VOLUME, COSTS, INSIDE SALES MANAGEMENT Mike Andrews, Vice President of Sales and Marketing, J. A. Riggs How do you manage profitability when your inventory costs are largely out of your control? That's the challenge Mike Andrews faces every day. Andrews is the vice president of sales and marketing for |. A. Riggs, the sole Caterpillar Inc. dealership for the state of Arkansas. It's a $250 million business in which the cheapest equipment products, such as Skid Steer loaders, sell for upwards of $25,000—and tKe largest tractors can sell for $1.5 million. Caterpillar Inc. publishes the list prices of its product line, with Riggs setting the customer sale prices. Competition in the marketplace leaves little wiggle room to price excessively. Margins are relatively small—the dealer might pay $90,000 for a vehicle or equipment it hopes to sell for $100,000. But Andrews relies on several different opportunities for profitability. The selling price, which the sales manager and rep arrive at together for each customer, is only one of them. “All machinery breaks down eventually,” says Andrews, and although Caterpillar Inc. can be depended ‘on to produce a high-quality and saleable product, one of Riggs’ most profitable lines is parts and service after the sale. Most Riggs customers plan on keeping their purchases for many years, and it’s critical to keep them in safe and efficient working condition. Dealer after-sale support adds value to each transaction and is required to maintain profit margins. Another profit center for Riggs is the rental equipment it offers customers—some customers prefer to rent rather than own the equipment. “Offering customersSales Volume, Costs, and Profitability Analysis 341 cost-effective solutions to their business problems keeps them coming to you rather than competition,” says Andrews. Still another big part of managing profitability is managing controllable costs. Each of Riggs’ twenty-seven sales reps is a profit center, with an expected profitability rate and a sales plan. Each rep costs the company about $75,000 a year in salary, commission, travel costs, and expense accounts. “They're fairly expensive employees,” says Andrews, “and if they don't produce the revenues, profitability, and market share required, it shows up very quickly. Every sales manager's dream is to hire the right people for the job.” Managing sales reps to get the best performance is a real balancing act between training and motivation. Reps who don't bring in the expected revenue don't stay on the payroll for long. But profitability doesn’t end there. While the dealership can't control what it pays for its inventory, it can manage that inventory to keep its profitability high. So Andrews keeps an eye on customer trends to refine his forecast of their equipment needs and project exactly what he'll need to have on hand as far as two years ahead of time. It can take up to a year and a half to get some larger vehicles from Caterpillar Inc., and Andrews can't use up resources keeping such big-ticket items sitting on the lot. In fact, the larger the ‘equipment, usually the farther in advance he needs to plan for it. “Our inventory plan has to match our sales forecast,” says Andrews. “All the pieces of our business plan have to work together to keep us profitable.” We've covered organizing and developing the sales force in Part Two, then managing and directing in Part Three, Now, in Part Four, we'll examine two critical areas that fall within the realm of controlling and evaluating sales force performance. First, in this chapter, we'll concentrate on sales volume, costs, and profitability analyses as key determinants of overall sales force effectiveness and efficiency. Our second topic—evaluating salesperson performance—focuses on the individual sales- person level and will be discussed in chapter 14. Some sales managers stress selling activities and sales volume while neglecting cost controls and profitability analysis. Although analyzing sales volume metrics is helpful in evaluating and controlling sales effectiveness, it neglects the profitability of sales efforts—and high volume does not ensure high profits.’ With the ever-increasing costs of selling, it’s important that sales managers emphasize the profitability of sales efforts? This requires analyzing costs and profitability by important marker segments (customers, product lines, and territories) and organizational units. From such analyses, sales managers can redirect resources and expenditures to those areas where the return per dollar spent is highest. In this process, they should be able to assess the impact of formal and informal control mechanisms on the sales organization and salespersons, as well as on customers.‘ Thus, in this chapter we will show you how to analyze sales volume, costs, and profitability in order to assess overall sales force productivity.5 FRAMEWORK FOR SALES FORCE ORGANIZATION AUDIT Analysis of overall sales organization performance can be best approached through a sales force audit—a comprehensive, systematic, diagnostic, and prescriptive tool designed to assess the adequacy of a firm’s sales management process and to provide direction for improved performance and the prescription for needed changes. The approach sales managers use in conducting an audit depends on the purpose“and perceived importance of the evaluation, the availability of evaluation information, management philosophy toward performance appraisals, evaluation skills of the raters, and the way the firm uses the planning process. As shown in Figure 13.1, a sales force organization audit includes an evaluation of four areas:342 Soles Management Sales Foree Organization Environment of the _ Sales Force Organization, | Figure 13.1 Conceptual Model for a Sales Force Organization Audit SOURCE: Dubinksy, Alan J., and Richard W. Hansen, “Improving Marketing Productivity: The 80/20 Principle Revisited.” California ‘Management Review 25/1 (Fall 1982): 96-105. 