different. At the end of the year the actual sales are very much When they are below the prediction level, the marketing
manager is sure to produce his ‘Magna Carta’ of reasons to justify the dismal results which had it not been for him, would have been even more dismal. And next year once again come the unrealistic predictions which the marketing manager insists are realistic and there begins the management accountant’s predicament. 2. MARKETING FINANCE INDEPENDENCE. Let us first examine to what extent marketing and finance functions are independent of each other. If you analyze the nature of these functions, you will find that there exists a great deal of independence. Marketing functions by and large lie outside the organization. On the one side, there is the marketplace and on the other, there is the organization. In the marketplace there are customers, negative The marketplace is customers and neutral or potential customers. political and social changes.
always in a state of flux. It is also continuously affected by economic, Such changes are again of a very complex and interdependent nature. All such changes and forces and interactions at the marketplace are transmitted to the organization through one important function of marketing, viz. market research. Based on such factors and forces the organization takes certain decisions which are again reflected in the marketplace. Finance function by its very nature is internal to the organization. An important part of the finance function, i.e. statutory accounting or custodian accounting, is responsible to outsiders, viz., shareholders, Government authorities, auditors etc. But all other functions under finance do not owe any allegiance to outsiders and the degree of dependence, too, is little. Financial management, particularly to the extent it relates to making available financial resources from outside, is influenced rather widely by external factors, especially capital market situations. But this influence is significantly different both in character and quality from the influences that market forces constantly exert on the marketing functions. These points would lead us to believe that the nature of marketing is completely different from that of finance. And these two functions have to be discharged more or less in an isolated manner. Also these two functions require completely different types of technical and
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human skills.
This would be evidence from the fact that a very
successful salesman often turns out to be an utter failure as an accounts assistant just as a very efficient accounts man may make a mess of sales if he is asked to handle this. 3. MARKETING FINANCE INTERDEPNDENCE A general tendency to treat marketing and finance as two different functions and separating them into water-tight compartments is happily yielding place to the coming together (of these two functions) with an attitude of mutual co-operation and coordination. This welcome change may be traced to two reasons. First, these two sets of people have generally realized that they are working for a common cause in order to fulfill common corporate objectives of survival, profitability and growth. Second, there are quite a few important areas where marketing and finance specializations tend to overlap. Some of these are: i. ii. iii. iv. Product planning including product selection, retention and abandonment as well as dilution in product portfolio; Product pricing including both short-range and long-range pricing policies and strategies. Evaluation of marketing performance – both general and specific marketing functions like product profitability analysis. Functional Cost Analysis to achieve cost effectiveness and also for v. vi. vii. exercising a systematic and meaningful control over marketing costs and expenses; Introduction and operation of an effective budgetary control system in marketing; Control of marketing operation – both the employment of funds and the cost of inputs; and Marketing investment decisions including monitoring their implementation. Then there are several commercial and fiscal issues (also under the domain of Finance) that should be addressed jointly by Finance and Marketing people: Some of these – illustrative and by no means exhaustive – are: i. ii. iii. iv. Sale on consignment basis, sale on approval or sales or return type of transactions. Leasing and hire purchase transactions. Interest element on credit granted and the related concept called average due date. Bills of exchange and hundies.
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v.
Recovery of excise duty through invoicing and keeping the said duty undisturbed even when the sale is made at a discount.
vi.
Recovery of sales taxes-both Central and State – through invoicing and collection of sales tax declaration forms (Forms C & D, as the case may be)
Some progressive companies in India have therefore set up Marketing Finance Cell on the same lines as Market Research Cells. A Marketing Finance Cell is staffed by personnel possessing expertise in both finance and marketing, so that they can provide staff assistance to marketing management at all levels in all the important areas listed above, as and when necessary. 4. COST – REVENUE – INVESTMENT FRAMEWORK IN MARKETING This is a perspective view of marketing finance, comprising three components. The term cost has a broad meaning here and covers in its ambit all costs of setting up as well as running a marketing organization. Some of these costs are of one – time nature – “the capital costs” in accounting terminology. Other costs are “revenue” or of recurring nature. But even those one-time capital costs become a part and parcel of the recurring costs through the process of depreciation or amortization, so that in the end all costs get absorbed or recovered through operations. Revenue is what the organizations earn by selling its products and/or services to customers outside the organization. The sum-total of all revenues is matched against the sum-total of all costs, both direct and indirect and the difference is worked out. When the difference is on the positive side (i.e. total revenue exceeds total cost), it means a positive surplus or profit. The negative difference means a loss. To keep the recurring operations going in marketing there has to be some investments. These are broadly of two types viz. investments on capital assets (e.g. motor cars, warehouses, office equipment, etc) and those on working capital (e.g. inventory, accounts receivable, etc.). The recurring costs of such investments have to be absorbed as stated above, along with the direct costs, by revenues earned through marketing efforts. (a) Depreciation etc. Recurring cost due to investments in marketing or diminution in respect of capital assets, usually takes any or both the following forms: inventory, value of amounts to be collected from customers,
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(b)
Financing or interest charges (actual or notional) covering all investments both in fixed assets and in working capital.
The cost revenge-investment inter-relationship discussed above is succinctly represented by a financial ratio called the Return on Investment (ROI). This ratio has broadly two components, viz., Return on Sales (ROS) or Margin Ratio and the Turnover of Capital Employed (Times). Return on Investment improves or deteriorates margin percentage on sales. Even with the same margin percentage, ROI can improve or deteriorate drastically through efficiency or otherwise in the deployment of funds or capital employed in marketing operations. In fact it is quite possible to improve ROI percentage by dramatically improving the rate of capital turnover (times), margin percentage remaining the same. This is what is called “Turn and Earn”. 2. PROCESS OF BUDGET SETTING There are important issues that need to be examined and sorted out before starting the detailed budget setting exercise: i) Corporate Objectives – Companies having systematic and organized long range planning (LRP) process will always have before them such long-term objectives, spelt out clearly and quantified. The companies which do not have a LRP system should also develop broad outline about its objectives on a longterm basis, at least for two or three years. The objectives should be set specially in two respects, growth and profitability. Preferably these should be broken up into present products and lines of activities on the one hand, and proposed new products and new lines of activities on the other. ii) Corporate Profit Planning – Profit planning and budgeting are two different things. They are rather interdependent and Profit planning more precisely, complementary to each other.
should precede the detailed budgeting exercise. Basically, profit planning provides a general blue – print of the expected profit and the broad elements through which this can be achieved during a particular budget period. By its very nature, it is a summary plan, not backed by a detailed action plan. From the practical point of view it is always convenient to develop a broad profit plan and get it approved by the top management before detailed budgeting exercise is taken up. budgeting exercise. This will obviate confusion and back and forth referrals which are common in a
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iii) Nature of Markets - By nature of markets, we mean the buyers’ market and sellers’ market. exclusively in the sellers’ market. Rarely is it found that a If that be so, then the company is operating exclusively in the buyers’ market or budgeting exercise would be relatively a simple one. More often than not, a company will be found to operate under a combination of these two types of markets – some of its products being in the buyers’ market and some others enjoying the privilege of being in the sellers’ market. This combination has to be broadly determined since it has a bearing on the marketing budgets. iv) Principal Budget Factor – This is also called a key factor, limiting factor, critical factor or governing factor. It is defined as the factor, the extent of whose influence must first be assessed to ensure that the functional budges are reasonably capable of fulfillment. areas, warehouse restrictions); Limiting factor may be in any of the operational sales activity (demand, sales efficiency, space, space); labour plant capacity (machine hour, namely
bottlenecks in key process); raw materials (shortage, import (general shortage, shortage of skilled labour); management (technical knowhow, efficient and effective executive) and capital (fixed capital, working capital). Key factor may be of an enduring nature or of a purely temporary nature (that is those which may be overcome by suitable management actions). But an adequate consideration of the magnitude or impact of such factors in existence during the budge year is a must in realistic budget – setting. v) Sales Forecasting – Since more often than not sales is the limiting factor, preparation of sales budget is generally the starting point in the budgeting exercise. Sales estimate or sales forecast is the basis of sales budget. Here is a list of the various factors to be considered in arriving at sales estimate or sales forecast : a) Analysis of the past sales to understand the trends of sales and also forecast the future trends. b) Demand Analysis and market analysis to ascertain market potential, market growth, the company’s share of the market, emergence of competition, competitors’ strategy, product design, pricing trends, customers, habits and preferences, etc.
6
c) Analysis of reports by salesmen as to expected sales – first hand and fresh from the field reports. d) Examination of general business conditions. e) Examination of special business conditions. f) Production capacity sturdy (or availability study, in case of a pure trading concern. g) Profitability analysis through sales mixes planning to ensure that the profit objective is fulfilled by the proposed sales forecast. vi) Spending for the future – There could be quite a few items of spending for the future like training and development of people, new product development and launch, developing an infrastructure for providing marketing intelligence and undertaking marketing research, etc. Such expenses may not
contribute directly to profit during the budget year and may often bring down the profitability, sometimes significantly. It is therefore, necessary to segregate such expenses from pure operational expenses, at least for the purpose of understanding the budget – year performance and profitability in the right perspective. Management may still commit such expenses on long – term considerations knowing fully well the extent to which this would reduce the profit for the budget year. After having thoroughly evaluated the above issues and prepared some basic inputs as a sequel, one might go about developing the detailed budgets. Efforts should be made of course to direct the entire budget setting activities along a systematic and logical approach, vide a schematic presentation given on page 138. 3. PARAMETERS FOR DEVELOPING MARKETING BUDGETS. Budgeting essentially involves developing a chart, a map or integrated and well – knit plan of action – as much detailed as possible – for a definite period of time to achieve some definite objectives. Budges are nothing but specific estimates of future events and situations. All such estimates have to be based upon some logic, some chain of reasoning, a set of assumptions and a number of parameters. Good budgeting practice requires that all such assumptions and parameters should be laid down in precise terms with quantification wherever possible. If this condition is not fulfilled, the credibility of budgetary controls system or objective evaluation of performance and effective control of operations. The subsidiary or support budget mentioned in the table
7
does provide some basic data and worksheets, including some important norms, and assumptions, in support of the principal budgets. Besides these, there could be a number of other assumptions and parameters of varied types. We give below only few such important parameters which would lie behind the framing of the market budgets. i) Distribution Plan: The existing distribution system and any proposed changes in it during the budget year (e.g. change – over from distributorship to distribution through the company’s own sales depots, changeover, partial or full, from sole selling agency system to company’s own marketing, etc.) ii) Advertisement Plan: The usual advertisement through media etc., as well as any extraordinary promotional campaign envisaged during the budget year with detailed cost – benefit analysis in respect of each such plan, change over from advertisement advertisement through through agencies agencies to to the the company’s company’s own own
advertising set – up again with a suitable cost – benefit analysis in this regard, etc. iii) Salesmen’s recruitment and training scheme with its financial implications. iv) Salesmen’s and executives’ travel plans, with estimated expenses against each, showing separately inland travel and foreign travel. v) Salesmen’s incentive scheme. vi) Inventory policy and any changes therein. vii) Credit policy and any changes therein. viii) After sales service set up and basis of charging for services. ix) Import and export policy of the Government. x) Breakdown of sales plan into quota in respect of the various profit centers as well as various sales executives under each. Budgets have to be approved by the top management or the budget committee. should be A detailed review of the budgets should along with some of the important precede the approval. For review and approval, budget figures presented parameters as stated above. Also, for comparison during review, budget statements should include various other sets of figures. Each budget statement should contain at least the following sets of figures : a) b) Previous year – 1 actual; Current year latest best estimates; and
8
c)
Budget year estimates. Sometimes, to gain a better idea of the trend for the purpose of budget review, previous year – 2 and even previous year – 3 actual figures are required in each budget statement. Once the annual budgets are framed, finanalised and approved, the budgets have to be broken up into shorter-period budgets are broken into monthly budgets. Some companies restrict themselves to quarterly budgets because of the special nature of their business operations, which some other companies may like to, develop fortnightly, weekly or even daily budgets.
