Accelerating Growth

Session 4

S. Sajeesh
9/8/2021 1
Agenda
 Review Questions and Insights
 Resource Allocation
 Allocation among marketing mix variables
 Allocating between acquisition and retention
 Bass Model – Predicting when sales will peak
 Optimal Production Planning
RESOURCE ALLOCATION
DECISIONS

3
Optimal Marketing
 Problem: $1 billion to invest in Marketing across
14 product categories (476 category-region
combinations)

 Method: Collect data on how current investments

impact future returns

 Solution: Reallocation

 Challenge: Overcoming resistance from country

managers. 4
Resource Allocation

 Resources among marketing mix elements for one

brand
 Method based on elasticities.
 Resources among different brands in a product
category
 Method based on elasticities.

5
Allocating Resources across Marketing
Inputs

Share of Market is proportional to

(Share of Voice) x
(Share of Mind) x
(Share of Distribution)
Market share identity model

The proportion of The proportion of

The proportion of
those who are aware of those who intend to
the segment-
the product who intend buy who actually
population aware of
to buy it do so
our product

In te n tio n M a rke t S h a re
M a rke t S h a re  A w a re n e s s  
A w a re n e s s In te n tio n
 Use market share identity model for resource
allocation

The proportion of
The proportion of The proportion of
those who intend to
the segment- those who are aware of
buy who actually
population aware of the product who intend
do so
our product to buy it

Inte ntio n M a rk e t S ha re
M a rk e t S ha re  A w a re ne ss  
A w a re ne ss Inte ntio n

promotion product place

price
Develop Formal Metrics for Resource
Allocation

A P
Market Share t  Advertisin g t  Intercept  Price t
S
 Salesforce t

is the same as:

A P S
M Sh t    Adv t  P rt  S f t
 A P S
M Sh t    Adv t  P rt  S f t

…but then…this is the same as

advertising elasticity Sales force elasticity

lo g(M S h t )  lo g(  )   A lo g( A d v t )   P lo g( P r t )   S lo g( S f t )

product “quality” price elasticity

 From elasticities to allocations
 The optimal allocation rule linking elasticities across
Marketing Mix variables
j
Xj   Bi
*
n


k 1
k

X j  Optimal allocation to the jth mktg mix variable

*

k  Marketing Mix Variables, e.g., Advtg, Sales force, Promotion

 j  Elasticity of response wrt jth mktg mix variable
Bi  Marketing Budget for brand i

 Like US/(US+Them)
Allocating resources across multiple
products within an SBU
 Once the market response function has been estimated, the
rule for optimal allocation across products
P  c e S
X i  n i i ii i  B
*

 Pi  ci eii Si
i 1

where B  budget for all n products

n  number of products
Si  sales (units) for the ith product
Pi  price per unit for the ith product
c i  cost per unit for the ith product
e ii  self - elasticity of the ith product' s sale
with respect to amount of resources devoted to it 12
Illustrative Allocation of Budget ($250M)

Product Price Margin (P-c) Sales ($ M) Sales Units (million)

Regular $4.00 2 1,400 350

Elite $40.00 28 30 0.75

Elasticity Matrix
Effect on Sales of
Expenditure
on Regular Elite
X1 Regular e11 e21=0
X2 Elite e12=0 e22
Optimal Allocation
Case X1 (Regular) X2 (Elite)
Case I
e11=0.4
246.3 3.7
e22=0.2

Case II
e11=0.4
242.72 7.28
e22=0.4

Case III
e11=0.2
235.85 14.15
e22=0.4
13
Empirical Generalizations on Elasticities

Elasticities

Own Price -2 to -2.5

Distribution 1.8
Sales force 0.5
0.5 for new
Advertising products
 Allocation between spending
on acquisition vs. retention
Session 4
Issues in Accelerating Growth

9/8/2021 15
Manage Marketing by the Customer Equity Test

Two approaches to customer relationship

management:
 Low end used car sales – one shot sales

 McDonald’s, Catalog retailers, banks – acquire and

retain customers
 Focus of such companies is on maximizing the value
of the customer to the organization
Problem – How to Allocate the Marketing Budget
Between Acquiring and Retaining Customers

One obvious choice:

- splitting the money equally between acquisition
and retention.

