Chapter

15 Marketing Cost and

Profitability Analysis
Business prophets tell us what
should happen – but business
profits tell us what did happen.

Earl Wilson

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

 A Comparison of Marketing Cost Analysis
and Production Cost Accounting (Fig. 15-1)
Comparison Marketing Cost Production Cost
Factors Analysis Accounting
Bases for Marketing unit: Unit of product
computing costs territory, customer
group, order size, as
well as product
More complex Relatively simple

Source of cost Salespeople in the Machines and closely

incurred field supervised workers
Less exact More precise

Cost-volume Volume is a function of Cost is a function of

relationship cost V=f( C ) volume C=f(V)
Difficult to measure Relatively easy to
measure
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
 Income and Expense Statement, 2002,
Colorado Ski Company ($000) (Fig. 15-2)
Net sales $27,000
Less cost of goods sold 18,900
Gross margin 8,100
Less operating expenses:
  Sales salaries and commissions $3,240
  Sales force travel 372
  Supplies and telephone 178
  Media space 870
  Advertising salaries 218
  Property taxes 120
  Heat and light 168
  Insurance 84
  Administrative salaries 930
  Other expenses 120
Total operating expenses 6,300
Net profit $ 1,800

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

 Expense Distribution Sheet, Colorado
Ski Company, 2002 (Fig. 15-3)
(showing allocation of ledger expense items to activity categories)

Activity Cost Categories

Personal Warehousing Order
Ledger expenses Totals Selling Advertising and Shipping Processing Administration
Sales salaries/commis $3,240,000 $3,240,000 — — — —
Sales force travel 372,000 372,000 — — — —
Supplies & telephone 178,000 43,200 22,200 40,900 43,500 28,200
Media space 870,000 — 870,000 — — —
Advertising salaries 218,000 — 218,000 — — —
Property taxes 120,000 10,000 14,500 66,000 14,000 15,500
Heat and light 168,000 15,300 17,400 100,500 16,200 18,600
Insurance 84,000 12,000 4,200 46,300 14,000 7,500
Administ. salaries 930,000 144,000 62,000 168,000 126,000 430,000
Other expenses 120,000 10,500 11,700 58,300 26,300 13,200
  Totals $6,300,000 3,847,000 1,220,000 480,000 240,000 513,000

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

 Allocation of Activity Costs to Sales Regions,
Col Ski Co. 2002 (Fig. 15-4)
Personal Warehousing Order
Activity Selling Advertising and Shipping Processing Administration
Allocation Scheme
Allocation Direct expense No. of pages No. of orders No. of invoice Equally among
basis to each region of ads shipped lines regions
Total activity
cost $3,847,000 $1,220,00 $480,000 $240,000 $513,000
No. of
allocation units — 61 pages 9,600 orders 120,000 lines 3 regions
Cost per
allocation unit — $20,000/pg. $50 per order $2 per line $171,000/reg.
Region Allocation of Costs
units — 21 pages 3,800 orders 39,500 lines one
Eastern
cost $1,070,000 $420,000 $190,000 $79,000 $171,000
units — 11 pages 2,500 orders 28,000 lines one
Midwestern
cost $747,000 $220,000 $125,000 $56,000 $171,000
units — 29 pages 3,300 orders 52,500 lines one
Western
cost $2,030,000 $580,000 $165,000 $105,000 $171,000
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
 Income and Expense Statement, by Sales
Region, Col Ski Co. 2002 ($000) (Fig. 15-5)
Total Eastern Midwestern Western
Net sales $27,000 $9,000 $4,500 $13,500
Less cost of goods sold 18,900 6,300 3,150 9,450
Gross margin 8,100 2,700 1,350 4,050
Less operating expenses:
  Personal selling 3,847 1,070 802 1,975
  Advertising 1,220 420 220 580
  Warehousing/shipping 480 190 125 165
  Order processing 240 79 56 105
  Administration 513 171 171 171
Total operating expenses 6,300 1,930 1,374 2,996
Net profit (loss) $ 1,800 $  770 ($24) $ 1,054
Net profit (loss) as percentage of sales 6.70% 8.60% (0.53%) 7.80%