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4. FLEXIBLE BUDGETING While fixed budgets portray a more or less rigid plan based on one set of conditions and one level of activity, flexible budgeting system attempts to develop a series of budgets for various levels of activity and under varying sets of assumptions. Conventionally, flexible budgeting system is associated with production budgets. But there is no reason why this concept should not apply to the marketing budgets also. Infract, marketing budgets could be framed on a more realistic basis and their control made more meaningful and effective with the help of the concept. The expense behavior analysis suggested earlier should form the bedrock of flexible budgeting in marketing, especially for marketing expense budgets. For example, we give here a summary of the marketing expenses broken up into the four functions and indicating the behavior of expenses: Illustration: Flexible Budgeting. The marketing expenses of P. Ltd. have been budged at Rs. 100 lakhs for the current year and their functional allocation is shown below: Functional Allocation of Budgeted Expenses: (Rs. In lakhs) Direct selling Distribution Promotion Other marketing Fixed 10 15 5 10 40 Variable 30 20 10 60 Total 40 35 15 10 100
The sales were budgeted at Rs.1000 lakhs and the quarterly break – up of the budgeted sales is, Quarter I Rs. 160 lakhs
10
II III IV
Rs. 240 lakhs Rs. 280 lakhs Rs. 320 lakhs
The actual sales during the I and II quarters were Rs.200 lakhs and Rs. 180 lakhs respectively and the actual marketing expenses were quarter I – Rs.26 lakhs and quarter II – Rs. 23.5 lakhs. A. Fixed Budgeting Under fixed budgeting, no distinction will be made between fixed and variable marketing costs and the total budgeted marketing costs of Rs.100 lakhs would be assumed to be incurred uniformly throughout the year. So quarterly budgets for marketing costs would be Rs.25 lakhs for each quarter. The report on sales and marketing costs would be as given below: (Rs. In lakhs) Quarter I Budget Actual Sales Marketin g expenses (F) Favourable (A) Adverse. B. Flexible Budgeting If a flexible budgeting is followed, the fixed marketing costs of Rs.40 lakhs would be assumed to be incurred uniformly throughout the year. The variable marketing costs would vary with the sales value in each quarter. Since Rs. 60 lakhs of variable costs represent 6% of budgeted sales, the budgeted marketing costs would be as follows: (Rs. In lakhs Fixed expenses Variable expenses 100.00 19.60 24.40 26.80 29.20 Total 40.00 60.00 Qtr.I 10.00 9.60 Qtr.II 10.00 12.40 Qtr.III 10.00 16.80 Qtr.IV 10.00 19.20 160 25 200 26 Quarter II Budget Actual 240 25 180 23.5
Varianc e 40(F) 1(A)
Varianc e 60(A) 1.5 (F)
When actual expenses are to be compared with the budget, the budgeted variable expenses will have to be flexed for the actual sales volume achieved to work out the variances. Marketing Expenses Allowed for Sales Achieved.
11
(Rs. In lakhs) Quarter I Fixed expenses 10 Variable expenses 12 (6% of actual sales) Total 22 Quarter II 10 10.8 20.8
The control report under flexible budgeting would be as follows: Quarter I Budget Actual Sales Marketin g expenses During the first quarter, the adverse expenses variance is only Rs.1 lakh under the fixed budgeting method. being higher than budgeted. It will be easy for the marketing department to justify this increase on the ground of sales Similarly, in the second quarter, the However, when we apply the The marketing department will be complimented for showing a favourable expenses variance of Rs.1.5 lakhs. flexible budgeting concept, the position changes significantly. 160 22 200 26 Quarter II Budget Actual 240 20.8 180 23.5
Varianc e 40(F) 4A)
Varianc e 60 (A) 2.7 (A)
adverse variance in the first quarter is Rs.4 lakhs and not Rs.1 lakh. Similarly during the second quarter there is again an adverse variance of Rs.2.7 lakhs and not a favourable variance of Rs.1.5 lakhs. In order to judge expense variance in the right perspective, the flexible budgeting approach would obviously be the correct one. For more effective control of expenses – the same approach or arriving at the revised budgeted expenses figures – the expenses should be allowed with references to the actual activity – can be extended to each functional area. And for this purpose, the budget should also be broken up department – wise as shown at the beginning. Further, to introduce more intensive control, the technique can be adopted on a monthly basis instead of quarterly as shown here. working will however, remain the same. 5. ADMINISTRATION OF BUDGETARY CONTROL SYSTEM Many organizations in India have a reasonably good budgeting system, but the budgetary control system is either non-existent or ill-structured or haphazardly implemented by them. In fact, no matter how systematically it is done, budgeting loses much of its significance and utility unless a budgetary control system is operated in The mode of
12
proper perspective. i) ii)
This comprises several important steps that
need to be taken up in a logical sequence, as follows: Developing the budgets as well as breaking these up into department/section wise details and also for shorter period; Continuous comparison a regular periodic intervals, say, monthly or quarterly, between the budgeted figures and the corresponding actual, using suitably designed formats; iii) As a sequent to (ii) above, location of divergences between the budgeted figures and actual figures and pinpointing those that are adverse in nature and higher in magnitude; iv) v) Analyzing the reasons for the divergences so pinpointed; Initiating remedial measures, again through the active involvement of the operating people, in order to correct the adverse divergences in the immediate next time – period; and vi) If any major divergence, whether favourable or adverse, is found to be beyond control during the budget period, then working out a rational basis for revising the budget itself. It is important to use suitably designed formats for presentation of budget actual comparison. suggested to this end: Budget TM (This Month) Budget YTD (Year –to-date) (Year-to date last year) Variance TM Variance YTD Variance YTD LY. Actual TM Actual YTD Actual YTD LY It should provide preferably a multiple frame of comparison and the following column-heads may be
Review and comparison between budgets and actual on a regular and continuing basis and generating budgetary control statements form only one part of the story. off control actions. actions. shoulder But the other part, perhaps the more important part, is the process through which these statements trigger The most vital requirement for this is that somebody has to take up the responsibility of initiating the corrective More often than not it is found that people do not like to the responsibility for taking corrective measures and The reason for the above may be
budgetary control ends there.
attributed to the human factor in budgetary control system, or in any other control system for that matter. People have been found to be a bit too sensitive to adverse variance confronted with the same; they start building up defense mechanisms in their own mind, rather than thinking constructively how to correct
13
the situation.
They start finding scapegoats alibis and excuses to
justify non-performance. An atmosphere of mutual faith and confidence has, therefore, to be created in the organization whereby people will look upon variance analyses not as fault – finding or witch hunting exercises, but engage themselves, in a genuine and constructive manner, in coordinated efforts so as to correct the adverse variances. This is of paramount importance, otherwise budgets and standards will continue to go wrong and the entire control mechanism will degenerate into mechanistic rituals with nothing coming out of these. 6. PROFABILITY CONCENT IN BUDGETING Budgeting in marketing area can be rendered more meaningful if the elementary concepts of statistical probability theory are introduced in the budgeting system. This may be explained with reference to a simple budgeting situation as indicated below: Profit Budget for the year 19x5 (Rs. Lakh) Pessimistic Sales at Rs.10 500 per unit Variable costs : Manufacturing Marketing Rs.0.50 per unit Marginal Cost Marginal Moderate 700 per Optimistic 800 unit Rs. 4.80 per unit 384. 40 424 376
Rs.5.10 per unit Rs.5 255 25 280 220 350 35 385 315
Contribution Fixed cost Manufacturing 100 Marketing 20 Administrative 10 Net Income before tax Tax at 50
130 90 45 45
100 20 10
130 185 92.5 92.5
100 20 10
130 246 123 123
percent Net Income after tax
In this case, the two important variables in the budget are the volume of sales and the estimate of variable expenses. We may assign probabilities to the pessimistic, moderate and optimistic estimates on the basis of our past experience and future expectations. Suppose, according to our judgment, the probabilities assigned to the pessimistic, moderate and optimistic sales estimates are 0.3, 0.5 and
14
0.2, respectively.
Similarly, let us assume that the probabilities
assigned to the pessimistic, moderate and optimistic estimates of variable costs are 0.2, 0.6 and 0.2 respectively. In the circumstances, we can have 3 further probable estimates of profits under each of the categories, pessimistic, moderate and optimistic, as indicated below: (Rs. Lakh) 1. 2. Sales @ 500 P=0.3 255 250 700 P=0.5 240 357 350 800 P=0.2 336 408 400 384 Rs.10 each) Variables costs Manufacturi ng x (Volume Rs.5.10 or P= 0.2 25 280 P= 0.6 25 275 P= 0.2 25 265 P= 0.2. 35 392 P= 0.6 35 385 P= 0.2 35 371 P= 0.2 40 448 P= 0.6 40 440 P= 0.2 40 424 376 130 246 123 123 0.0 4 4.9 2
Rs.5.00 Rs.4.80) 3. 4. 5. 6. 7. 8. 9. 10 . 11 . Marketing Marginal cost Marginal
220 225
235 308 315 130 130 130 105 178 185 89 89 0.1 0 8.9 0 92.5 92.5 0.30 27.7 5
329 352 360 130 130 130 199 222 230 99. 5 99. 5 0.1 0 9.9 5 111 115 111 115 0.0 4 4.4 4 0.12 13.8 0
contribution Fixed costs 130 130 Net income 90 95 before tax Tax at 50 45 percent Net income 45 after tax Joint 0.0
47.5 52. 5 47.5 52. . 5 0.18 0.0 6 8.55 3.1 5
probability 6 Net income 2.7 after tax x 0 joint probability (9 x 10)
Expected value of income after tax: Rs. 84.16 lakh It may be observed that the absolute estimates incorporated in the budget give rise to a variation of the net income after tax form Rs.45 lakh to Rs. 123 lakh and as such can provide us with an unstable base for future projections. A much better quantification of the future expected income after tax is possible if we incorporate probabilities of a few key variables in our analysis.
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1. Marginal Costing – Basic Concepts; 2. Optimsing Product mix ; 3. The Break Even Concept; 4. The Break-Even Chart; 5. Cost Volume Profit Analysis; 6. Break Even Analysis in a Multi-Product Situation; 7. Conclusion. 1. MARGINAL COSTING – BASIC CONCEPTS Marginal costing is the technique of segregating fixed and variable costs and thereafter arriving at the cost which would vary in proportion to the volume of production or sales. Total costing or absorption costing is the opposite of marginal costing. In the western countries, the expression direct costing and direct cost are treated to be synonymous with marginal costing and marginal cost, correct. We should, therefore, consider only variable cost as the same as marginal cost is to isolate the cost that can be saved when one less unit is produced over a given level. Fixed costs are costs that tend to be unaffected by variations in the volume of output. The important words here are ‘tend to be unaffected’ that is, fixed cost does not necessarily remain fixed for good. But it is assumed to be so under certain set of circumstances and within a particular range of activities and for a specified period. Variable costs are those that tend to vary directly in relation to the volume of output. Usually direct material, directly chargeable expenses and a part of the overheads constitute the total variable cost per unit. It is interesting to note here that, judged from the angle of a unit of product, fixed costs are the only variable costs and variable costs are the costs that remain fixed. This is because fixed costs are fixed in quantum but variable costs are fixed in rate per unit of product. A distinction should be made between marginal or variable cost of production and marginal cost of sales – the latter should include the
16
post – manufacturing variable costs, mainly for selling and distribution activities, while the former will obviously take into account the variable costs related to manufacturing operations only. There is some controversy as regards treatment of direct labour in marginal costing. This is due to its general treatment in the western countries as variable cost and accordingly shown as such in the publications of these countries. While it may be correct from their point of view, it is erroneous in the context or developing countries like India, where direct labour, for that matter, all labour costs, are by and large fixed in nature. Some exceptions are wages paid under piece work system (cases are rather few), part of the overtime pay, wages paid to purely casual workers engaged occasionally for handling extraordinary volume of work, etc. On a realistic assessment, the amounts, involved in these are not significant; and these components of labour cost may be considered as variable. countries like India. There are two more categories of costs, namely, semi-fixed and semivariable costs. Semi-fixed costs increase in steps up to a certain Examples are extent; thereafter they remain fixed at that level. But the rest bulk of labour cost should be treated only as fixed cost, under the situations obtaining in the
supervision, depreciation on shift operations, etc. Semi-variable costs are those that vary but not in proportion to production or sales- the variation may be at a lower rate or at a higher rate. Examples of such costs are power, telephone and telex changes etc. For marginal costing, these semi-fixed and semi-variable costs should be subsequently segregated into fixed and variable elements, taking into account the degree of fixity and variability of such costs, so that ultimately we are left with only two categories of costs, fixed costs and variable costs. Contribution is the difference between sales volume and marginal cost of sales (that is, total variable cost). profit. This is called contribution, because it represents the amount contributed towards fixed cost and Thus profit is arrived at after deducting fixed cost from contribution. Symbolically, C = SV – MC (C = Contribution, SV – Sales Value and MC = Marginal Cost) OR, C + MC = SV. Also: C = P + F (where P = Profit, F = Fixed Cost)