8 Sales force organization environment—Evaluates the external environmental factors (economic, sociocultural, competitive, technological, and political-legal) and the intra-organizational factors (company structure, sales-marketing department linkages, marketing mix). & Sales force organization planning system—Evaluates the sales department’s goals and objec- tives, its overall sales management program, and the program’s deployment. & Sales manager—Assesses the adequacy of sales management at all levels in terms of leadership, motivation, and communication skills as well as in empowering salespeople and seeking their participation in decision making. 8 Sales management functions—Assesses the major sales management functions of recruitment, training, compensation, supervision, forecasting, evaluation, quotas, sales, costs, and profitability analyses. ; a When investigating each of these areas, the sales management auditor will first acquire a wealth of information for identifying the sales organization’s weaknesses and strengths and then offer advicewe Sales Volume, Costs, and Profitability Analysis 343 about what the firm should do to address any deficiencies. Sales personnel, customers, the sales and marketing support teams, other company personnel, internal company documents (marketing plan, sales plan, policy manuals, and surveys), industry publications, trade association information, and readily available published reports, newspapers, books, and periodicals can all provide information. Auditors must be objective and unbiased, so oftentimes they will come from outside the sales organi- zation or even outside the company. Some managers suggest that a detailed audit is an extravagance or questionable luxury, given the cost and time required. They prefer conducting audits only after some major problem has emerged. Waiting, however, until competition has become fierce, market share has eroded, key salespeople are leaving in droves, or profitability has headed south may make it too late to take corrective action that works. Therefore, it’s advisable for sales managers to conduct a sales force audit regularly, at least once a yeat. The cost of an audit is often easily offset by the potentially substantial returns from taking timely corrective action to solve sales force problems early before they become large. To learn more about conducting effective sales force organization audits, sales managers can enroll in comprehensive training programs offered by firms such as ES Research Group (www.esresearch.com). SALES VOLUME, COSTS, AND PROFITABILITY ANALYSIS It usually takes a long time to complete a comprehensive assessment of the sales department's effec- tiveness and efficiency. However, let’s now turn our discussion to conducting an analysis of sales volume, costs, and profitability because these are the key factors by which we can quickly gauge the performance of the sales department. Because total sales (or even profits, for that matter) provide an incomplete picture of a firm’s sales patterns, sales managers also should evaluate costs and profitability at the same time to reveal strengths and weaknesses of the company’s different marketing units. In analyzing the productivity of sales force efforts, sales managers should note the linkages among sales volume, selling costs, and profits by market segments.’ To determine the profitability of different market segments, it’s necessary first to analyze the sources of sales volume and then to subtract the costs for producing those sales. Although the analytical task seems straightforward, it does present challenges, especially in assigning marketing costs (such as advertising, administration, dt warehouse and office rent) that are indirect or common to more than one market segment. Since selling costs are really a subcategory of marketing costs, and because a combination of selling and marketing costs are required to produce sales, we'll use the more general term marketing costs andlysis. And, because sales managers are more interested in profitability than in costs, we'll use marketing profitability analysis to describe the overall process of sales volume, costs, and profitability analysis. ? Marketing profitability analysis requires an in-depth analysis of the elements making up an organization’s profit-and-loss. or income statements. It reclassifies the traditional accounting statement expenses into cost centers according to the purposes or functions for which the expenses (costs) were incurred. For example, a sales organization may pay employees for performing such functions as direct selling, order processing, or sales administration. These salaries can be further allocated to territories, products, customers, or salespeople. This type of analysis can be invaluable to sales managers for eliminating or adding new selling activities or for changing the allocation of current efforts.® Let’s discuss sates volume analysis first. 