- Can we do better?

17
Decision Calculus

 Complex problem is broken down to simpler modules

 Simplifying assumptions are made

 Judgments , data, and simplifying models are used to

solve the simpler modules

 Simpler models are integrated to solve the original

problem
Balancing Acquisition and Retention Efforts

 Two questions on acquisition:

1. Current spending/prospect and current acquisition rate
2. Maximum acquisition rate possible without budget
constraint

 Two questions on retention:

1. Current spending/customer, current retention rate
2. Maximum retention rate possible without budget
constraint
Acquisition Rate as a Function of Acquisition Spending

0.45

0.4

0.35

0.3
Acquisition rate

0.25

0.2

0.15

0.1

0.05

0
0 5 10 15 20 25 30 35 40
Acquisition spending $ per prospect

20
Retention rate as a function of retention spending

0.7

0.6

0.5
Retention rate

0.4

0.3

0.2

0.1

0
0 5 10 15 20 25 30 35
Retention spending $ per customer

21
 First Year Contribution From a Prospect

 Acquisition spending/prospect = $A (say $ 20/prospect)

 Acquisition rate = a (say .2)

 Margin per customer per year = m (say $250)

 First year contribution from a prospect

is (m*a – A) ($ 30)
Value of a Retained Customer in Any Year

 Retention spending per customer – R (say $

21/year)
 Retention rate – r (say .7)
 Retention spending/retained customer - R/r ($30)
 Margin per retained customer per year – m ($250)
 Value of a retained customer – (m - R/r) ($220)
Customer Equity of a Prospect

r
a * m  A  a * (m  R / r ) *
(1  r )
Where:
 a - acquisition rate (this depends on A)
m – margin/customer in one year
A – acquisition dollars/prospect
r – retention rate (this depends on R)
R – retention dollars/customer
d – discount rate of future cash flows
r’ - r/(1+d)

24
Managerial Inputs

Acquisition related inputs:

 Current acquisition spending $/prospect = $ 5
 Current acquisition rate = 0.2
 Ceiling acquisition rate = 0.4

Retention related inputs:

 Current retention spending $/customer = $ 10
 Current retention rate = 0.4
 Ceiling of retention rate = 0.7

Margin/customer and discount rate:

 Margin/customer = $ 125
 Discount rate = 0.05
Optimizing the Acquisition and Retention Dollars

Customer equity is a function of acquisition dollars

(A) and retention dollars (R).

In the excel sheet we calculate the customer equity

for various acquisition and retention dollars. We
choose the acquisition and retention dollars that
maximize the customer equity.

26
Optimal Acquisition Spending and Retention Spending

Acquisition related inputs:

 Current acquisition spending $/prospect = $ 5
 Current acquisition rate = 0.2
 Ceiling acquisition rate = 0.4

Retention related inputs:

 Current retention spending $/customer = $ 10
 Current retention rate = 0.4
 Ceiling of retention rate = 0.7

Margin/customer and discount rate:

 Margin/customer = $ 125
 Discount rate = 0.05

Optimal A - $ 19/ prospect

Optimal R - $ 31/ customer
Customer equity - $ 73.90
Questions to Ponder

 What will happen to acquisition spending and

retention spending if the margin per customer per
year increases?

 What will happen to acquisition dollars if the

ceiling for the acquisition rate increases?