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Or C – P = F or, C -F = P The cost identification and profit build – up in Marginal Costing is illustrated below, under one product assumption and with hypothetical figures: Cost & Profit under Marginal Costing (i) (ii) (iii) (iv) Direct materials Variable cost of Direct Labour Direct Expenses (Variable) Variable Overheads : Factory Office & Administration (v) (vi) (vii 3 1 9 55 100 45 Cost per unit (Rs) 40 3 3
Selling & Distribution 5 Marginal cost of sales – (i) to (iv) Selling Price Contribution per unit – (vi) – (v)
) Rs. In lakh Total contribution on 1 lakh units sold Total Fixed Costs Total Profit 45 25 20
The proponents of marginal costing technique strongly maintain that products do not earn profits – what they offer is only contribution. Fixed costs are not directly related to the products – they are only ‘period costs’ and should be related to the business as such. But the total fixed cost of the business has to be deducted from the total contribution earned by all the products and the result will be the total profit of the business. Marginal costing technique, therefore, precludes any apportionment of fixed costs among products – fixed costs as the period costs of the business are considered separately in arriving at profits of the business. Let us assume that Company X Ltd. deals in three products, A, B and C. The hypothetical profit built-up would be as follows: Illustration – (i) Month: M Units A sold 1 B 2 20 40 C 3 30 90
(lakhs) Contribution per 45 unit (Rs) Total Contribution (Rs. Lakhs) Contribution 45
175 18
fund
of
the (Rs. 75
business
Lakhs) Total fixed cost of the business (Rs. Lakhs) Total profit the (Rs. Lakhs) of
100
business
Note: ‘Contribution fund’ is the total contribution earned by all the products. Assume that the total production capacity (interchangeable between the products) is limited to 6 lakh units per month. It is interesting to examine how total profit of the business will change, merely because of a change in the sales – mix, whilst all other factors (viz. product – wise unit contribution and total fixed cost of the business) remain unchanged. Illustration – (ii) Month: M Units A sold 3 B 1 20 20 C 2 30 60
(lakhs) Contribution per 45 unit (Rs) Total Contribution fund of the business Rs/Lakhs Total fixed cost of the business (Rs. Lakhs) Total profit the (Rs. Lakhs) of 135
215
75
business 140
Illustration – (iii) Month: M Units A sold 1 B 4 20 C 1 30
(lakhs) Contribution per 45
19
unit (Rs) Total Contribution (Rs./lakhs) Contribution fund of the (Rs. business
45
80
30
155
Lakhs) Total fixed cost of the business (Rs/Lakhs) Total profit the (Rs. Lakhs) of
75
80
business
The total profit of the business improves from Rs.100 lakhs to Rs.140 lakhs because of a more favourable sales – mix in Illustration – (ii), then comes down to Rs.80 lakhs in Illustration – (iii) when sales-mix becomes relatively unfavourable. And for all such changes in overall profits, the total fixed cost of the business has no role to pay whatsoever. This substantiates further why fixed cost is to be considered as a ‘period cost’ and not ‘product cost’ as emphasized under Marginal Costing technique. We may now introduce the concept of Contribution to Sales ratio. This measured in terms of either unit or total, was earlier called P/V ratio, usually expressed as a percentage. The expanded form of P/V ratio is Profit Volume Ratio which is unfortunately confusing, perhaps a misnomer. The ratio is not profit to volume, but contribution to sales, therefore C/S ratio. Assuming sale price to be Rs.100 and contribution Rs. 40, the C/S ratio would be: Contribution/sales or 40/100 or 0.4 or 40 per cent. We may now introduce the C/S Ratios, (i.e. ratios of contribution to sales) respectively inventing some additional figures, in the above illustrations: (Rs. /unit) Sale Price Marginal Cost Contribution C/S Ratio A 100 55 45 45% B 40 20 20 50% C 90 60 30 33 1/3%
Product wise profitability and therefore, product preference from Sales – mix point of view may now be summarized as follows:Criterion Order of preference
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i)
Contribution A
C
B
per unit (when unit sale is a constraint) ii) C/S Ratio B (when constraint) Contribution C/S Ratio sale price/value is a 45 45% 20 50% 30 33 1/3% A C
2. OPTMISING PRODUCT – MIX. According to management accounting principles, a product mix that maximizes the total contribution earned would be the optimum one. Also, the key factor or limiting factor which imposes a constraint on the volume of output should be identified so that the contribution per unit of the limiting factor could be worked out for the various products. This would help in the ranking of the products, and the product which yields the highest contribution per unit of limiting factor would be produced, subject to other constraints, to the maximum and thus the profit maximized. Such ranking of the products, in addition to highlighting the most profitable products, would also ensure allocation of available resources in such a manner that a proper product – mix can be chosen, given a set of constraints. Even when the firm may have the option of increasing prices of products to improve profits or may find that it would have to produce certain quantity of an unprofitable product as its demand is interrelated to that of some highly profitable product, or it may not be practicable for the firm to increase the costs on sales promotion, cost analysis techniques may be used to identify the more profitable alternatives so that a “what if” analysis can be made in respect of other options available and a proper product-mix chosen. Let us envisage a situation where more than one product is manufactured by the same types of machines, using the same basic raw materials but yielding varying rates of contribution per unit. There may be constraints in one or more of the different machine-hours, availability of raw material and/or say, demand. The marginal costing techniques (for example, study of contribution per unit of limiting factor) can be brought to bear upon the problem of determining the optimum product – mix in such a situation. Illustration The following particulars are extracted from the records of a company
21
Details Sales Consumption material Material Cost Direct wages (assumed to
Per unit Product A Rs.100 of 2 kg. Rs.10 cost Rs.15 be Rs.5 3 Rs. 5 Rs.15
Product B Rs.120 3 kg. Rs.15 Rs.10
variable) Direct expenses Machine hours used Overhead expenses Fixed Variable
Rs.6 2 Rs.10 Rs.20
(A) Comment on profitability of each product (both are the same raw material) when * * * * Total sales potential in units is limited Total sales potential in value is limited Raw material is in short supply. Production capacity (in terms of machine hours) Is the limiting factor. (B) Assuming raw material as the key factor, availability of which is 10,000 kg, and maximum sales potential of each product 3,500 units, find the product – mix which will yield the maximum profit. Working/Solutions Product A Direct materials 10 Direct wages 15 Direct expenses 5 Variable overhead 15 Marginal cost 45 Sales 100 Contribution 55 C/S Ratio 0.55 Contribution per kg. of Rs.27.50 material Contribution machine hour Thus the profitability of each product will be determined on the basis of the principle: the higher the contribution per unit of limiting factor, the more profitable is the product. Accordingly a statement of profitability under different conditions may be prepared. Limiting Factor i) Sales volume Ranking of Products BA Ranking based ib Unit contribution 22 per Rs.18.33 Per Unit Product B 15 10 6 29 51 120 69 0.575 Rs.23.00 Rs.34.50
ii)
Sales
value/Sale BA AB
C/S ratio Contribution per kg. of material Contribution machine hour. per
Price iii) Raw Material iv) capacity hours)
Production BA (machine
Under the situation, in part (B), the product preference will be in the same order as (iii) above subject to the conditions that maximum demand for each of the two products is 3,500 units. In other words, 3,500 units of more profitable product will be produced firs. The balance of available raw materials will then be utilized for the production of the less profitable product. Thus, the optimum product – mix would be as follows
roduct Units Raw materials Total materials required (Kg) 7,000 3,000 10,000 raw per Unit (Kg) A B 3,500 1,000 2 3* (10,000 – 7,000)/3KG = 1,000 UNITS. The technique as illustrated above has, however, limited applicability. It can give us the desired result in all cases where the principal limiting factor or constraint is only one and in a view cases only where the constraints are two in number. And in many other cases of two constraints an in all cases where constraints are more than two (which is most akin to reality, needless to say) optimum product or sales-mix can be determined by the application of Linear Programming technique. 3. THE BREAK-EVEN CONCEPT. In marginal costing technique, contribution (c) is understood as contribution towards fixed cost (F) and profit (P). In other words, C = F + P or C-F = P or C – P = F Accordingly, if P=O then C must be equal to F only. This situation is called break-even point, which indicates a noprofit-no-loss situation. At this point, the total contribution (C) earned is equal to what would be necessary to meet only the total fixed expenses (F) of the business. Sales below break even point means incurring loss (a part of fixed expenses remaining unrecovered) and sales above this point would enable the business to earn profit. It is
23
also important to note that once the break even point is reached, all earned (since total fixed cost stands already recovered at the breakeven point itself). The difference between the break-even sales or activity and actual (or projected) sales or activity is called margin of safety. The higher the margin of safety, the greater is the capacity of the enterprise to withstand fluctuations in actual activity due to internal or external reasons. It may be noted also that margin or safety and break-even point, related as proportions or percentages to sales, are If the complementary – both will together equal 1 to 100 per cent. per cent), of the sale value and vice versa. The break – even (BE) point may be worked out by different methods The simplest one is: Total fixed cost __________________ Unit contribution Assuming total fixed cost to be Rs.20 lakhs, the BE point at Rs.40 contribution per unit will be: Rs. 20 lakhs _______________ Rs.40 With the help of C/S ratio also, the same result can be obtained in terms of sales value: B.E. Sales Value = Total Fixed cost C/S ratio Total fixed cost Variable cost 1 - _________________ Sales Rs.20 lakhs = = ______________ 40% Rs.50 lakhs = = Rs.20 lakhs ____________ 1-60/100 Rs.50 lakhs __________________ Or __________________ = 50,000 units.
margin of safety is 0.4 (40 per cent), then break even must be 0.6 (60
Let us take some illustrations at this stage. 1. Data Period (quarter) I Sales Rs. Lakhs 30 Net Profit Rs. Lakhs 2
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II Required i) ii) iii) iv) v) vi) C.S. Ratio
40
6
Fixed cost per quarter B.E. Sales value per quarter Margin of safety as on quarter II sales. Sales required in quarter III to earn a profit of Rs.10 lakhs. Profit expected during quarter IV, given the sales forecast for the period, Rs.45 lakhs.
Workings i) The crucial stage is to find the C/S ratio. It may be noted that, as per the given date, there have been net profits in both the quarters. This means that the total fixed cost per quarter has It may also be been covered fully in each of the two quarters.
recalled that all post break –even contributions are actually net profits, fixed costs having been already covered at the break-even point itself. Therefore, the additional net profit of Rs.4 lakhs (6-2) is actually the additional contribution earned on the additional sales of Rs. 10 lakhs (40-30). Thus the C/S ratio would be 4/10 = 0.4 or 40%.
ii)
Total contribution = 40% of Rs.30 lakhs = Rs.12 lakhs = Rs.12 in quarter I Therefore, cost Or Total contribution in quarter II Therefore, fixed cost = 40% on 40 lakhs = Rs.16 lakhs = Rs. 16 lakhs – Rs. 6 lakhs (net profit) Rs.10 lakhs fixed lakhs – 2 lakhs (net profit) Rs. 10 lakhs.
(Note: Fixed cost per quarter has to be the same.) iii) B.E. Sales value Fixed cost per quarter per quarter = __________________________ C/S ratio = Rs. 25 lakhs
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iv) Quarter II sales B.E. Sales
= Rs.40 lakhs = Rs. 25 lakhs
M/S as percentage of quarter II sales = 15 on 40 = 37.5% (Therefore, B.E. = 62.5% of the sales) v) Contribution required to each a profit of Rs.10 lakhs = Rs.20 lakhs (fixed cost Rs.10 lakhs + profit Rs.10 lakhs) Contribution required Sales required ______________________ C.S. Ratio Rs. 20 lakhs _____________ 40% = Rs.50 lakhs Alternatively, sales required = B.E. Sales + additional sales Required for a contribution of Rs.10 lakhs Rs.10 lakhs = Rs.25 lakhs + _______________ 40% vi) Contribution to be earned on Rs.45 lakhs sales = 40% of Rs.45 lakhs = Rs.18 lakhs. Therefore, net profit = Rs.18 lakhs – Rs.10 lakhs (fixed cost) = Rs. 8 lakhs. 2. Summarized Profit/Loss Account for the year ended on 31.12.19x8. Rs. Lakhs Sale ( 4 lakhs units @ Rs.100 400 each) Variable cost of sales Contribution margin Total fixed cost Profit before tax (PBT) Tax @ 60% Profit after tax (PAT) 300 100 50 50 30 20 = Rs.50 lakhs
For the year 19x9 (i.e. 1-1-19x9 to 31-12-19x9) the company has projected its operations as follows: i) ii) iii) i) ii) iii) Sales: 5 lakhs units @ Rs.100 each. Proportion of variable cost of sales to sales: unchanged. Total fixed expenses : to go up to Rs.55 lakhs The break-even sales (units and value) for 19x8 The break-even sales (units and value) for 19x9 Why is there a difference in the break even sales between the two years?
Required.
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iv)
What would the revised C/S ratio be if the company was to achieve in 19x9 a break even situation at the same break even sales value as 19x8?
v) vi)
To achieve the revised C/S ratio as per (iv) above through price revision, what would be revised price in 19x9? To achieve the revised C/S ratio as per (iv) above through changes in variable cost of sales what would be the revised variable cost of sales per unit in 19x9?
Working: Rs.50 lakhs (total fixed cost) i) B.E. Sales: 19 x 8 – units: _____________________________ Rs.25 (contribution/unit) = 2 lakhs. Rs.50 lakhs (total fixed cost) Value = _____________________________ Rs.25% (C/S Ratio) = Rs. 200 lakhs. Rs.55 ii) B.E. Sales: 19 x 9 – units: __________ = 2.2 lakhs Rs.25 Rs.55 lakhs) Value = _______________ 25% iii) Since there is no change in C/S ratio, the only person for the difference in the B.E. Sales between the two years is the increase in total fixed expenses by Rs.5 lakhs in 19 x9 over than in 19x8. Rs.5 lakhs) Check: _______________ Rs. 25 Rs. 5 lakhs Or _______________ 25% iv) To achieve B.E. at a sale of Rs.200 lakhs, with Rs.55 lakhs of total fixed expenses, the revised C/S ratio would be: = Rs. 20 lakhs = 20,000 Units ) ) Addition ) to original ) B.E. Level = Rs.220 lakhs.