4 Sales Volume Analysis Collecting, classifying, comparing, and evaluating an organization's sales figures is a process referred to as sales volume analysis. All organizations collect and classify sales data as the framework upor344 Soles Management SALES MANAGEMENT IN ACTION Sales Timing Can Be Everything Sales at Sire Technologies (wwwsiretechnologies .com), a Salt Lake City software company selling to state and local governments, were unpredictable—up dramatically one quarter and sharply down the next, Sire didn't know how much money was coming in and when, so planning became virtually impos- sible. Sales negotiations with government agencies are known for bureaucratic delays, and Sire sales reps must persuade large committees made up of employees across several departments before closing its typical software sale of $20,000 to $80,000. To bring some: predictability to sales, Sires hired a new sales manager with analytical skills in sales costs, He identified six distinct steps in the Sire selling process, ranging from identifying prospects to signing a contract. Utilizing Salesforce.com, an off-the-shelf CRM product, he began) collecting’ and tracking key data at each stage. In this analytical process, the sales manager learned that his salespeople needed at least thirty-two leads in the pipeline at any one time to generate a single Sale. Each sales- person's ae was monitored daily for potential problems such te te frequent contact, with specifi Eades salespeople were then counseled about hoy ck on track: By which to construct their accounting records and statements. To sales managers, sales figures are the most immediately visible and readily available means to judge how well the organization is performing. They regularly use sales analyses to compare current performance to past sales, competitors’ sales, or forecasted sales. From these evaluations, management decides the direction and scale of future sales efforts. In some companies, sales figures are not always readily available due to a long sales cycle, as described in the Sales Management in Action box. Key Considerations in Sales Volume Analysis. Because a sales volume analysis will try to identify deviations between actual and expected sales performance of some marketing unit, and then recommend attion based on that identification, sales managers first need answers to the following questions:? = How will we define a sale? We can think of a sale in three ways: it can occur (a) when an order is taken, (b) when it is shipped, or (c) when the customer pays. Most companies consider a sale to take place at the time of shipment, but some keep records for all three definitions to analyze what volume and type of orders make it through each of the stages. Whatever the definition, the firm must apply it consistently if sales comparisons across time periods are to be meaningful. = How will we measure sales? Will we measure sales in dollars, physical units, and/or as a percentage of total sales (product A sales as a percentage of total sales)? ® At what organizationaWlevel will we conduct the sales analysis? Will we analyze the overall sales organization, or will we analyze it by region, district, or territory?Sales Volume, Costs, and Profitability Analysis 345 * How will we break down the sales analysis? Common categories include sales by territory, product (or product line), customer group (or individual customer), customer size, customer type (consumer, industrial, government, institutional) method of sale (phone, catalog, in person, e-commerce), order size, distribution method, and salesperson. % What will we use as our basis (or bases) of comparison? Popular bases include sales in prior periods, the fiscal period’s sales forecast or sales quota, competitors’ sales (or market share), and average sales for the period. = What information sources will we use? Customer invoices, cash register receipts, salesperson call reports, salesperson expense reports, individual customer or prospect records, financial records, credit memos, and warranty cards can all provide information for conducting the sales analysis. The most illuminating kind of sales analysis disaggregates the sales information into multiple marketing units or cross classifications. A territory-by-customer sales analysis will be more revealing than merely a territory or customer sales analysis alone. Similarly, a three-way sales analysis (territory-by-customer-by-product) will uncover more information than a two-way (territory-by- customer) sales analysis. Additional gradations of sales information can be especially valuable in identifying weaknesses and strengths in the marketing units. Too much disaggregation of the data, though, may result in information overload—management is simply inundated with sales infor- mation with which to make decisions. Thus, sales managers need to make a trade-off between the specificity of the sales information they desire and the time and resources they have to expend on the sales analysis. Sources of Sales Information. Depending upon the depth of sales analyses and the breakdown. desired, the sources of sales information will vary widely. In a simple sales analysis, only aggregate sales figures are needed for the desired market segment. But for comparisons with quotas, market potential, historical sales, or industrial averages, the sales manager will want much more information collected and classified. A sales invoice is the most important single source of sales information, but most companies utilize other