28
Summary

 Decision calculus can be used to solve

complicated marketing problems
 Marketing variables are jointly optimized
 Many times you have to use data with managerial
judgments to make decisions
 Quality of decisions depends on the quality of
managerial judgments

29
Practice Problem
 What is the optimal acquisition and retention dollars for the following
scenario?

Acquisition related inputs:

Current acquisition spending $/prospect = $10
Current acquisition rate = 0.25
Ceiling acquisition rate = 0.40

Retention related inputs:

Current retention spending $/customer = $ 20
Current retention rate = 0.4
Ceiling of retention rate = 0.7

Margin/customer and discount rate:

Margin/customer = $ 150
Discount rate = 0.05
30
Bass Model

Predicting the Timing of Peak Sales

S. Sajeesh
 Can we predict a product’s
performance?
 Adoption of a product depends upon
 the innovators who are influenced by the product and the
promotions
 the imitators who are influenced by the total number of people
who have bought it till date.
 We can predict performance if we can predict the sales through
each of these sets of people.

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Indian School of Business
 The Math…

Advertising effect WOM effect

Marketing Decision Making 33

Indian School of Business
 Estimating Bass Model


S (t )  pM  (q  p) N t 1  N (t 1) 
q 2

S (t )  a  bN (t 1)  c( N (t 1) ) 2

q  cM
Marketing Decision Making 34
Indian School of Business
Some results using Bass Model

Product Category p q
Cable TV 0.02116 0.26980
Camcorder 0.04400 0.30400
Cellular 0.00800 0.42100
CD Player 0.15700 -
Radio 0.02700 0.43500
TV (Color) 0.02126 0.58253
Home PC 0.12100 0.28100
Hybrid Corn - 0.79750
Tractors - 0.23400
Ultrasound - 0.53400
Dishwasher - 0.17900
Microwave 0.00200 0.35700
VCR 0.02500 0.60300
Personal computers 0.00306 0.25320
Mammography 0.00494 0.70393
Vacuum Cleaner 0.02114 0.20937
ATM m/c adoption by
banks 0.00810 0.19700
Average 0.0300 0.38000
Marketing Decision Making 35
Indian School of Business
More insights using Bass Model

• A pure innovation scenario, p > 0, q = 0

• (p + q) controls scale

• (q / p) controls shape (note that the

condition (q / p) > 1 is necessary for the
PLC curve to be bell-shaped)

Marketing Decision Making 36

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BASS MODEL – Application
 ‘Product A Sales
700

600
Sales (units)

500
Predicted
400

300
Actual
200

100

0
0 1 2 3 4 5 6 7 8

Period
Go to
Analysis

Marketing Decision Making 38

Indian School of Business
Diffusion Model Analysis:
‘Product A
Cumulative Sales Actual Sales
Period CS(t-1) CS(t-1) 2 S(t)
0 0 0 158
1 158 24964 307
2 465 216225 458
3 923 851929 541
4 1464 2143296 615
5 2079 4322241 608

Regression Coefficients: Model Parameters:

A 254.518 M 3854.064
B 0.443 p 0.066
C -0.00013 q 0.509

Return

Marketing Decision Making 39

Indian School of Business
 Product B Sales
2500

2000
Sales (units)

1500 Predicted

1000 Actual

500

0
0 1 2 3 4 5 6 7 8

Period
Go to
Analysis

Marketing Decision Making 40

Indian School of Business
Diffusion Model Analysis:
Product B Sales
Cumulative Sales Actual Sales
Period CS(t-1) CS(t-1) 2 S(t)
0 0 0 147
1 147 21609 269
2 416 173056 354
3 770 592900 501
4 1271 1615441 649
5 1920 3686400 891

Regression Coefficients: Model Parameters:

A 217.578 M -630.033
B 0.346 p -0.345
C 0.000002 q 0.001

Return

Marketing Decision Making 41

Indian School of Business
Diffusion Model Analysis:
Product B Sales
Cumulative Sales Actual Sales
Period CS(t-1) CS(t-1) 2 S(t)
0 0 0 147
1 147 21609 269
2 416 173056 354
3 770 592900 501
4 1271 1615441 649
5 1920 3686400 891
Model Parameters:
M 4553.197
p and q borrowed from Product A p 0.066
q 0.509
Go to
Graph

Marketing Decision Making

Indian School of Business
 Product B Sales

900
800
Sales (units)