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Rs.55 lakhs ______________ X X = 27.5% v) Let the revised price be P Then P – 75 = 27.5% of P P = Rs.103.44 (app) vi) The revised variable cost of sales per unit would be 100 – 27.5 = Rs.72.5. = Rs.200 lakhs (X = C/S ratio)
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CHAPTER 18 EVALUATION OF SALESMAN’S PERFORMANCE 1. Clearing the Ground; 2. Problems in Salesman’s Performance Evaluation; 3. Evaluation Parameters and Criteria; 4. Salesman’s Compensation and Incentive Schemes; 5. Concluding Observations, 1. CLEARING THE GROUND Every one of us in our own sphere is a salesman. Even as a child is born it has to adopt the selling technique may be by crying, to persuade its mother to give it food. different sphere and under Throughout out life we have situations. Salesmanship likewise to sell ourselves and therefore adopt selling techniques in different therefore is not something uncommon or unusual. However, when we think of a salesman in a commercial or industrial enterprise, this thought of ours is immediately associated with certain specific qualities, the qualities that go to make a salesman. More important among these are attitude, knowledge (of the product, market and people), habits and selling skills. Selling skills again are broadly determined by one’s ability of aggressiveness or submissiveness depending upon the situation. The purpose of this Chapter is to discuss broadly two important issues, one logically leading to the other, viz. evaluation of salesman’s performance, and to develop a rational compensation package for the sales force. However, as an integral part of these two interrelated aspects, it will be necessary at the outset to focus on the need for performance evaluation and the various problems that may be encountered, especially when quantitative approach is attempted. The need any purpose of designing and implementing an adequate method of measuring a salesman’s performance in any marketing organization can hardly be exaggerated. Broadly and essentially this would help the marketing or sales manager to evaluate his sales force and improve its efficiency. It would help the manager in the task of creating, directing and stimulating a sales force to effectively respond to new challenges in the market situation. useful in. a) Developing Salesmanship as an inter-personal influence process. b) Motivation of salesman and supervisory leadership. Besides this, in more specific terms, a good performance evaluation system could be very
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c) Making decisions regarding selection, induction, training, award, promotion, transfer etc. d) Identifying the need for continuous training and development of sales force. e) Improving marketing, marketing aids, strategies and tools (e.g. working documents, demonstration materials etc.) f) Determining and restructuring salesman’s territories and work assignments. g) Improving sales planning e.g. Planning call cycles, routes and visits, job preparation, distribution centers etc. h) Introducing sound compensation and incentive systems supported by a ration evaluation scheme. The concept of productivity of salesman is relevant in this context. A salesman is considered to be productive only when the results achieved by him would not only offset the cost of efforts expanded on him by the company but also leave some surplus thereafter, which would satisfy the company’s predetermined norms of expectation from him. These norms could be expressed in the form of certain ratios, viz. sales per salesman, gross margin per productivity
salesman, contribution per salesman, net marketing margin per salesman, etc. cost should be looked upon from two angles, viz. direct costs and indirect or associated costs. Direct costs are actually the compensation package including commission, if any; the company has to offer to the salesman. The indirect or associated costs, mostly of a hidden nature, represent the costs that have to be incurred to equip the salesman to do his job, and to provide the necessary facilities and services to enable him to sell. Examples of such costs are traveling expenses entertainment expenses, promotional literature, samples, other selling aids used by the salesman etc. It was estimated sometimes ago by a pharmaceutical company that it cost Rs.25,000/per year to maintain even a newly appointed medical representative, though his basic salary would be only around Rs.500/- per month. This total cost of Rs.25, 000/- Takes care of both the direct and indirect elements. The question that necessarily follows is what should the company expect in monetary terms from the salesman before taking a decision to appoint him and commit itself to this cost of Rs.25,000/and more importantly, what sort of checks and balances or evaluation and control systems the company should operate to achieve it. 2. PROBLEMS IN SALESMAN’S PERFORMACE EVALUATION
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Now, we come to certain problems that are inherent in any salesman’s performance evaluation system, which might affect and distort the results of quantitative evaluation. enumerated below: a) First is the problem arising out of evaluation based on qualitative judgment Vis – Vis quantitative data. Needless to say, in any qualitative evaluation are always the possibility of personal bias and subjective value judgment vitiating the evaluation. Similarly, if evaluation is based entirely on statistical data, the results may not be always correct, particularly because certain important qualities, of a salesman can only assessed, not quantitatively established. persuade situation. b) Next is the problem of comparison between salesmen based on the results of evaluation. Such comparison can never be on apples to apples basis, since a great deal of human element is involved and different salesman have to work under different geographical and environmental peculiarities and constraints, in addition to the difference in the features and problems of the different products they handle. c) Third is the problem of determining standard or bench marks. Evaluation should always be based on such predetermined standards of performance or norms. If the standards or norms are not realistically set, evaluation will be vitiated. d) Fourth is the problem involved in determining the periodicity of evaluation. Evaluation based on very short-term results may be correct and it could sometimes be damaging in consequence. Similarly, evaluation based on very long-term results is not desirable because, if the results are not satisfactory, it will have a great impact on the operating results of the company for a longer period. Besides these, promotion, resignation, retirement and transfer of salesman create several problems in deciding upon the periodicity of evaluation. e) Sometimes salesman’s performance evaluation based on quantitative data may throw up certain discoveries and, intriguing question. For samples, all salesmen in all other regions have surpassed their respective sales quota by 20 percent, but those in Region A have failed to reach 80 percent people and as well as an alteration depending These are between upon the broadly determined by one’s ability to impress, influence or aggressiveness submissiveness Some of these problems are
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of the quota; sales volume for the company as a whole has increased by 20 percent but contribution falls short of the target by 5 percent and so on. f) Next is the problem of comparing variation in sales activity of different groups in the sales force and comparing relevant parts of job for each salesman within each sales group. g) The last problems in the list refer to the accounting system or the data base records are not adequate to provide precise comparison of salesman or sales-group performance. For example, difficulty will arise in evaluating an improvement in gross sales volume achieved by a group against the profitability of the mix of products another group has sold. Similar would be the difficulty in comparing the performance of a man in one sales group with that of a man in another group when the makeup of the job is different in each group. It can be appreciated that unless the issues stated above, are properly analyzed thoroughly, evaluation based on primary results along might be not only erroneous but also misleading. The above problems also indicate the need for developing a scheme of evaluation with multiple measures criteria to make dissimilar data more comparable. 3. EVALUATION PARAMETERS AND CRITERIA. A brief survey of existing literature shows that efforts have not wanted in developing suitable evaluation schemes to tackle such a multivariety situation and provide a handy tool to the sales manager. The techniques developed so far range from the accounting system after introducing some necessary minor modifications. A systematic and rather practicable approach has been suggested by James C. Cotham III and David Cravens*. According to them copying with dissimilar performance data is not a simple task, but by using the standard deviation personal selling influences are observed. The standard deviation adjusts seem in fly incomparable performance data so that measurement can be made against the same yardstick, thus allowing sales managers to make direct comparisons of dissimilar sales efforts. The technique, called a Z score or standard Score, can be utilized to place different measures of performance on the same scale. The formula for calculating the Z score is: P-M Z score = _________
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S.D. Where P = A raw performance measure for salesman, M = Mean (average) raw performance for the sales group; S.D. = Standard deviation of raw performance measure for the sales group. Consider a sales job with two performance measures, of volume and profitability. Assume that salesman Joseph produces Rs.2,000/- in volume in excess of his work target; the average for his sales group on the volume dimension is Rs.1,000/- and the standard deviation for the group is Rs.2,000/- Joseph’s Z score on the volume dimension is 2,000/1,000/- divided by 2,000/- which is equal to 0.50. If this Z score on the profitability dimension is 1.32 computed in the same fashion, then his composite performance (assuming equal importance of both dimensions) is 1.82 (o.50 plus 1.32) After a performance score has been adjusted to a common measuring scale using the Z score technique, it can be added to one or more additional standardized measure for a particular salesman to obtain a composite measure of his performance. This method provides a mode of examining salesman’s performances of specific dimensions. It also furnishes sales managers a composite measurement of any number of combinations of quantitative and qualitative measures of performance for men in a sale group. Simultaneously, this technique eliminates the need for devising a single overall performance measure, which is generally difficult to deal with. Cotham and Cravens have extended their model to measure inter-group performance as well. We will now discuss an alternative approach that can be more easily put into practice. The simple model delineated here has already been successfully tries in at least two companies, one engaged in consumer marketing and the other in industrial marketing. While applying this model, however, some suitable modifications would be needed, depending on the situations obtaining and specific purpose or purposes in view. At the outset, it should be stressed that our evaluation scheme like any other requires that the sales manager should. a) Organize sales activities into appropriate sales groups (such as industry, customer or product) and/or sales territories; b) Delineate the salesman’s job in each group or territories; c) Set benchmarks or standards of performance for each part of the job; and d) Establish specific methods of evaluation and the criteria and techniques to be adapted to this end.
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Out suggested approach provides, in the first place a check list of 20 parameters or criteria that could be used for the purpose of evaluation of salesman’s performance. While the list is only indicative and by no means exhaustive, it is neither desirable nor practicable for any company to adopt all these criteria – only a few say, four to sis may be chosen. It is also important to assign suitable weight ages to the criteria chosen, since all these may not be of equal importance. The criteria in the list are orientated towards an evaluation only of quantitative or financial nature. Now the list with a rational grouping, follows; A. Sales Achieved 1. Market Share 2. Sales Quantity 3. Sales Value B. Activity & Productivity 4. Number of calls. 5. Number of orders. 6. Value of orders booked 7. Value of orders per call (batting average) 8. Ratio of order value booked to the total value (Hit Ratio) C. Financial Performance 9. Contribution and C/S Ratio. 10. Direct selling expenses ratio. 11. Direct Sales margin. D. Working Capital Management. 12. Average inventory 13. Average outstanding receivables. 14. Average working capital locked up. E. V ital Performance Index. 15. Marketing Return on Investment (ROI) F Others 16. New Product Performance 17. Number of accounts obtained. 18. Number of accounts lost. 19. Number of customer companies. 20. Information about competitors, plan and strategies. In respect of each of the above criteria there should be some predetermined standards or norms expecting for those where such norms cannot be easily established (e.g. item nos. 19 and 20). Also
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the above criteria have to be adopted for evaluating the results of as a particular period, say a week, a fortnight, month or a quarter; and this period should be used uniformly, regularly and without discrimination for all salesmen in the organization. Based on a hypothetical situation and data and using a few of the criteria chosen from the above list, a comparative evaluation of three salesmen has been made and this is shown in Tables I and II. 4. SALESMAN’S COMPENSATION AND INCENTIVE SCHEME. It is almost an accepted practice that a salesman’s compensation package should not be a fixed one, regardless of his performance or achievement. Incentive scheme in some form or the other should be initiated to provide his productivity and at the same time enable the organization to share a part of the results arising out of the organized producing. The reverse is also true. If a salesman does not perform well, his total compensation package should get reduced to reflect, to some extent at least, the effect of his poor performance. does not pay back to is as per its norms. The organization also is not obliged to protect his pay packet as long as he The provision of such negative incentive would also act as a positive motivation to all salesmen. Accordingly, many companies have developed a scheme for compensating their salesman based on two broad elements viz fixed remuneration (Salary D.A. etc.) and incentive payments (commission, bonus awards etc.) As regards the fixed element of a salesman’s compensation packet, it should be ensured that the amount is not too low for him to meet his basic requirements but should not be, at the same time, too high to dissuade him from putting in extra efforts required to earn some incentives. Coming to the second element of the compensation. Viz. incentives, it is to be noted that there cannot be any straight – jacket scheme applicable to all companies or even to all salesman of a particular company marketing diverse, products and services. Every company has, therefore, to develop the scheme or schemes which suit it most. In developing a nature of the markets, area potential, seasonality in sales and a financial evaluation of the type of benefit – cost-analysis under various alternative situations that could be envisaged under the scheme. In developing a suitable incentive scheme for salesman the parameters and criteria of performance evaluation indicated earlier, may be effectively made use of. In that case, it would be advisable to choose a few criteria, say only five or six of them, which are considered to be the most important to the company. In respect of each such criterion chosen, suitable norms or standards have to be established. Further,
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appropriate weightage should also be given to those criteria, since not all of them could be equally important. Again, in respect of each of the criteria so chosen, a suitable system of reward and penalty should be built into the incentive scheme to take care of the performance, higher or lower than the norm. To elaborate these points let us take the hypothetical illustration, as outlined in Tables I, II and III. 5. CONCLUDING OBSERVATIONS Any scheme for the evaluation of salesman’s performance and the financial incentives following from it should have adequate provisions for the following inter alia: a) Experimentation with changes through lateral transfers should be encouraged. This is often useful since a particular salesman attached to a particular produce or territory for a relatively long period might tent to take things for granted. b) Personal evaluation through a good judgment system can never be replaced by quantitative analysis, however, detailed and scientific it may be. In fact, a judicious combination of personal evaluation and quantitative evaluation should be the right answer. c) While evaluation based on short-term results are required to operate the schemes, similar analysis and evaluation for a longer term is also necessary to develop long-range marketing strategies. d) Each sales manager has to develop his own method of performance evaluation and update it with changes over time. e) Marketing information system has to be sufficiently geared to meet the requirements for developing and successfully operating the evaluation and compensation scheme. We will discuss this aspect in detail in the last section of the book, viz. marketing control. AN ILLUSTRATION OF A MULTIPLE – CRITERIA EVALUATION CUM COMPENSATION SCHEME. TABLE I S.No. THE PLAN PRODUCT_____________ Evaluation Weightage Criteria Norms Basis score :maximum 12 for each (6 points for achieving of
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norm + or – for deviation as 1. Market share 30 25% shown below + (-) 1 for increase (decrease) every 5% or 2. Value orders 3. Batting average 4. Sales Value 10 Rs.10 lakhs 10 Rs.25,000 of 15 Rs.10 lakhs part. -doby
every Rs. 1 lakh or part. -Doby every Rs.5, 000 of part. -doby every Rs.1 lakh or part. -doby every 5% or part -do- -do-
5.
C/S Ratio
15
40%
6.
Marketing ROI20
20
20%
TABLE EVALUATION PRODUCT MONTH (Based on the Plan in Table I) P ZONE M DATE Salesman –A Figures Scor e Market 35% 8 Z ________
SR.No Criteria . 1. 2. 3. 4. 5. 6.