sources as well, depending on the types of analysis desired. Major sources of sales information are shown in Table 13.1. Collecting Sales Data. Firms usually report their sales figures in both dollars and units because inflation can distort doliar comparisons across different time periods. Sales data are frequently subcategorized by territories, product types, customer classes, order sizes, method of sales, time period, organizational unit, or salespersons to provide more meaningful information to management. Each subcategory can be further broken out for more in-depth analysis. For example, sales by, territory breaks down into product types, customer classes, and so on, as shown in Figure 13.2. Total Sales Volunie. In any sales analysis, total sales volume figures are usually the first ones studied. Sales managers want to know the trend of sales over the past several years in terms of units and constant (un-inflated) dollars. Comparing relative changes in total industry sales with company sales gives the sales manager a benchmark for performance against competitors. Trends in company market share (company sales/industry sales) are excellent indicators of relative competitive perfor- mance. In Table 13.2, CENTEX Company’s sales volume has risen faster than industry sales from 2002 through 2008, and sales (in constant dollars) have continued to increase. Even though these aggregate sales figures indicate that all is going well, an aggressive sales manager would resist the temptation to be complacent and go ahead with a more in-depth sales analysis to see how sales force productivity might be improved."346 Soles Management SES PoC eee discounts and allowance shipment and freight costs Salesperson’s call reports Prospects and customers called upon; names of persons customer's product needs and usage; orders obtained the company Internal financial records _Sales by major market segments (territories, customers, products, or salespersons); direct selling expenses; deals, and type of outlets where purchased Test markets Dollar or unit purchases; market share; repeat purchases; impact of different marketing expenses on sales | SOURCES ANO TPES” RUN DESCRIPTION OF DATA Sales invoice Customer name and address; products or services bought, ¥ sales in units and dollars; name of salesperson; customer's industry and/or trade channel; terms of sales, including ethod of payment; mode of contacted; products presénted or discussed; prospects or Salesperson's expense Itemized daily expenses for travel, lodging, food, and accounts entertainment of prospects and customers Individual prospect/ Prospect or customer name and address; customer's industry or Customer records trade channel; number of calls by company salesperson; sales in dollars and units; estimated annual usage of each product type sold by the company; annual purchases from administrative costs; costs and profits by market segments Warranty cards Basic demographic data on customers; where purchased; price paid; reasons for purchase; service expected Store audits Dollar or unit sales volume; market share in product category Consumer diaries Dollar or unit purchases by package size, brands, prices, special Southwest Tertory mpiters office Machines so hpisaes & Government: Wholesales Government. Retalers | ea shi sy State vals ide Small” Federal’ State. Local: Large. Small 4 a Figure 13.2, Subcategories of a Sales TerritorySoles Volume, Costs, and Profitability Analysis 347 | EEE Vere e ci et er $15,689 2003 16,912 2,782 2004 17,176, 3373 18,234 9 18,982 2007 19,871 3,916 2008 20,466 4231 *“nflation-adjusted dollars With the press of other duties, sales managers are often lulled into inattention to sales analyses when total sales figures appear favorable, because they forget the iceberg principle. Only about 10 percent of a floating iceberg is visible above the surface of the water. Yet it is the underlying 90 percent that can sink a mighty ship, when the captain superficially evaluates the iceberg based on its visible part. Favorable total figures can easily hide unprofitable market segments and unproductive sales activities. To uncover more of the iceberg, it is necessary to divide total sales figures into their successively smaller components. For example, we might start with an analysis of sales volume by territory, and then subdivide territorial sales to the individual salespeople who gencrated those sales. Next, we might assign each salesperson’s sales to product lines. Finally, we can subdivide product- line sales into customer classes. Each sales manager will need to decide what type and how many breakdowns are needed to get at the desired underlying explanations for sales volume figures. Through this sequential process, sales managers can unravel the outer covering at each top-to- bottom hierarchical level to see exactly where sales revenue originates, as illustrated in Figure 13.3. Working with our data from Table 13.2, we can break out 2008 sales data by geographical territory, as shown in Table 13.3. Southeast Midwest Northwest Southwest Totals 4,200 4,231 1.01348 Sales Management Figure 13.3 CENTREX Company: Hierarchical Analysis of Sales Volumes by Market Segments Sales Analysis by Territory. Scanning the territorial classification in Table 13.3, we readily see that all the territories met or exceeded their quotas for the year, except for the Midwest region, which achieved 98 percent of quota and had the highest total sales. Although everything looks