Discussion on Assignment 4 Cost-Based Advertising Budgets

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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)
• How does it work?
• What are its virtues?
• What are its weaknesses?

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

You can see this being used to set and control the total budget for the market at the SBU level

What is the Percentage 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 = 17.41% x (\$98 x 94,000)

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.

You can see the Percentage of Sales method being used to allocate corporate budget between the Domestic market and the Foreign market

What is the Revenue 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

• 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… 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

Quantity Sold

119,000

112,000

1,600,000

1,700,000

Simple Average Return FORECAST IS PROBABLY WRONG

Quantity Sold

119,000

112,000

1,600,000

1,700,000

Quantity Sold

119,000

112,000

∆Q

110,000

1,480,000

1,600,000

1,700,000

• 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)
• 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)

Having a Target Rome as a target profit goal for your promotion budget is normally used for the SBU level of setting total budget under normal unchanging conditions.

A Cost Based Similarities!
• 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)