Weight ed Score 240 60 70 50 75 140
Salesman – B Figures Scor e 20% Rs.11 lacs Rs.22,00 0 Rs.10 lacs 30% 12% 5 7 5 6 4 4
Weight ed Score 150 105 50 60 60 80
Share Value of Rs.8 lacs 4 orders Batting average Sales Value C/S Ratio Marketin g Rs.27,00 7
0 Rs.9 lacs 5 35% 22% 5 7
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635 Weighted Average Score (Max. 6.35 12) * HYPOTHETICAL TABLE III COMPENSATION PLAN (Minimum Basic Salary Per Month Rs.2, 000 (ASSUMED) Score Upto 6 6.1 to 6.5 6.6 to 7.0 7.1. to 7.5 Compensation A. B. NOTE: Basic Rs. 2,000 2,000 2,000 2,000 Basic Rs. 2,000 2,000 Incentive Rs. 500 1,000 1,500 Incentive Rs. 500
505 5.05
Total Earning Rs. 2,000 2,500 3,000 3,500 Total Rs. 2,500 2,000
1. the award to a salesman for high scoring say 10 or above in a month may be, in addition to the usual monetary award, a nonmonetary one e.g. declaring him as an outstanding salesman of the month, giving a rolling trophy, awarding a merit certificate etc. 2. Payment of incentives may be effected only after 2/4 weeks from the end of the relative month, since some time is required for generating the basic data and working out the scores as per Table II. The basic pay however may be given at the end of the each month in the usual manner. The model illustrated above is based on hypothetical situations and data. But this being a simple one, any marketing organisation may adopt this with suitable modifications as may be required.
1. Preview, 2. Meaning and Significance of Marketing Audit, 3. Methodology, 4. Inferences and Recommendations, 5. Concluding Observations. 1. PREVIEW In the foregoing chapter of this book conscious attempts have been made to highlight the salient f features of marketing management process vis-a-vis the various factors and forces that at continuously at
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play in the market place.
It has been stressed that the essence of Market-oriented culture is a
marketing lies in “market orientation” as distinct from “product orientation”, or any other orientation. necessity in today’s increasingly competitive world. In market-oriented environment a company gears the efforts needed to produce what the market demands. service. Marketing process is an amalgam of a host of variables, e.g. objectives, strategies, tactics, etc. and these are subject to rapid obsolescence in the fast changing marketing environment. Marketing executives being engaged in continuous analysis, planning and control can hardly find time to suit back and examine what they have been doing and how they could improve their effectiveness in the context of the only unchanging thing that the “change” Marketing audit is an effective tool for assessing critically the need for such change and identifying key area for enhancing the sectoral as well as overall marketing effectiveness. Market leadership is established by creating customer satisfaction through produce innovation and customer
2. MEANING AND SIGNIFICANCE OF MARKETING AUDIT. Marketing Audit a sub-system or component part of Management Audit. While Management audit has a very broad and all pervasive scope, Marketing Audit can stand on its own feet and may be conducted either as a part and parcel or independent of Management Audit. “Marketing Audit is a comprehensive, systematic, independent and periodic examination of company’s or business unit’s marketing environment, objectives, strategies and activities with a view to determining problem area and opportunities and recommending plan of action to improve the company’s marketing Kolter) The above definition clearly spells out the following characteristics: Comprehensiveness Systematic Covers all the major activities of the company. There should be structured audit performance.” (Prof.
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programmed to be followed in proper Independent sequence for timely be The completion of the audit. Marketing audit can by outside consultants. for obvious reasons. Marketing audit should intervals. Normal practice of conducting an audit takes a narrow view. In this connection, Prof. Shuchmen says: “The marketing audit is a tool that can be of tremendous value not only to the less successful, crisisridden company but also to the highly successful and profitable industry leader. Even best can be made better. In fact, even the best must be better, for few if any marketing operations can remain successful over the years by maintaining status quo” It appears that marketing audit is more important in successful companies simply because they have a tendency to breed complacency. Webster defines an audit as “a formal or official examination and
conducted by internal experts or second alternative is preferred Periodic be
conducted at regular periodic
verification of an account, a methodical examination and review”. This is the concept of accounting audit which is carried out according to a fixed time table and under highly standardized procedure. In marketing audit there is no such clear-cut procedure. The accounting audit is directed towards the outsiders (shareholders, creditors, public etc.) whereas in marketing audit it is intended to deal with a specific marketing problem or assessment of component of marketing effectiveness, exclusively for internal uses. In fact, the term “audit” assumes much broader connotation and import when used in the context of Management audit as well as Marketing Audit. 3. METHODOLOGY It is not possible to present a comprehensive list of all the tools and techniques that are generally used for conducting management audit as well as one of its most important components, marketing audit. This is particularly because the approach and methodology vary widely not only between one audit unit and another but also among different
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experts carrying out marketing audit even for the same or identical unit. We would briefly discuss here nevertheless some of the important and well-accepted tools and techniques that generally form part of the methodology. It needs to be emphasized that one has to adopt a judicious blend of these tools and techniques, having regard to the nature of the audit-unit and the purpose of the marketing audit. i. Pre-Audit Briefing: It is described that there should be a pre-audit discussion with the company officials to agree upon the broad audit areas such as: a) Objective and purpose – general/specific, b) Coverage, c) Depth of study, d) Time schedule, and e) Expected specific outcome. ii) Basic Instruments: There are two accepted instruments for reviewing the overall marketing effectiveness: a) Marketing effectiveness rating review, and b) Marketing audit, as a sequent to (a) a) Marketing Effectiveness Rating Review Structured questionnaires are prepared to cover the major attributes of marketing orientation namely, customer philosophy, marketing and organization, marketing information, strategic orientation
operational efficiently. b) Marketing Audit: The major components required attention of a marketing auditor are: Marketing Environment Audit, Marketing Strategy Audit, Marketing Organisation Audit, Marketing Systems Audit, Marketing Productivity Audit and Marketing Function Audit typical questionnaires related to these areas have been given at the end.
iii) Swot Analysis: Swot Analysis is an almost universally accepted tool for auditing marketing operation. Swot (as mentioned earlier also) is the abbreviated version of strengths (S), Weaknesses (W), Opportunities (O) and Threats (T). The S & W parts of SWOT are actually
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Organizational Analysis (internal) and the O & T comprise Environment Scanning (external). SWOT analysis can be conducted through questionnaire technique or brain-storming sessions. As an illustration, we are giving below only a few of the SWOT’s listed during a brain-storming session of senior marketing executive of a leading instrumentation company, while a marketing audit was being carried out: Strengths: i. ii. iii. Wide range of products, thereby offering better business potential. Efficient after-sales service provided by the company. Availability cases. Weaknesses: i. ii. iii. Poor Government liaison and public relation. Inadequate efforts on a continuing basis for development of new markets. Technological obsolescence in respect of some of the products manufactured and/or marketed by the company. Opportunities: i. ii. Fast growing and varied markets offered by the Indian Economy for the products of the company. Increased markets for the company’s products arising out of Government legislations re-pollution control, stricter adherence to quality standards, etc. iii. Scope for introduction of new products with latest technology opportunities, Threats: i. Changing customer behaviour evident from unethical practices which the company is not willing to indulge into. ii. iii. Social-political instability in some regions causing retardation in industrial activities. Scarcity in foreign exchange leading to conservative import policy. and due thus to exploring the market gap technology of both indigenous and imported instrumentation equipment as alternatives, in some
prevailing in India.
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iv. Data Generation and Analysis: Data collection is an integral part of the marketing audit and for satisfactory result, interfacing with company officials and file references are a pre-requisite. A cursory glance over the questionnaire given at the end will corroborate that apart from statistical data due emphasis is placed on the personal views obtained through interactions – both one to one basis and at times in groups. Because of this, an effective communication with all levels of management is needed. For generating necessary data and information, different types of questionnaires may have to be designed and administered, depending again on the purpose and scope of the marketing audit. In course of conducting a fairly comprehensive marketing audit of a large engineering conglomerate (a multi-national unit with diversified produce portfolio), as many as six questionnaires were designed and used respectively for: Company’s Executives (senior-level-all etc.) functions), Customers (direct), Customers (indirect-agents
Principals/Suppliers and Competitors. v. Brain –Storming : The expression was first coined by Alex Osborn. This involves collaboration of personnel to “storm” a problem. It is in fact a creative conference aiming to generate a host of ideas-good, bad or indifferent. In a brain storming exercise, quantitative and qualitative facts and figures are usually available to facilitate marketing audit, provided the brain-storming session comprises participants well-informed in the reference subject. 4. INFERENCES AND RECOMMENDATIONS This is the concluding part of marketing audit. The effectiveness of the audit is directly related to the auditors skill and professional expertise and of course objectivity with which the analysis of data (derived from pre-set questionnaires) are made, inferences are drawn from the analyzed data (identifying for example areas where immediate corrective actions might be needed) and appropriate recommendations are incorporated in the audit report. Much as the reader would like us to present some case studies on marketing audit in keeping with the age-old adage. “Examples are
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better than precepts.” It would not be practicable for us to do so here. We are nonetheless giving below a few interesting outcomes that were included in the respective marketing audit reports, by way of illustrations only. i) Audit Unit – large consumer products – based chemical company in a neighboring country: a. Immediate formation of a task force for expansion of the
product-range by introducing at least ten new products in certain identified field like. b. Establishing appropriate methods for evaluation of promotion and advertisement activities with a view to ensuring cost effective promotion. C. conducting an attitude survey of marketing and sales personnel and simultaneously generating pertinent data rather counterparts in the industry, in order to restructure their compensation and incentive package. ii) Audit Unit – an old established foundry in the Eastern India: a) The order – shipping – billing – cycle time (worked out at around 78 days for a new order and about 68 days for a repeat order) being very high, given the industry norms, needs to be cut down by the least 25% in each case within one year. b) The present success rate against enquires or “Hit Ratio” of 1:8 can be improved to 2:8 or 1 : 4 given the proper organization and support system in marketing operations, in order to double the capacity utilization (from the meager 20% at present) as well as the turnover level. c) Taking a hard took at and revamping as necessary, the pricing policy and strategy of the company in order that demand and state of completion etc. are built into the pricing system, rather than allowing the same to be entirely cost-based as existing now. d) Introducing an effective market – research function in the company not only for regular market share or hit ratio analysis but also for undertaking researches on the changing pattern buying behaviour with respect to the company’s products. 5. CONCLUDING OBSERVATIONS It is the consensus opinion that the marketing audit should be conducted by outside consultants in order to have an independent look
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of the market orientation – present and future- and to submit an unbiased report free from push and pull of various interested groups. After all outside experts would not have any axe to grind, score to settle or corporate ladder to climb! The marketing auditor is to determine what is being done, appraise what is being done and recommend what should be done. It is essential that the audit should be conducted and completed within an agreed time frame so that the data forming the background of the audit do not become outdated and thus nullify some inferences and recommendations. Also important is the auditor getting familiarized with the company’s background including extend of professionalism, work culture, breadth of experience, result-orientation, cost-consciousness and recommendations. The ultimate object of marketing audit is improving the marketing effectiveness and market-orientation and in no way should it be a tool of assessing individual competence. In other words, Marketing Audit should never be allowed to degenerate into a faultfinding or witch-hunting exercise. Once these are ensured, progressive organizations will no longer shy away from getting marketing audits conducted. Thus, the prevailing apprehension or mistrust in this area could also be set at reset. MARKETING AUDIT INSTRUMENT QUESTIONNAIRE. (Please indicate your rating by a ?mark against each criterion under the *5 Point Rating Scale for I to V. briefly under VI). I. Marketing Environment: The extent to which you are conversant _______________________________ with the changes in the environment A Macro Environment i) Economic. ii) Financial and fiscal. iii) Social. iv) Political. B. Task Environment i) Market segments ii) Customer iii) Competitor. 1 2 3 4 5 Please put your observations
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iv) Substitutes of products v) product/process technology II. Marketing Objectives and Goal: i) The degree of clarity of corporate objectives and how they lead logically to the marketing objectives, ii) The degree of clarity in the marketing objectives. iii) Clarity in priority ranking between different marketing objectives (e.g. market leadership, market shares, volume sales growth, rupee sales growth, marketing profitability etc.) iv) The extend to which the marketing objectives are qualified. _______________________________________________________________________ _ *1 = very Poor, 2 = Below Average, 3 = Average, 4 = Good and 5 = Excellent. III. Marketing Organisation: i) Degree of effectiveness in the ____________________________ Existing marketing organization 1 executives iii) Extent of smooth interaction between marketing and other departments. IV) Marketing Mix. Indicate your rating of effectiveness against each of the following elements of the Marketing Mix/functions. i) Product (range, packaging, performance, quality, after sales service, etc.) ii) Price (including financial terms) iii) Promotion (mode, channels, medial etc) iv) Placement (distribution channels and network – both coverage and cost effectiveness) V. Marketing Systems: Indicate your rating of effectiveness against each of the following areas under marketing systems i) Marketing MIS (state of business monitoring and development) ii) Marketing budgets and business plans iii) Marketing long range plans iv) Cash flow in marketing Operations v) Product line profitability 2 3 4 5 ii) Degree of clarity of authority and responsibility of marketing