good, CENTREX Company’s new sales manager, Claudia Middleton, wants to investigate sales in each of the territories by breaking them out into subcategories. Before doing this, she reviews the procedure for assigning sales quotas to ensure that each quota was assigned fairly and based on one or more sound measurements of potential, such as Sales & Marketing Management's annual “Survey of Buying Power Index.” Middleton also considers any unusual conditions in the individual territories (such as more intense competition or a union strike) that might have adversely affected sales; or conversely, an anticipated shortage of the company’s product that may have created windfall sales to customers stocking up in order to guide further sales analysis. If quota was barely achieved in a territory where industry demand was sharply up during the year, further investigation is called for. After considering each territorial circumstance for the period, the sales manager can start with the territory that“suggests the most promise for productivity improvement. Since the Midwest territory was the only one to fall short of quota (.98), Middleton begins with that region’s sales, broken out by sales representative, as shown in Table 13.4. Upon finding that the lowest-performing sales rep was Jared Laivrence, who reached only $2 percent of his quota, she decides to dig deeper into Lawrence's sales for the year. Sales Analysis by Product Line. Table 13.5 shows that Lawrence did a good job of reaching product quotas—except for band saws, for which he achieved only 20 percent of quota. In checking with the company’s production manager, the sales man-ager learns there were no unusual quality control problems, shortages, or delivery problems on band saws. Furthermore, the marketing vice president said that there had been no recent change in the marketing mix for band saws in any territory and that total salesor band saws were running slightly ahead of last year. To probe a little deeper, Middleton decides to ask her sales administration assistant for a breakout of Lawrence’s sales of band sdws by customer.Sales Volume, Costs, and Profitability Anolysis 349 f TABLE 13.4” CENTREX Company, 2008, Midwest Territory: SEE EES CHS Elav Johnstone 95 Merrill 110 Schwartz 115 Peabody 110 Lawrence 130 Diaz 116 Gupta 108 Totals 890 ADV] ES ER eae er au eh ecules 2008 Sales by Product Line ($10,000's) te PRODUCT LINE QUOTA ‘ACTUAL Lathes 53 52 Milling machines 44 49 Band saws 60. 2 Grinders 37 44 Punch presses 46 47 Totals 240 192 Analysis of band saw sales by customer, shown in Table 13.6, reveals that one customer, Babson & Hines, accounted for Lawrence’s poor performance on that product line. Babson & Hines was Lawrence's biggest customer and had been targeted for 80 percent of his entire sales quota for band saws. With a change of purchasing agent at Babson & Hines, the customer had switched to another supplier, leaving Lawrence out in the cold. Embarrassed about losing such a large account, which he had begun taking for granted, Lawrence said nothing to the new sales manager, hoping that he might regain some of the business later in the year or make it up by increasing sales on other product lines. Lawrence did not expect his deception to be picked up, because the previous sales manager seldom ed sales by market segments as long as overall sales were favorable. Claudia Middleton has a private conference with Lawrence following the next monthly sales meeting. She explains to him that in the future, she expects to,be alerted immediately about sales problems so that she might provide assistance. Lawrence, relieved that he was not reprimanded for his mistake in judgment, leaves Middleton's office feeling respect for his manager’s thorough analysis of sales force dperations. Lawrence’s sales by customer illustrate the validity of the concentraticx principle (sometimes called the 80-20 rule), which asserts that the major portion (80 percent) of any organization’s sales,350 Sales Management eli TABLE 13.6'* CENTREX Company Sales Representative Lawrence: SECS Customer Bre eee Masson’s Machinery Co. Vinson & Gore Fabricators Gearhart’s Foundry Levitt’s Metal Works 1 Babson & Hines ° 1 6 Dalton Tubing Co. 1 Totals 30 costs, or profits often come from a small proportion (20 percent) of customers or products. If Lawrence had allocated his selling time with customers in proportion to sales, he might have retained the Babson & Hines account. Many progressive companies today use telesalespeople to make telephone and e-mail calls on small customer accounts, so that field salespeople can spend more time with large accounts. Beyond revealing all kinds of valuable information about “who, what, where, when, and how” sales revenue is generated, sales volume analysis lays the foundation for the next stage in profitability analysis—the in-depth study of the costs of achieving sales. Profitability Analysis Although a sales analysis is a useful control tool, it does not give the complete picture of the sales organization's effectiveness. Recall that the sales analysis focuses on the results generated by the sales force. It says nothing, however, about the attendant costs, profitability, and return on investment that the results produced. Thus, cost and profitability analysis complements a sales analysis. Historically, sales managers have not been very cost or profit oriented. This is not to say that they don’t recognize the need for profitable sales volume. They