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

 Methods Used to Allocate Indirect Costs
(Fig. 15-6)
Method
Divide cost equally among territories or
whatever market segments are being
analyzed.
Allocate costs in proportion to sales
volume obtained from each territory (or
product or customer group).
Allocate indirect costs in same proportion
as the total direct costs. Thus if product A
accounted for 25 percent of the total
direct costs, then A would also be
charged with 25 percent of theindirect
expenses.
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
Evaluation
Easy to do, but inaccurate and usually unfair
to some market segments.
Underlying philosophy: apply cost burden
where it can best be borne. That is, charge a
high-volume market segment with a large
share of the indirect cost. This method is
simple and easy to do, but may be very
inaccurate. Tells very little about a segment’
Again, easy to do but can be inaccurate and
misleading. Falsely assumes a close
relationship between direct and indirect
expenses.
Income and Expense Statement by Sales Region, Col Ski Co
2002, in $000, using contribution-margin approach (Fig. 15-7)
Total Eastern Midwestern Western
Net sales $27,000 $9,000 $4,500 $13,500
Less cost of goods sold 18,900 6,300 3,150 9,450
Gross margin 8,100 2,700 1,350 4,050
Less direct operating expenses:
  Personal selling 3,082 845 595 1,642
  Advertising 732 254 127 351
  Warehousing/shipping 160 64 42 54
  Order processing 130 43 30 57
Total direct expenses 4,104 1,206 794 2,104
Contribution margin $ 3,996 $1,494 $  556 $1,946
Less indirect operating expenses:
  Personal selling 765
  Advertising 488
  Warehousing/shipping 320
  Order processing 110
  Administration 513
Total indirect expenses $2,196
Net profit $1,800
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
 Fig. 15-8 Ways to Increase Order Size and
Reduce Small Order Marketing Costs
•Educate customers who buy from several different suppliers. Stress the advantages of
purchasing from one supplier.
•For customers who purchase large total quantities in frequent small orders, stress the
advantages of ordering once a month instead of once a week. Point out that the buyer
eliminates all handling, billing, and accounting expenses connected with three of the four
orders. Note further that the buyer writes only one check and one purchase order. In
addition, stress that there will be only one bill to process and one shipment to put into
inventory instead of three or four.
•Educate the sales force as well as customers. In fact, it may be necessary to change the
compensation plan to discourage acceptance of smaller orders.
•Substitute direct mail or telephone selling for sales calls or unprofitable or small-order
accounts; or continue to call on these accounts, but less frequently.
•Shift an account to a wholesaler or some other type of middleman rather than dealing
directly, even by mail or telephone.
•Drop a mass-distribution policy and adopt a selective one. This new policy may actually
increase sales because sales reps can spend more time with profitable accounts.
•Establish a minimum-order size.
•Establish a minimum charge or a service charge to combat small orders
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
 Return on Assets Managed (ROAM)
Sales $ 10,000,000
Cost of goods sold 7,000,000
Gross margin 3,000,000
Salaries 150,000
Commission 850,000
Travel 150,000
District office expense 400,000
Total direct expenses 150,000
Contribution margin $ 1,450,000
Accounts receivable 2,200,000
Inventories 2,000,000
Total assets $ 4,200,000

Contribution margin 1,450,000

Profit on sales % = Sales volume = 10,000,000 x 100 = 14.5%

Sales volume $10,000,000

Asset turnover = Accounts receivable + = $ 4,200,000 = 2.38
Inventories

ROAM = Profit on sales % x Asset turnover

1,450,000
= x 10,000,000
10,000,000 4,200,000

= 14.5% x 2.38 = 34.5%

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.