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vi) Marketing intelligence (including market researches and surveys) vii) Sales analysis (from different angles) viii) Market share analysis (overall as well as for different market segments) ix) Sales force – recruitment and training. x) Marketing performance evaluation. VI. Marketing Strategies : i) Does your company have long-range strategy in respect of your product group? If so, what methodology is adopted? ii) Is the long-range strategy supplemented by short range strategies and tactics? If so, how are they linked and determined from each other? iii) What is your perception of the degree of clarity in communication of strategies developed or when strategies are changed? iv) What methodologies are adopted in monitoring the implementation of these strategies? What and to what is their effectiveness? v) Does the Company have a contingency planning methodology for your product group? If so, what and to whom extent? vi) Extent of use of sophisticated techniques (e.g. Product Life Cycle concept, Boston Consulting Group model etc.) that are adopted in developing marketing strategies. (Note: Adequate space to be provided below each question) Remarks or Additional Comments, if any ______________________________________________________________________ Name: ___________________________ Signature: ________________________ Designation ______________________ Date: ____________________________ Location: ____________________________________________________________ Responsibility Area: _________________________________________________ (Business Centre/ Products/Territory, etc.)______________________________________________
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Marketing Finance Interface Towards Organizational Integration and Effectiveness In the manufacturing sector, companies are leveraging technology to gain competitive advantage. In the service sector, supply chain management and merchandizing are in sharp focus, while in the knowledge management domain, data mining and data warehousing continue to dominate knowledge based unit. The bottom line is that irrespective of the nature of business, to survive in this market, a company has to provide excellent products or services at the most competitive rates. The changing business scenario and the infallibility of some basic truths about marketing management and financial management have brought into sharp focus the critical need of marketing finance interface for competitive growth. The Cover Story focuses on the areas of marketing finance interface, like financial aspects of brand management, strategic cost management, cost analysis in marketing decisions, pricing policies appraisal and control of marketing performance, etc. Marketing Finance Independence Marketing functions by and large lie outside the organization. On the one side there is the market and on the other there is the organization. In the marketplace there are positive customers, negative customers, neutral potential customers and non-customers. Markets are always in a state of flux. They are also continuously affected by economic, Such changes are again of a very political, and social changes. and decisions,
complex and interdependent nature. All such changes and forces and interactions at the marketplace are transmitted to the organization through one important function of marketing-market research. Based on such factors and forces the organization takes certain decisions which are again reflected in the marketplace. The finance function by its very nature is internal to the organization. An important part of the finance function, i.e. statutory accounting is responsible to outsiders, viz. shareholders, government authorities, auditors, etc. But the other functions under finance do not owe any allegiance to outsiders and the degree of dependence too is little. Financial management, particularly to the extent it relates to making available financial resources from outside, is influenced rather widely by external factors, especially capital market situates. But this influence is significantly different both in character and quality from
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the influence that market forces constantly exert on the marketing functions. Marketing Finance Interdependence Behind these apparent elements of diversity, there is an element of inherent unity in the two functions, marketing and finance. This unit or point of contact is to be traced to the fact that both these sets of professions are working for a common cause and endeavoring to reach a common destination for the organization, viz. its survival, growth and profitability, on the course might be different. The magnitude and complexity of finance function will keep on increasing at a geometric rate if the organization can ensure highly dynamic marketing function. The number and more importantly, the type of people required for efficient discharge of finance functions depends, to a large extent, on the nature and degree of success in the marketing function. If marketing fails, finance, and for that matter all other functions in the organization, will have to come to a grinding halt. Similarly, marketing also depends, heavily on finance. In the first place the finance function has to provide necessary support in a continuous manner to marketing so that it can become effective and successful. This is especially important in respect of working capital for marketing operations. Besides this, it has been seen on a number of occasions how wrong decisions in the marketing area could be stalled by timely interference of efficient finance people. There are also instances to prove how a dynamic marketing move has been halted because of unimaginative and unwarranted intervention from finance people who are incapable of understanding or appreciating marketing issues. In today’s environment, marketing and finance functions work hand in hand to enable companies achieve competitive edge. There are quite a few important areas where the marketing and finance functions overlap. Some of these are: (i) Introduction and operation of an effective budgetary control system in marketing. (ii) Product planning including product selection, retention and abandonment as well as dilution in product portfolio. (iii) Product pricing including both short-range and long-range pricing policies and strategies.
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(iv)
Marketing
investment
decisions
including
monitoring
their
implementation with suitable feed-back-oriented control systems. (v) Evaluation of marketing performance, including both general and special marketing functions (vi) Control of marketing operations – both the employment of funds and the cost of inputs. (vii) Functional Cost Analysis to achieve cost effectiveness and also for exercising a systematic and meaningful control over marketing costs and expenses. (viii) Valuation of Brands and brand risk analysis. Interface and integration Finance and marketing cannot and should not work in isolation. There exists the need for a highest degree of coordination between these two functions so that the organization as a whole could achieve sustainable growth. There cannot be meaningful co-operation, far less any coordination, between two sets of people if they do not understand each other. Such back of understanding might lead to a situation when each will abdicate to the other. This may not be damaging when the going is good. But during a period of rough sailing, each will develop hostility towards the other. This is true of finance and marketing people in Needless to say, no organization can many Indian Organizations.
afford to allow such hostility except at its own peril. Obviously the only way to avoid such a situation is to develop a better understanding by each of the other’s discipline and sphere of operation. Any functional management, and marketing cannot be an exception, includes planning, organization, and control in the first place, and taking decisions and evaluating the results of such decisions at the end. There are also such things as direction and motivation which are important to marketing. But all such functions of marketing management must have some relevance to finance. Sometimes such relevance could be direct and sometime indirect or a little contrived. But any management function which does not take into account the finance implication involved, would mean nothing but groping in the dark with consequent uncertainty of success. This would be more so for marketing because the results of all marketing operations have ultimately to reflect in the Balance Sheet of the organization through its Profit and Loss Account.
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The above observations apply particularly to marketing decisions. Some management professionals believe that there are only two people in the organization who take decisions – the managing director and the marketing director. In fact, everybody right from the marketing executive up to the topmost person in charge of marketing operations has to take decisions day in and day out. Such decisions could be short-term or long-term, repetitive (programmed) or singleshort (unprogrammed). However, one basic requirement of each and every decision, to make it a right decision and at the right time is that the decision-maker should be above to envisage clearly, even before he takes the decision, its effects on the company’s bottom line and balance sheet. It has to be appreciated that the develop such a faculty is not an easy job. This requires a substantial exposure to accounting, finance and management accounting concepts. While nobody expects that a marketing man having acquired such expertise will change his role and join the finance function of the organization, it is highly desirable that he/she should require and develop such expertise even to meet the challenges of his/her marketing function. In complicated situations involving hard-core financial implications, he/she can always draw upon the greater degree of expertise available in the finance department of the organization and sometimes even outside the organization. But he/she must have the ability to understand when he/she should seek such assistance. Otherwise ignorance must have the ability to understand when he/she should seek such assistance. Otherwise ignorance will not be bliss to the individual, especially in the long run. In ordinary situations he has to often take quick decisions, otherwise he may lose a business opportunity. And in such cases he cannot afford to waste time by referring the matter to the finance department. He himself has to take the decision on the spot and it has to be the right one from the financial point of view. An example in view is the decision regarding pricing and terms of payment, especially while negotiating a big tender or an export order. It is equally important to note that the finance professionals will also have to play an effective role in this area. They in particular should: (a) Have a reasonably good exposure to some of the basic concepts of marketing.
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(b) Develop an appreciation of the uncertain and competitive environment under which marketing people have to operate and, therefore, develop the need to adopt a flexible attitude towards their plans, programs and activities; and (c) Endeavor to replace accounting control through conventional budgeting system, particularly of marketing costs and expenses, by a more purposeful managerial control based on a profit-centered approach. Marketing objectives should be logically derived from and be an integral part of the corporate planning process. Peter Drucker in The Practice at Management sets out seven distinct marketing objectives that are necessary in most businesses. These are: 1. The desired standing of existing products in their present market. This may be expressed in sales value as well as in percentage market shares, measured against both direct and indirect competition. 2. The desired standing of existing products in new markets, measured in the same way. 3. The existing products that should be abandoned, for technological reasons, because of market trends, to improve the product mix, or as a result of management’s decision concerning what is business should be. 4. The new products needed in existing markets, defined in number of products, their properties, sales value and projected market share. 5. The new markets that new products should develop in sales revenue and percentage market share. 6. The distributive organization needed to accomplish the marketing of goods and the pricing policy appropriate to them. 7. A service objective measuring how well the customer should be supplied with what he considers value by the company, its products, its sales, and service organization. One of the principle areas of marketing finance interface relates to marketing budgets. Companies having a systematic and organized Long-Range Planning process (LRP) will always have clearly spelt out long-term objectives. The companies which do not have an LRP system should also develop a broad outline about its objectives on a long-term basis, at least for two to three years. The objectives should be especially in two respects. Viz. growth and profitability. Preferably these should be broken up into present products and line of activities on the one hand and proposed new products and new lines of activities, on the other. An attempt should be made at the outset to ensure that the annual marketing budges under preparation broadly
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conforms and contributes to the company’s growth and profitability objectives for the next few years. Next, companies have to deal with the problem of achieving “goal congruence”. It is often seen that some products could be marketed or some lines of activities could be developed with relatively less marketing efforts. While the marketing department would try to put higher budget figures for such products or activities, at the expenses of others, this might not be in conformity with the corporate goals and objectives, especially from a long-term point of view. It could so happen that the Profit Volume Ratio (Contribution/Selling Price) of such products may be low. There are several instances when products with low PV Ration have been suffered the lack of focus and consequently lower volumes. Such cases completely disturb the cost volume profit relationship and are against the long-term interests of companies. Similar problems might also arise in the case of a company engaged in marketing both its own manufactures and, also of others as selling agents. In the process, the long-range corporate goals and objectives should predominate. The next issue concerns, “corporate profit planning” and the marketing department’s responsibility in this regard. In the first place, a broad profit plan prepared in advance and duly approved by the management, results in confusion and repletion in the budget exercise and consequently delays i8ts finalization. solely responsible for achievement or Secondly, even though cause improvement, or marketing has the major role in achieving the profit target, it is not deterioration in the profit position. Production could be more efficient and economic or less so that what is envisaged would straight away reflect in the cost of products, non-marketing administrative expenses can go up or come down even substantially, due to efficient or inefficient handling of finance, the incidence of interest could be much lower or higher than envisaged and so on. And all these will directly affect profitability. Therefore, it is necessary at the outset to establish, specify and quantify, as far as practicable, the responsibility of the marketing department viz-vis other departments in achieving the profit targets. The last basic issue we shall discuss here is “spending for the future” as against spending for the present. Too many companies still reward executives for short-term profits. Very often a manager will not spend
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money on the future, and with luck he will get promoted out of his job, or retire from it before the future arrives. Some others have to live with the consequences. There could be quite a few items of spending for the future in the marketing area, viz. launch of a new profit, an advertisement popularizing infrastructure campaign new for uses for of penetration existing marketing into new markets or an products, developing
providing
intelligence,
undertaking
marketing research, etc.