often make the mistake, though, of treating volume and cost control as two separate entities. Some sales leaders are so motivated to generate sales that they give little consideration to the costs of obraining those sales. Others are short- sighted abott cost-volume relationships. Furthermore, some sales managers incorrectly assume that the more their salespeople sell, the more money their firm is making. Sales managers, in pursuit of sales, are often reluctant to delete unprofitable products, drop unprofitable customers, or eliminate unprofitable territories. An ever-growing number of sales organizations are emphasizing a profit perspective in their evaluation process.!” Marketing costs analysis goes beyond sales volume analysis to investigate the costs incurred and the profits generated from sales volume. By subtracting the costs identified with the sales revenue from various marker segments or organizational units, we can determine the profit contributions of the segments and units.' Sales managers should utilize all their resources to achieve that balance between sales volume and costs that will result in the highest long-run organizational profits. But it is often difficult ro decide how to allocate these resurces, because the precise impact of expenditures on different elements of the marketing mix—like advertising, sales promotion materials, sales calls, and post-purchase service—isn’t readily measurable. Any effective marketing costs analysis requires cooperation among,Sales Volume, Costs, ond Profitability Analysis 351 the sales manager, the headquarters marketing team, and the accounting department. One way to understand this need for integrated efforts is to consider input-output efficiency Input-Output Efficiency. We need different mixes and levels of selling aid supporting marketing, efforts to achieve different sales objectives. The relationship between these inputs (marketing efforts) and the outputs (sales goals) is known as input-output efficiency.'? To illustrate, suppose a regional sales division of MicroComputer Solutions Corporation has the objective of selling 2,000 new office computers during the year. The input is the mix and level of direct selling and supporting marketing efforts required to achieve the output, the sales objective. It is projected that to help introduce the new product to prospective customers, the sales force will have to make 3,000 additional sales calls during the year, and twenty advertisements will be needed in selected trade magazines. In addition, the sales manager estimates that the inside office sales force will accept about 600 collect telephone calls inquiring about the new machines. A summary of these activities is presented in Table 13.7. ali NTN EP elect lees ENC) st blebs is a) 3,000 sales calls @ $100 $300,000 Sell 2,000 new computers 600 telephone calls @ $1.50 900 ($1,000,each) @ $500 20 trade magazine ads @ $1,000 __20,000 segment oe Totals $320,900 $1,000,000 By dividing the dollar outputs by the dollar inputs ($1,000,000/$320,900), we derive an efficiency ratio of 3.116. Minimum Average Costs. Many organizations fail to function most efficiently because they don’t operate near the optimal point on their average cost curves, representing selling and supporting marketing costs. Instead of making 3,000 sales calls, it may be more efficient, based on a $10,000 tharket survey, to mail out 6,000 sales promotion brochures about the new product and make only 1,500 sales calls on the best prospects identified by marketing research. By reallocating the mixture of direct selling and marketing support activities, the firm might achieve the same sales goal with greater efficiency ($1,000,000/$186,900 = 5.35), as shown in Table 13.8. | EET ue eu ues ~ SALES EFFORTS (INPUTS) LS, (QUTP 1500 sales calls @ $100 $150,000 Sell 2,000 new computers 600 telephone calls @ $1.50 900 ($1,000 each) @ $500 1 market survey @ $10,000 10,000 STDS ESE SE 6,000 sales promotion brochures 6,000 @ $1.00 20 trade magazine ads @ $1,000 _ 20,000 : Totals $186,900, $1,000,000352 Soles Management Cooperation Between Marketing and Accounting Departments. Sales organizations often incur high average costs for selling tasks because they over-utilize direct selling activities and under utilize their marketing support team. By cooperating with the marketing specialists in advertising, marketing research, or sales promotion, the sales force eau often function much more efficiently. It behooves sales managers to attempt to operate at the optimal point on their average selling cost curve, As you can see in Figure 13.4, typically an optimal number of sales calls are required to operate at the lowest average selling cost per unit. At $1, reps are making an insufficient number of sales calls to produce desired sales, so per unit costs are high at C1. At $3 the sales manager is relying too heavily on costly sales calls, so per unit costs remain too high at C3. Only at $2 is the optimal number of sales calls being made to achieve the lowest per unit costs at C2. Beyond this optimal point, the sales manager ought to shift from sales calls to other marketing and promotional activities. Average Cost Curve Cost 3) Sz Ss Sales Calls igure 13.4 Average Per Unit Sales Cost Curve for Direct Selling Historically, accounting systems have been concerned mainly with reporting aggregate financial data to stockholders and creditors in order to raise outside funds. Gradually, accounting statements were redesigned