Marketing Profitability Analysis Defined
Profitability control is a marketing control tool used to perform marketing profitability analysis. The profitability analysis is a systematic and logical process used to analyze profits earned from various marketing activities and marketing channels. Firms show a growing interest in using marketing profitability analysis to quantify the true profitability of varying marketing activities. Gaining insights to true profitability, marketing managers can:
- Reduce unnecessary resources required to execute different actions.
- Increase resource productivity.
- Acquire resources at a reduced cost.
- Increase prices of products that consume increased amounts of support resources.
Marketing Profitability Analysis Steps
Marketing profitability analysis involves the following steps:
- Identifying functional expenses.
- Assigning functional expenses to marketing entities.
- Preparing a profit-and-loss statement for each marketing entity.
After marketing managers identify functional expenses, assign those expenses to marketing entities and prepare their respective profit-and-loss statements, the marketing professional then needs to determine if corrective action is necessary based on their profitability analysis.
Marketing Profitability Analysis Example
Using the marketing profitability analysis steps is better explained using an example. In our example, suppose you are the marketing director for a mid-sized vitamin (nutraceutical) manufacturer, and you want to determine the profitability of selling your product direct-to-consumer through three types of retail channels:
- Health and wellness centers.
- Retail supermarket chains.
- Independent pharmacies.
Below is an oversimplified profit-and-loss statement for the vitamin manufacturer that I’ll use for our marketing profitability analysis example.
Let’s examine the following steps in determining our marketing profitability analysis.
Step 1: Identify Functional Expenses
Functional expenses are costs incurred for a specific product or service. In our example, the functional expenses are those costs incurred for specific marketing activities for each marketing channel.
In our analysis example, assume that the incurred expenses in the profit-and-loss statement are to:
- sell the vitamin products
- advertise them
- pack and ship the product
- bill and collect funds
Our first task is to measure the total expense for each activity. We can assume that the sales team incurred most of the costs. The rest of the salary expenses went toward the advertising manager, packing and delivery staff, and the in-house accountant. The Functional Expenses chart below demonstrates the salary, rent, and supplies cost breakdown for each activity.
The rent, in our example, is divided amongst the four activities. However, because the sales team works outside of the firm, the rent is not allocated to the sales team but divided by space used, among the other three activities.
Most of the floor space and rented equipment are for the packing and shipping department. The $7,200 allocated to the supplies activity account covers promotional and packing supplies, delivery fuel purchases, and office supplies.
Step 2: Assigning Functional Expenses to Various Marketing Entities
In step two, we measure how much functional expense is associated with selling through the various marketing channels. The table below, Allocating Functional Expenses to Channels, shows the selling effort made for each channel. The number of sales calls per channel, indicated in the sales column, refers to how many times a salesperson called or visited one of the channel locations. The total selling expense for all three channels was $7,425, and the sales team yielded 675 units. Note that a unit in our marketing profitability analysis example refers to one item, for example, one sales call or one advertisement. In our case, the cost per sales call unit to our marketing channels costs $11 per call.
Respectively, we ran 450 ads with a total expense of $5,400, which yielded $12 per advertisement. The cost for packing, shipping, and billing follows the same formula, generating $18 per package to pack and ship and $9 per order to bill and collect.
Step 3: Preparing a Profit-and-Loss Statement for Each Marketing Entity
We can prepare the profit-and-loss statement for each channel partner in the final step. In our profit-and-loss statement example below, the health center channel earned 55% of total sales. The channel had the highest cost of goods, yet the highest gross margin as well. After expenses, the health centers channel netted a profit of $9,150 for the firm.
The total cost for calls to the health centers was the highest of the three channels, yet its advertising costs were half that of the pharmacy channel, bringing in a meager $430 net profit. On the other hand, total sales calls to retail chains were higher than the pharmacy channel, yet the retail chain channel was at a $2,975 loss for the firm.
Go through the remaining channel partner data below and see where you might identify areas that can help generate more net profit.
Analysis and Corrective Action
On the surface, it may be easy to eliminate the retail chains channel since they showed a loss compared to the two other channels. Yet, eliminating the retail chain channel may be premature or naive at best. Marketing managers need to determine the possible root causes of revenue loss before removing a channel partner. Marketing managers need answers to the following questions before eliminating a channel:
- What are the factors that buyers buy based on retail outlets (channel partners) versus the brand?
- Are there any trends that impact the relative importance of the three channels?
- Are the firm’s marketing strategies consistent across all three channels, or does the company vary the marketing message based on channel partner?
- Has the firm conducted a market analysis on competitors currently sold in each of the channels?
Marketing managers can use the answers from the above questions to evaluate the following alternatives:
- Establish special charges for handling smaller orders.
- Provide more promotional assistance to the retail chains and pharmacies.
- Increase ad spending for the retail chain channel.
- Evaluate the marketing message and make necessary changes to the messaging strategy for the retail and pharmacy channels.
- Remove the poor-performing retail units of each channel.
- Create an incentive plan for the retail chain channel to improve total sales.
- Do nothing.
Marketing profitability is not without its limitations. Depending on how well marketers understand the analysis methods and constraints, the analysis can lead or mislead marketers. Some advocates argue that the full cost must be allocated to marketing entities, while others say that only direct and traceable costs are necessary for evaluating a marketing entity’s performance.
Regardless of which side of the argument you stand, marketing profitability analysis does not necessarily prove that the best course of action is to eliminate unprofitable marketing entities, like the retail chain channel in our example. The marketing profitability analysis merely indicates the relative profitability of different channels, products, territories, or other marketing entities. It is up to the marketing manager to ask clarifying questions that lead to effective corrective action of their marketing activities.