700
600 Predicted
500
400 Actual
300
200
100
0
0 1 2 3 4 5 6 7 8

Period
Return to
Analysis

Marketing Decision Making 43

Indian School of Business
Diffusion Model Analysis:
Product B Sales
Cumulative Sales Actual Sales
Period CS(t-1) CS(t-1) 2 S(t)
0 0 0 147
1 147 21609 269
2 416 173056 354
3 770 592900 501
4 1271 1615441 649
5 1920 3686400 891
Model Parameters:
M 7639.068
p 0.030
q 0.456
Go to
Graph

Marketing Decision Making 44

Indian School of Business
 Product B Sales
1000
900
800
Sales (units)

700
Predicted
600
500
400 Actual
300
200
100
0
0 1 2 3 4 5 6 7 8

Period
Return to
Analysis

Marketing Decision Making 45

Indian School of Business
Summary
 As the market matures, it presents special
challenges
 Special managerial capabilities
 Need for inter-functional coordination
 Key to managing in a mature market is
predicting the timing of peak sales.
 Marketing needs
 Bassmodel – Forecasting category sales
 Market Share Model – Predicting brand sales
Marketing Decision Making 46
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 Optimal Production Planning

Session 4
Issues in Accelerating Growth

9/8/2021 47
Production Planning
 Team T just found out that TONE did not sell
well. They felt that they produced too much. Did
they produce too much?
 Team T also found out that they sold out on
TOPS. Did they produce too little?

48
Demand Forecast for TONE
Demand probability  The team developed a sophisticated
model to arrive at the likely
120 0.05 demand. There was disagreement,
140 0.05 uncertainty; and it was duly
accounted for in the Table on the
160 0.1 left.
180 0.15  A suggestion at the team meeting
200 0.3 from a vocal member of the group:
We should produce based on our
220 0.15 best guess of what the demand will
240 0.1 be.
 Our statistics professor told us that
260 0.05 our best estimate = Mean
280 0.05  Mean = 200
 Therefore we should produce 200
units.
49
How much should I
produce ?

What does it depend on?

What factors?

50
How much should I produce?

 Uncertainty in demand
 Cost of lost sales
 Inventory holding costs and Obsolescence costs.
 Flexibility in the Production process
 Experience Effects
 Effect on Competition

51
A More Careful Approach !

Demand probability  What is my opportunity cost

if I over produce?
120 0.05  My transfer cost is $100
140 0.05  My Inventory Holding Cost
is 10%.
160 0.1  What is my opportunity cost
if I under produce?
180 0.15
 I make $60 per unit.
200 0.3  Let us assume there is no
flexibility in production.
220 0.15
240 0.1
260 0.05
280 0.05

52
 Minimize Opportunity Cost

Production
240
Demand Probability Over Under Inventory Cost Lost Sales Cost Cost
120 0.05 120 0 120 0 60
140 0.05 100 0 100 0 50
160 0.1 80 0 80 0 80
180 0.15 60 0 60 0 90
200 0.3 40 0 40 0 120
220 0.15 20 0 20 0 30
240 0.1 0 0 0 0 0
260 0.05 0 20 0 20 60
280 0.05 0 40 0 40 120

TOTAL 610

Can use Solver

to find production
that will minimize
opportunity cost

53
Qualitative Guidelines
 For which segments should I be more careful in
production planning?
 For which segments I am better off being optimistic?

 How do I account for flexibility in production (as in the

Markstrat world) more formally in my production
planning decisions?

 How do I account for the fact that I can use the product
again next period and left over units do not go obsolete?

 How do I account for the fact that if I produce less, my

competitor gets the leftover demand, has more money to
spend and then kills me next period!
54
Summary
 Resource Allocation
 Allocation among marketing mix variables
 Allocating between acquisition and retention
 Bass Model – Predicting when sales will peak
 Optimal Production Planning
All the very best!!

Thank you…

S_sajeesh@isb.edu

Marketing Decision Making 56

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Feedback

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