to provide analysis of production costs for internal management use. But only in recent years, with the widespread use of computers, have accountants seriously turned their attention. to marketing costs analysis. Due to their critical function as the revenue-producing arm of the company, marketing activities often constitute a company’s largest total expenditures. To progressive accounting and marketing departments, marketing costs analysis offers rewarding opportunities to cooperate in improving overall productivity. Three continuing problems account for the long neglect of marketing costs analyses by accounting systems: (1) inadequate communication, (2) lack of marketing costs standards, and (3) inability to collect and analyze the huge volume of marketing data. Inadequate communication between marketing and accounting managers arises partially from their different perspectivesyon the use of cost data. Accountants tend to see costs as an end, something to be reduced. Marketers, however, see costs largely as a means to an end or benefit usuallyssales. Sales managers are particularly sensitive to potentially adverse effects on sales if marketing expenditures are curtailed too mucha ay Soles Volume, Costs, and Profitability Analysis 353 [Accounting cost analysis is primarily designed to provide a historical financial record of overall company operations and to ensure that production costs stay within established standards. By Contrast, marketing cost analysis is more concerned with future decisions; it seeks to learn the specific cos and profit contributions of different marketing efforts. While recognizing their different pershet on on cost analysis, marketing and accounting managers should try to cooperate with one another for the overall benefit of company productivity. Lack of marketing costs standards has stowed the development of marketing costs analysis. However, based on experience and research, standard costs that include labor material, and machinery resources needed to produce a certain output can be predicted and standardized as norms Jn conducting production costs analyses. Unfortunately, the marketing outlays needed to produce a given level of sales are much less predictable, because results vary widely depending on the marketing Ben elocted for changing marketing scenarios. Marketing managers seldom can precisely determine the costs of inputs needed to achieve a desired sales level. Moreover, many marketing expenditures, uch as advertising and customer service, don’t have an immediate, readily measurable impact of sales, They work over'a period of time, making it difficult to identify sales results in one period with the marketing costs to achieve those sales. Trees tional secounting practice, most marketing expenses are charged off in the period incurred, while production costs are identified with per unit output that is held in inventory until awd. Even the terins costs and expenses highlight the accountant’s difficulties with marketing oprra- sons. Accountants tend to speak of production costs and marketing expenses, suggestive of their {Iferene levels of specificity. Marketers often use the terms interchangeably but tend to think of marketing expenses as investments that will pay off in future sales. The challenge remains for accoun- aac catketers to find hew approaches to managing marketing costs for improved profitability. Inability to collect and analyze the huge volume of marketing data has long hindered the progress of marketing costs analysis, But with more sophisticated collection and analysis software, the mass of marketing data has become increasingly manageable. Today, even small firms often have access fe the latest computer sofeware, which can handle the countless calculations necessary 10 compile and ‘analyze marketing information in a timely fashion for decisions on sales force efforts and other marketing activities. Today’s sales managers can also receive full-color managerial charts and graphs, Girectly from computers, summarizing the mountains of marketing sales volume, costs, and profit “hues in almost any form desired. Compt: graphics enable sales managers to identify and respond more quickly to opportunities and chali enges in the marketplace. Benefits of Marketing Costs and Profitability Analysis. Two terms—costs and expenses—have often been used interchangeably in describing marketing costs analysis. But costs tend to be specific and directly related to volume output, while expenses are more general or indirect expenditures: therefore, we tend to say production costs and marketing expenses. Marketing costs analysis recog nizes that sales are achieved through marketing expenditures that contribute uniquely to profits. By identifying the productivity of different marketing expenditures, sales managers are able to improv the precision and productivity of their decisions in (1) allocating sales force efforts and sale department resources, (2) preparing sales department budgets, and (3) obrair ing support for the sale force from other elements of the company’s marketing mix.! Several sales volume, marketing costs, and profitability analysis management software prograrm are available from vendors such as Salesforce.com (www-salesforce.com), CB Software System (wow. cbsoftware.com), Program URL (www.programurl .com), and SYSPRO (www-sysPr0-60% You can compare the top six sales analysis computer software programs at www: 2020software.con Some sales managers ffploy the