Needless to say such expenses may not
contribute directly to profits during the budget year and may often bring down the profitability, sometimes significantly. It is, therefore, necessary to segregate such expenses from pure operational Management expenses, at least for the purpose of understanding the budget- year performance and profitability in the right perspective. may still commit such expenses on long-term considerations knowing fully well the extend to which this would reduce the profit for the budget year. One of the most critical areas of marketing finance interface lies in the concept of Strategic Cost Management. Strategic Cost Management – The Paradigm Shift Traditional cost management techniques primarily relate to analysis of operating data with a view to achieving cost-effective operations and gain competitive advantage. It is in no way connected to the analysis of strategies pursued by the companies to ascertain their effectiveness in gaining competitive advantage. Strategic Cost Management relates to the integration of cost management techniques like Marginal Costing, Absorption Costing, Standard Costing and Target Costing, focus on standalone analysis to achieve cost-effective operation. Marginal Costing underscores the divergent cost behaviour of variable and fixed costs. It focuses on cost-profit-volume relationship and key areas of break-even point, margin of safety, and profit volume ratios. It is considered a very useful tool in decision – making. Absorption Costing, on the other hand, proceeds on the premise that overhead (works administrative, selling and distribution) should be absorbed over volumes for cost-effective operation. Standard Costing is a useful tool for implementing budgetary control which sets norms and analyzes variances in material, labor and overhead cost and provides for variance distribution on a global basis. actual cost against targets. Target Costing analyzes
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All these cost management techniques focus on operations rather than strategy. managers Costing was used as a control measure, to enable line keep of costs today under is control. in The rapid changing business in ushering transformation
environment
manufacturing and product management systems forcing companies to adopt a more proactive approach which would extend beyond the traditional ambit of cost and management accounting. The basic premise of strategic cost management is that a firm can gain competitive advantage through the analysis of both financial and non financial information. Financial information includes figures pertaining to sales, cash flow and stock price. Non-financial information consists of details such as market share, product quality, customer satisfaction, corporate governance and growth opportunities. Financial information indicates a firm’s current financial position, whereas non-financial information position. indicates a firm’s competitive position. Customer satisfaction is crucial to the determination of a firm’s competitive Thus, Customer Relationship, Management (CRM) has become a crucial component in this exercise. The competitive position is assessed on the basis of customer satisfaction, internal business processes and innovation and learning. Financial and non-financial measures together constitute Critical Success Factors. These factors are essential for a firm’s growth and success. A company’s journey to competitive edge gets fuelled by the culture of innovation within it. In this context, it would be pertinent to mention about two important and relevant research contributions. In “Seeing What’s Next”, Christensen, Anthony and Roth have discussed the theories of innovation that can be used to predict industry change, while in the “Blue Ocean Strategy”, Kim and Mouborgne have focused on how to create uncontested market space and make “competition irrelevant”. This is the context of Strategic Cost Management (SCM). SCM integrates three strategic management themes. are: * Value chain analysis * Cost driver analysis * Strategic positioning analysis. Value Chain Analysis Each organization has certain value creating activities. These activities start with the receipt of material inputs and extend to the ultimate realization of sales proceeds. Value chain analysis is a strategic The three themes
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analysis tool that can be used to identify area in which value can be enhanced for customers or costs can be reduced. Value chain The value analysis, thus, helps a firm gain competitive advantage. firm. The value chain of a manufacturing firm includes activities like procurement of raw materials and consumables, manufacturing, assembling, testing, packaging, warehouse, distribution, retail sales and customer service. Organizations can split operations into a Similarly, the value of a number of activities to analyze their value chain and to identify critical success factors that need improvement. service industry (say the retail sector) comprises merchandizing, supply chain management logistics, display and promotion, customer care and service. Value chain analysis is centered on a product or service and caters to all the activities taken up for delivering it. An Individual firm positions itself at some point in the value chain, depending upon the competitive advantage it can have over other firms. For example, in the software industry TCS, Infosys, Wipro and Satyam are major players in India, who occupy different positions in the value chain depending on their core competency. Value Chain Analysis Involves Three Stages. Stage 1 : Identifying value chain activities; Stage 2 : Identifying the cost driver(s) for each activity in the value chain; Stage 3 : Creating competitive advantage by reducing cost or adding value. Identifying Value Chain Activities. In the first stage of value chain analysis a firm identifies all the activities in its value chain. The value activities differ from industry to industry. In the engineering industry, procurement cost of raw materials, its yield, length of the operating cycle, the effectiveness of the manufacturing process, the efficient use of technology are in focus, whereas in the pharmacy sector, the emphasis in the present WTO dominated environment is on R & D and molecules and clinical trials. the development of new In the FMCG sector, the focus is on
chain of a manufacturing firm differs from the value chain of a services
promotion, advertising, brand management and distribution, while the
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financial services sector is focused on product innovation, wealth management and relationship marketing. Identifying Cost Drivers Cost driver is the factor that causes or “drives” specific costs that are incurred. It is the factor that explains the consumption of resources, and affects a change in the cost of an activity. For instance, productivity is the key driver in manpower cost, and yield is the key driver in material cost. In this step, those activities that have potential for cost reduction are identified and analyzed. Creating a competitive advantage by Reducing Cost or Adding Value The third stage relates to a detailed study of the value activities and cost drivers that have been identified earlier to determine the nature of existing and potential competitive advantage. This helps the firm improve its strategic positioning. In addition, analysis of value activities also enables the firm to identify areas in which the company can provide greater value. For example, Shoppers’ Stop uses high-end information technology, based on supply chain management to coordinate with its suppliers to quickly restock its stores. Similar strategies are followed by Pantaloon and Westside to strengthen the process of merchandising. This enables these retail chains to maintain optimum stocks of all products and thereby reduce inventory costs. Most manufacturing companies in India use ERP systems form either SAP or ORACLE to streamline their inventory, manufacturing, delivering systems and financial control systems. Cost driver analysis is derived from the concepts of Activity – based Costing (ABC). ABC attempts to focus on the activities performed in producing products in the manufacturing process rather than on simply allocating resource costs to products using a volume base. ABC aims to ascertain the cost of products by acknowledging that – production complexity and production diversity are factors underlined by activities that can be costly but are independent of the volume of output. In ABC systems, cost drivers for activities are used to generate product costs and are considered to be more accurate and appropriate for decision-making, pricing, performance evaluation etc. Brand Valuation
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Another Emerging Issue is Branch Valuation A full-fledged brand valuation exercise can help a company strengthen its interdepartmental communication and also develop a reliable information system. The exercise will indicate the strengths and weaknesses of the company’s brands and will be a useful tool in devising brand management strategies. The company can identify its most resourceful brands and can thus differentiate between strong brands and brands which are only glamorous and not that strong, and thereby aid in resource allocation to maximize shareholder returns. The recent trend of acquiring established brands to ensure growth amid tough competition has led to the wide acclaim of the brand valuation concept in negotiating the transaction price. Brand valuation can also help in identifying brands to be included in the portfolio A survey conducted by The Economic Times has revealed that the growth in the top line as well as bottom line of the major Indian Groups-Tatas, Birlas and Ambanis – in the past five years have been largely due to acquisitions. In these acquisitions, valuation of both the corporate brand and the product brand has played major roles. According to Arindam Bhattarcharjee and C. Prashanth: “Branch Valuation could be central theme for any brand management where the idea is to manage the asset value of the brand. In line with this perspective, valuation methods should assist brand managers in carrying out a comprehensive health check for the brand. Most prevalent methods, centered on financial number crunching, will not serve this purpose. An effective method would be one which derives its inputs from the consumers of the brands. The underlying objective in this method would be to allow consumers to say what the brand is worth. After all, the consumer’s perception of the brand ensures the reliability of the brand’s earning in the future.” Cost Analysis in Marketing Decisions Cost Analysis plays a major role in marketing decisions. Some of the major application aspects in this area are: Decisional Phenomena of a Business Decisions have to be taken in an enterprise mainly with regard planning and controlling its operations Decision making is a management prerogative. In fact, managements at different levels
have to take a wide variety of decisions. All such decisions may be grouped into two classes viz. (a) Single – short (or unprogrammed)
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decisions and (b) repetitive (or programmed) decisions. Each single – short decision is a unique decision in respect of a unique problem. All capital expenditure decisions are of this type. Repetitive decisions are those that have to be taken at periodic intervals with reference to some repetitive problems or aspects of a business. Some examples of repetitive decisions are advertisement media selection and expenditure planning, decisions regarding inventory level norms, pricing decisions, decisions, about optimum product and/or sale-mix, and so on. Any decision, whatever be its nature and type is essentially and circumstances. According to Drucker, modern management should be interested not so much in present decisions as in the “futurity of the present decisions” Though decisions are taken with an eye on the future, the past is always a never failing guide, especially in respect of repetitive decisions. A proper systematic analysis of past financial data would definitely offer a good guide to the “decisionsmaker”. A right decision at the right time cannot be taken simply on the basis of some quantitative data and information. There are nonfinancial or qualitative factors as well, which sometimes weigh more heavily than the financial or quantitative factors. In fact, a good decision-maker does have always before him an array of both financial and non-financial factors relevant to a particular decision-making problem. The skill of the decision maker lies primarily in his ability to analyze the interdependence and interaction of both these sets of factors, especially with regard to their futurity. The Concept of Cost Analysis It may be noted in this connection that the financial accounting framework of any enterprise is rigid and straight-jacketed. Even the cost accounting process is by and large of a rigid nature for two reasons, first, the recording of costs and expenses have to follow the conventional accounting pattern, and second, the costing method adopted for a particular firm has to be somewhat right, although, as we have seen depending on the nature of industries, it is possible to adopt different costing methods for cost finding. Because of the rigidity of the systems, data available from the financial accounting and cost accounting records would be more or less uniform and, as such, suit only some specific but limited purposes. But in a business enterprise, decision-making problems are varied. specific decisional problems. Therefore, there is need for varied types of analyses of the accounting and cost data to suit This is what we may all cost analysis.
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We may indicate here, certain basic features of cost analysis. These are as follows: i) The purpose of cost analysis is essentially to generate, and subsequently to provide financial and quantitative data to decisionmakers so as to aid and improve the decision-making process. ii) The scope of cost analysis is almost unlimited. iii) Cost analysis is made with reference to the data available from both accounting and cost accounting records and also various other statistical data not available directly from such accounting records. More often than not, these analyzers pertain to the costs and expenses and, only at times, to revenues. iv) The types of cost analysis are varied – as varied as the decision – making problems of an enterprise. v) Since cost analysis is intended to serve only internal purposes, viz. decision – making, the results of such analyses are not subjected to scrutiny by outside authorities, especially auditors. vi) The results of cost analysis need not be accurate. Very often in the interest of speed, even approximate results may be enough for the specific need. The degree of accuracy to be desired would depend upon the nature of the decision for which the cost analysis is made and the timing of such decision. The concepts of sensitivity analysis and statistical test of significance are relevant in his context. vii) Cost analysis is made using certain tools and techniques. These techniques vary from the simplest to the most sophisticated. Also though may of the costing techniques are applied in this area; there is no limitation on borrowing techniques from various other disciplines like statistics, engineering and operations research. Some Important Techniques of Cost Analysis i) Fixed and Variable Cost Analysis Fixed and Variable Cost Analysis is used in Marginal Costing. The cost, profit, volume analysis underscores the relationship between costs, volumes and profits. The concept of Profit Volume Ratio (Contribution /Selling Price) is used by Marketing Managers to rationalize produce mix for greater profitability. Break even Analysis is another technique of marginal costing which is frequently used by marketing managers. ii) Different Cost and Incremental Revenue Analysis Different cost relates to increase in total cost due to difference in two activity levels. Differential cost includes variable cost and also fixed
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cost, if any. When fixed cost remains unaffected to change in activity, both marginal cost and differential cost would be the same. Differential cost and incremental revenue analysis is helpful in various types of decisional problems (e.g. whether or not to accept an additional bulk order at a price lower than the existing one, whether to increase the production units in a situation when larger supply might bring down the price, etc). The decision rules to be applied while using this technique are: - Keep on increasing production/sale as long as the incremental revenue is higher than the differential cost. - Stop further increase in activity at the point where the differential cost tends to be higher than the incremental revenue. - Fix the level of activity at the optimum point where differential cost equals or approximates incremental revenue, as this is the point where maximum profit will be earned. Any activity planning below this level would mean sacrifice of profit and above this level, loss of profit. iii) Relevant Cost Analysis Through a cost relevance study an attempt is made to arrive at what is called the relevant cost, i.e. the cost (disregarding how much of it is variable and how much fixed) relevant to a particular decision. Relevant costing concept has wide application in the areas of introduction of new products dropping a product or product line, changing the production process, introducing mechanization to replace manual work, etc. For example, when we are considering a proposal to drop a product line, a part of the fixed cost in this connection might cease to exist after the line is dropped, while a part of it may still continue to be incurred and shared by other product lines. This fact should be considered in arriving at the cost relevant to that particular decisional problem. iv) Analysis This is another popular technique intended to analyze the effectiveness (in financial or even non – financial terms) of a particular cost. Cost – effectiveness analysis has two important fields of application. (a) One may be able to find the cheapest means of accomplishing a defined objective. For example, there may be a number of alternative modes of distribution, with varying cost estimates, of the same goods to reach the same customers. Obviously, that alternative will be chosen which ensures the lowest cost.
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(b) One may be interested in ensuring the maximum value out of a given expenditure in a situation where there is difficulty in exact quantification, in financial terms, of the value or the benefits. An example in view may be measuring the effectiveness of advertisement and promotional efforts, given a number of alternative media, with the same amount of expenses. Under both the approaches mentioned above, benefits cannot be quantified in strict monetary terms. But the point of difference between the two approaches is that, in the first case, the benefit is fixed but the costs are varied, while in the second case the cost is fixed but benefits are varied. v) Opportunity Costing Technique. Opportunity costing technique is used in selecting the right course of action or decision out or two mutually exclusive alternative measures. Usually the gains and losses of one such measure become the losses and gains respectively of the other measure. An attempt is made to find which of the two ensures a net positive gain, called the opportunity gain, and obviously, that particular alternative would be chosen. Sometimes a situation may arise in which there are only two alternatives quite opposite and mutually – exclusive in character – acceptance of one would necessarily – mean rejection of the other. For example, a marketer may have to decide which of the two products he would recommend to the same customer – one manufactured by his company and the other an agency product – both able to serve the particular customer’s need but having different costs, prices may be used with advantage. exclusion of the other. vi) Benefit Cost Analysis This is a simple technique applicable in situations where there are a number of alternatives, not mutually exclusive in character (unlike the situation requiring the adoption of opportunity costing techniques). Under benefit cost analysis, an attempt is made to ascertain the total cost and total benefits in respect of each of the alternative decisional problems in a given area or to meet a desired objective. In assessing the cost, both direct and indirect or associated costs are considered. Similar is the case with benefits. Thereafter, a ratio of benefit to cost and future potentials. In situations like this, opportunity costing technique The alternative which shows a net positive opportunity gain for the company should be chose to the
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is computed for each alternative.
