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# Discussion on Assignment 4 Cost-Based Advertising Budgets - PowerPoint PPT Presentation

Discussion on Assignment 4 Cost-Based Advertising Budgets. Ted Mitchell. There are THREE levels of budgeting setting 1) The Strategic level Allocating corporate budget between the Domestic market/SBU and The Foreign Market/SBU

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### Discussion on Assignment 4Cost-Based Advertising Budgets

Ted Mitchell

• There are THREE levels of budgeting setting

• 1) The Strategic levelAllocating corporate budget between the Domestic market/SBU and The Foreign Market/SBU

• 2) The SBU levelFinding the optimal amount for the total budget to achieve the goal (profit, market share)

• 3) The Incremental Change levelThe change in current budget to achieve an improved result (profit, market share)

• 1) Assume that your boss considers period 3 your typical period. He always sets his total promotional budget using the Affordable method. In period 4 he anticipates a sales volume of Q = 94,000 unitsa variable cost per unit of V = \$25marketing profit after Total Promotion MC = \$400,000He has set his price at P = \$98 per pairWhat can he afford to spend on total promotion, TP?

• MC = (P-V)Q –TP

• TP = (P-V)Q – MC

• TP = (\$98-\$25)94,000 -\$400,000

• TP = (73)94,000 -\$400,000 = \$6,462,000

• What are the key virtues of setting the promotion budget with the Affordable Method?

• Its simple!

• The key weaknesses of the Affordable method when setting promotion budgets are?

• It assumes you know what is the normal sales, normal profit and which profit you are using!

• That the amount you spend on total promotion has no effect on sales!

• Takes a lot of information

• What is the budget for the market at the SBU levelPercentage of Sales Method of Setting the Promotion Budget?

• How does it work?

• What are its virtues?

• What are its weaknesses?

• 2) Assume that your boss considers period 3 your typical period. He always sets his advertising budget using the Percentage of Sales method (Ad/R = 0.1741). In period 4, he anticipates a sales volume of Q = 94,000 unitsa variable cost per unit of V = \$25He has set his price at P = \$98 per pairHe normally sets his advertising budget as a percentage of normal sales!What will be his advertising budget in period 4?

• Ad = Ad/R x R

• Ad = 17.41% x (\$98 x 94,000)

• Ad = \$1,603,809

• What are the key virtues of setting the advertising budget as a Percentage of Sales?

• You don’t have to know what the actual amount of the normal profit.

•  You only need the forecasted sales!

• What is the key weakness of the Percentage of Sales method when setting advertising budgets?

• Assumes that the sales revenue determines the advertising budget.

• What is the allocate corporate budget between the Domestic market and the Foreign marketRevenue Return on Promotion Method of Setting the Promotion Budget?

• How does it work?

• What are its virtues?

• What are its weaknesses?

• 3) Your boss is smart enough to know that changes in promotion cause changes in sales. He wants to increase the quantity sold in period 4. He believes that period 3 is typical of the sales that are generated by the promotion effort. He wishes to increase his sales in period 4 by spending another \$100,000 on promotion. What volume of extra sales can he expect using his normal Revenue Return on Total Promotion?

• R = R/TP x TP

• ∆R = R/TP x ∆TP

• ∆R = 323.63% x \$100,000 = \$323,630

• How much must he sell to breakeven on the additional \$100,000 he spends on the promotion?

• BER = F/Mp = \$100,000/0.7432 = \$134,444

• Lots of distance between BER and the expected change ∆R

• A key virtue is promotion cause changes in sales. He wants to increase the quantity sold in period 4. He believes that period 3 is typical of the sales that are generated by the promotion effort. He wishes to increase his sales in period 4 by spending another \$100,000 on

• You can check the expected revenue against the breakeven revenue

• Works Best for the Incremental Change to the Current Budget at the SBU level

• The classic objective task is based upon

• Audience response models AIDA

• The objective is to increase awareness or interest or desire

• The task is to pick the tools that will generate the goal.

• Question 3 continued… revenue!He has a goal!

• He wants to increase his sales revenue by \$200,000 in period 4 by increasing his total promotion budget. By how much will he have to increase his promotion budget to increase his sales revenue if his revenue return on promotion is R/TP = 350%?

• ∆R = R/TP x ∆TP

• \$200,000 = 350% x ∆TP

• ∆TP = \$200,000/350% = \$57,143

• What is the key weakness of setting promotion budgets based upon the revenue return on promotion, R/TP?

• The key weakness is that the Revenue returned on Total Promotion is an average rate and not an incremental rate.

• The Increase in Revenue Does Not Guarantee new profit

Simple Average Return FORECAST revenue!

Quantity Sold

119,000

112,000

1,600,000

1,700,000

Advertising

Quantity Sold

119,000

112,000

1,600,000

1,700,000

Advertising

Marginal Return ∆Q/∆AD revenue!

Quantity Sold

119,000

112,000

∆Q

110,000

∆AD

1,480,000

1,600,000

1,700,000

Advertising

• What if the Goal is the % Profit Returned By Promotion? A Target ROME!

• Normal ROME in Period 3 is MC/TP = 141%Normal Gross Profit in period 3 is \$6,830,434

• Then the total promotion budget needed to get a normal profit after promotion, ME is

• TP = G/(1+ROME) = \$6,830,434/(1+1.41)

• TP = \$2,834,205

• Normal on the spreadsheet period 3 was

• TP* = \$2,840,000

• How did I get the formula for total promotion budget based on the normal target profit after promotion stated as the %ROME wanted

• TP = Gross Profit/(1+ROME)

• Start with basic profit equation

• MC = PQ –VQ – TP

• TP = PQ – VQ – MC

• My target profit is MC = ROME x TP

• TP = (P-V)Q – ROME(TP)

• TP + ROME(TP) = (P-V)Q

• TP(1+ROME) = (P-V)Q

• TP = (P-V)Q/(1+ROME) = G/(1+ROME)

A Cost Based Similarities! promotion budget is normally used for the SBU level of setting total budget under normal unchanging conditions.

• Set a price based on the variable cost and markupP = V/(1-Mp)

• Set price based on the average cost and ROSP = BEP/(1-ROS)

• Set promotion budget based on gross profit and ROMETP = G/(1+ROME)