Obviously, the alternative which
ensures the highest ratio of benefit to cost would be most acceptable. This technique may be used, say, in deciding upon priorities for allocation of limited resources or marketing efforts when there are varied and complex marketing opportunities available. vii) Engineered Costs, Committed Costs and Managed Costs Engineered costs are those elements of cost for which the right or proper amount can be estimated. Director labour, direct material and perhaps most of the costs conventionally called “variables” can be treated as engineered costs. The committed costs are the inevitable consequences of past commitments. Depreciation, executive salary, even rent, etc. are examples of committed costs. Managed costs (or discretionary costs) represent those which management wants to vary within wide limits. Research and development, advertisement, accounting and administration costs, staff fringe benefits and welfare, etc. fall under this category. The above concepts were introduced by Robert A. Antony in connection with the evaluation and control of operations under the profit center system. However, these concepts are also useful in the area of effective expenses control, especially in marketing operations. viii) Cost Analysis and Decision-making Cost Analysis has profound impact on the following decisions: a) Introduction of New Products Introduction of new products may take either of the two forms viz. - Introduction of add-on products or line extension products, and - Launching of new products or a product line. The technique to assess the profitability of line extension products is the incremental contribution estimates. Usually such incremental contribution is also the profit since there may be no addition to fixed overheads in such a case. The same technique of contribution analysis would be followed in assessing the profitability of a new product line. In this case, however, the relatable fixed cost (i.e. the fixed cost arising directly out of the introduction of the new product line) would have to be deducted from the initial contribution to arrive at the net incremental contribution from the new product line. This contribution may again be taken to be an additional profit of the business since its other general fixed costs supposedly stand recovered through the sale of other existing products.
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In any such analysis, forecasts of sales, variable costs and fixed costs have to be made realistically. Sales forecast would result from a market survey and market research. Variable cost should be forecast with reference to the existing cost structure and cost behaviour in respect of similar products in the company and/or other companies. The forecast of fixed costs is intimately lined up with the question of capacity proposed to be built up for production and marketing. Ordinarily, fixed cost will contain two elements, viz. depreciation on the additional fixed assets to be installed and interest on additional working capital requirements. b) Discontinuing a Product from the Marketing Plan The same technique as in (a) above may be used here with slight modification. The objective should be to find the net gain or loss consequent upon the discontinuance of a product or product line. Such net gain or loss would result from the loss in contribution and saving in relatable fixed expenses on the one hand and the greater impact of general fixed expenses on the serving products, on the other. The decision rules in such a situation would be as follows: I) The product should not be dropped as long as the contribution earned by it is adequate to cover the direct fixed cost relatable to the product. Therefore, if the direct fixed cost is higher than the contribution, the product should be dropped. II) General fixed costs and common expenses, which cannot be saved even after a particular product is dropped, have no role to pay in the decision – the total amount involved should be segregated and considered to be the expenses of the company as a whole whether the product is dropper or continued. c) Launching a Promotional Campaign The steps to be taken and the techniques to be adopted in the financial appraisal of such a campaign are summarized below: I) A decision – tree or a schematic diagram to identify all the decision alternatives and their interrelationship; II) Sales forecasts under each alternative as per I; III) Net contribution (after deduction of both variable costs and relatable fixed expenses) under each alternative;
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IV) Application of Discontinued Cash Flow (DCF) techniques to find from the results in (III) the Net Present Value (NPV) and/or the Internal Rate of Return (IRR) under each case, taking a uniform time horizon; V) Opportunity cost concept (e.g. opportunity loss by way of interest on money for promotional outlay, in working out (III). VI) Risk analysis in respect of (II) VII) “Roll back concept” to find the best payoff alternative under (III). Two sets of results would be available, under (III) and (IV). These have then to be studied, weighted and compared against norms (e.g. I.R.R. against the cutoff rate) to identify financially the most profitable alternative. Of course, a host of non-financial factors (e.g. marketing aspects in this case) will have to be considered before a ‘go’ or ‘no go’ decision is taken in this respect. Pricing Policies and Decisions Any business enterprise should as its primary objective, aim at optimization of profit or surplus so that it can sustain and also grow. The concept of optimization implies the existence of certain constrains some internal and some external. Efforts should be directed towards optimization of surplus against all such constraints. Profit or surplus depends on three factors primarily, viz. price, cost and volume. Price may or may not be controllable. So also is cost. Again volume may have to be restricted because of external or internal factors – some controllable and some not so. What is more important is that all these factors are intricately and intimately interdependent. This makes pricing a very difficult task. A widely varying combination of a host of factors influence, from time to time, pricing decisions both in the short run and in the long run and thereby determine the profit that an enterprise earns or would earn. The Marketer’s Dilemma More often than not problems relating to pricing baffle the marketer. And in quite a few situations he literally faces a dilemma. Let us look at some of the pricing problems that confront the management of an enterprise. 1. High-Price-Low-Volume vs Lo-Price-High-Volume While profit may be maximized under any of these situations, at least in the short run, it is extremely difficult to suggest a long term solution to this dilemma – whether to go for lower unit profit with higher volume
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or the reverse. The reason is it all depends on a number of factors, both external and internal. 2. Uniform End-Selling Price vs Discriminating Prices Both have advantages and disadvantages. of profitability through price discrimination. unidimensional approach here also. 3. “Cost Plus” Basis of Pricing This is a widely talked of concept. Moreover, in its ultimate analysis, price has to be cost-based, directly or indirectly. Price and cost cannot afford to remain unrelated to each other for long. But some pertinent questions that might arise are: What is cost? Is it historical cost, standard cost, or marginal cost? Should it include the cost of ideal capacity and of excess of capacity too? However some may argue to substantiate that “cost is a fact” within a certain range, cost is only what the cost accountant reports. 4. Price Revision Consequent upon cost escalation, imposition of special tax, duty, etc. price revision may have to be effect. Sometime, because of marketing considerations, for example, competitors’ pricing strategy, revision in existing prices, upward or downward, may be necessary. A number of problems arise in determining the quantum of any price revision, if not in a change in the pricing policy itself. Any wrong decision in this area may turn out to be suicidal. More important is the There cannot be any question of practicability in the area of operation, besides the question
Various Bases of Price Determination i) “Full cost plus” pricing ii) Marginal cost based pricing iii) ROI and cost of capital based pricing Development of Pricing Strategies Development of appropriate pricing strategies, especially from a longterm point of view, is a must for the survival and growth of any
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marketing enterprise.
The task involved has two aspects, viz., an
understanding of the price a buyer is willing or prepared to pay, and setting detailed objectives of the firm underlying its proposed pricing plan. The price a buyer is prepared to pay will depend on various factors like: (i) The position and power of the brand in the market. (ii) Value of goods to buyer – the buyer’s need of the product and his ability to do without it – nearness to situation of the need. (iii) Ability to deploy funds for the purpose – other demands on buyer-s budger. (iv) Price charged by competition – price charged for substitutes. In certain circumstances the product will be faced with a “backward leaning” demand curve, indicating that more will be bought at a higher than a lower price. This in turn may be due to snob appeal, fear of scarcity, psychological value added to the product, etc. Now we come to the second aspect viz. objectives. The age-old
objective of profit maximization suffers from a host of definitional and conceptual imprecisions as well as practical difficulties. Consequently, there is the need for considering multiple objectives and their mutual interdependence mainly from the marketing angle. In fact, pricing can ‘be a key to achieving far broader corporate objectives than those implied in the limited commercial concept of profit. Some of these objectives are : earning a target return on investment, achieving or sustaining a certain level of market share, ensuring a planned level of economic product/operations, achieving a specified rate of growth in turnover and/.or profit, meeting or beating competition, systematic product dilution and pruning and avoidance of government interference or restriction. Only upon a clear understanding of the various issues involved in both the aspects stated above, it would be necessary to design a price strategy for each product and each significant market segment separately for adoption in the short run and in the long run. Examples of some of the more common price strategies are: (i) Penetration Pricing, i.e. deliberately keeping prices low or moderate to achieve a sizable market share as quickly as possible. (ii) Price cutting – mainly to drive competitors from the market.
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(iii) “Skimming the cream” i.e. starting with a relatively high price and coming down later, if necessary, rather than following a course the other way round; (iv) Marginal pricing or contribution theory pricing – mainly to earn some contribution by using capacity otherwise unutilized. It may be mentioned in this connection that there should be some variation in pricing strategies by products or service types. weapon in the hands of the marketing manager. In the consumer group filed, for example, pricing is the most powerful But in industrial marketing, pricing may not be so powerful a tool. In the professional service sector, members usually do not knowingly compete with each other on professional charges – attempts should be made to improve upon the client’s financial results by other means, with of course each firm following a pricing strategy unique to itself. New Product Pricing Depending on the nature of the new product, suitable pricing strategy has to be developed. If the product is only anew pack or even a line extension product, pricing can be based on marginal cost and incremental contribution approach. This would ensure some distinct marketing advantage through greater competitive edge, especially during the initial period of introduction of the product. Once the product or pack get a good foothold in the market, its price may be progressively adjusted to bring in line with the other products or packs. If the product is new to the company but not new to the country, an extensive market survey and research should be conducted not only to get a feel of its market, but also to have an order of magnitude estimate of the price at which it can sell. The final price may then be determined after considering the total cost as also the marginal cost, competitors, relative prices, the special features of the product vis – vis the competitors’ and so on. Application of the technique of value analysis has been found to be highly effective in this area of pricing. In case the product is absolutely new to the consumers and there is no precedent to guide the pricing policy, the only approach left is one of trial and error with the objective of ultimately arriving at the desired price after sometime. But two factors are to be considered in such pricing decisions, namely recovery of research and development cost on the new product and cashing on the good brand image of the
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company by fixing up a relatively high price initially. In fact, this factor of brand image is taken into account in all new product pricing decisions. Some other important factors which provide some rough and ready criteria in the pricing of new products are as follows : (i) Snob Value The company may fix price for the new product if it is superior quality counterpart of an existing product, to give it the snob value it needs (ii) Product Life Considerations If the product life is shorter (for example, medicines, toys, etc.) its price should be kept high. But if the product has a longer life (for example, machine tools) undercutting of price initially may some times be necessary to penetrate into the desired market effectively. Appraisal and Control of Marketing Performance The results of business operation in general and marketing operation in particular are reflected in the annual accounts after the close of the year. It might be seen at that time that the results do not meet the expectations or the desired level established at the beginning. But by then they become historical – fait accompli! The results can, however, be favorably molded through suitable control actions only if periodic reviews of performance that: (i) Adverse situations can be controlled, to some extend at least, before they get out of hand; (ii) Uncontrollable adverse factors can be identified and quantified soon after these emerge; and (iii) Some safety valves can be provided against the possibility of efforts slackening sometime or the other during the year. There are different modes of marketing performance analysis and appraisal for the purpose of effectively controlling the operations. We have already discussed one such approach, viz. profit center system. This is considered to be a more sophisticated approach. Besides this, there are two other widely used approaches : (I) Sales analysis and sales variances analysis (ii) Comparative analysis of performance of various marketing subunits vis-a-vis reestablished norms. Sales Analysis and Sales Variance Analysis are made. Thus, the importance of performance evaluation and appraisal from time to time lies in the fact
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Sales analysis and sales variance analysis are commonly used techniques of marketing control – control exercised through comparison and application of the principle of exception. Selling and Distribution Cost Analysis Selling and distribution cost analysis is important for both cost determination and cost control. For the purpose of cost determination and distribution expenses should be grouped into two categories: (i) The direct expense which can be allocated to functions, area, division, product groups or products, salesmen, etc; (ii) The indirect or general selling and distribution expenses which cannot be so allocated and should therefore be apportioned on some suitable basis. Sales Variance Analysis The technique of variance analysis of standard costing can be used very effectively for the purpose of sales variance analysis which in turn could be used to locate precisely the reasons for divergence between budgeted or expected results and actual results. Sales variances can be calculated in two ways, viz. A. The Value Method This will show the variances in terms if sales value. Total sales value variance and then volume variance into price variance and then volume variance may be further analyzed into quantity variance and mix variance. B. The Profit Method Under this method variances are shown in terms of their effect on profit (or gross margin or contribution). This is a more improved method than the former. These variances are also called margin variances and the mode of their calculation and analysis would be the same as under (A) above, with the only difference that here sales value would be replaced by profit in each case. Product Line Profitability Analysis Profitability analysis is of different types. Since net profit is the simplest and the most easily understood criterion of performance, often it is necessary to arrive at, through preparation of comparative profit and loss statement, product or product line-wise, territory-wise, or even salesman-wise net profit figures. In preparing such statements, management accounting tools and technique are being Proper analysis of such reasons will help initiate suitable control actions as well.
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increasingly used. Specially, the technique of analysis of selling and distribution costs is of great use in any such profitability analysis. Profitability analysis of divisions or product lines or products is relatively, simple in case of small or medium-sized marketing organizations handling a few divisions and operating through a few selling establishments. But in case of a multi-product, multi-market marketing organization with highly diversified product range and operating through multiple selling and distribution establishments, division-wise and product-wise profitability analysis becomes a very complicated exercise. And in such cases, computer is often made use of. This requires a detailed systems study and suitable programming to get realistic performance results in the form of profits.
Conclusion In the foregoing paragraphs, an attempt has been made to identify some areas where marketing finance interface can help in achieving sustainable growth. Management Accounting tools like Cost Driver Analysis helps in differentiation and strategic positioning. The concept of Branch Valuation helps an organization in realizing the value of its brands in the market. There are a host of other applications which help organizations create enduring value in the marketplace. Concepts like strategic Cost Management (SCM) represent paradigm shifts in cost management. In SCM, cost management becomes a The function of strategic choice and has an acute external focus.
interface with the value chain brings external focus to the concept. The structural cost drivers and the executive cost drivers integrate managerial and technical skills towards better cost management. Cost leadership has an internal focus while differentiation focuses on strategic positioning which is the hallmark of competitive advantage. Santanu Ray Director The Icfai Business School, Kolkata, The author can be reached at santanuray @ibsindia.org.
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