services of specialized companies like Hyperion Solutions Corps ration (www -hyperion.com) to collect, organize, and analyze data to improve the performance the overall sales organization. :354° Sales Management ing the Latest software In addition to diligently analyzing costs and profits by market segments v programs, resourceful and insightful sales managers often can spot inefficiencies needing correction by applying their common sense—with sometimes surprising benefits. Profitability Analysis Procedure. In conducting a marketing costs (or profitability) analysis for a sales organization, sales managers can approach the analysis systematically by following these steps: (1) Specify the purpose of the analysis, (2) identify functional cost centers, (3) convert natural expenses into functional costs, (4) allocate functional costs to segments, and (5) determine profit contribution of segments (Figure 13.5). Let’s discuss each of these steps. functional = a cre costs to segments cost centers ty is Figure 13.5 Marketing Profitability Analysis Procedure Specify the Purpose. Sales managers must first decide the precise purpose of the analysis. That is, what do they want to determine the profitability of—sales territories, sales representatives, customers, product lines, or organizational units such as district or branch offices? Depending upon the answer to this question, the treatment of marketing costs will vary. Some costs may be direct for ‘one segment but indirect for another. For instance, a salesperson’s salary is a direct cost to an assigned territory but indirect, with regard to the different product lines or customer classes that he or she sells in that territory. Even compensation usually breaks down into fixed costs (salary) and variable costs (commission based on sales). By specifying the precise purpose of the analysis, sales managers are able to classify expenses as direct or indirect costs and as fixed or variable costs.’ Identify Functional Cost Centers. Functional costs refer to reclassified natural expenses into the activities or functions for which they were incurred (e.g., “salary expense” reclassified into direct selling, transportation, or advertising function salaries). As shown in Table 13.9, we can broadly categorize functional cost centers for sales organizations into (1) order-getting costs and (2) order-filling costs. Order-getting costs pertain to those activities that obtain sales orders, such as direct celling and advertising expenditures. Order-filling costs relate to those activities that follow the sale (such as order processing, packing, shipping, and delivery) and are necessary to fill a customer's purchase order. Each functional cost center should contain a homogenicous group of directly related expenses instead of arbitrarily allocated ones. Aisne Palen urbe LU oe ORDER-GETTING Costs CORDER-FILLING COSTS Sales promotion and publicity Product packing and shipping Product and package design Transportation and delivery Advertising Customer service Sales discounts and allowances Warehousing . Sales adminstygtion laventory controt Credit Accounts receivable collection355 Sales Volume, Costs, and Profitability An Convert Natural Expenses into Functional Accounts. In marketing costs anal: natural accounting expenses (the traditional expense categories like salaries, rent, depreciation, etc.) used in accounting statements must be reassigned to categories based on the purpose of each expense. Because nearly all expense data are collected by the organization’s accounting system, analysis ought to start with the traditional accounting statements. The most important of these is the profit-and-loss (or income) statement, which takes this basic form: Sales ~ Cost of goods sold = Gross margin ~ Expenses = Net Profit Traditional income statements are of limited value to sales managers because they fail to reveal the costs of performing different marketing activities. Working with the simplified income statement for the CENTREX Company Sales Department in Table 13.10, we have assigned the natural expense accounts to functional accounts in Table 13.11. f TABLE 13.10: CENTREX Company Sales Department USSU cl cucu eae sales Cost of goods sold 623,451 Gross margin 4543,192 Sales Experises Salaries 831,110 Commissions 169,334 Travel 151,491 Sales promotion 20,115 Advertising 45,000 Postage 62,078 Supplies 160,623 Rent 188,606 1,628,357 Net Profit, $2,914,835 B TABLE 43.17 CENTREX Company: Natural Expenses Assigned to Functional Areas : “SEUNCTIONAL ACCOUNTS" £ Order Processing Packing Direct Sales Adver- and Marketing and Natural Expenses Selling Promotion tising tration __—Billing Research Shipping Salaries $831,110 $590,190 $21,400 $25,650 $64,250 $31,000 $27,340 $71,280, Commissions 169,334 169,334 Travel 151,491 150,488 1.003 Sales 20,15 20,115 promotion Advertising 45,000 45,000 Postage eo7é” 3,000 9671 22 629 798 agp 47.219 Supplies 160623 7,716 = 21247-2023 183 928 2101 126.425 Rent 188,606 79,18 200» $300 15,100 ©» «23.400 12,150 45,270 $1,628,357 $999,914 $80,633 $78,185 $80,222 $56,122 $43,087 $290,194356 Sales Management Sales Processing Packing Direct. Sales. Adver- Admi and Marketing and Natural Expenses. Selling Promotion ising tration _ Billing Research Shipping Salaries. $831,110 $590,190 $21,400 $25,650 $64,250 $31,000 $27,340 «$71,280 Coimmissions “169,334 “<469,334 Travel 151,491 150,488, 1003 Sales 20,18 20,5 promotion Advertising 45,000 45,000 Postage 62,078 3,000 9.671 nz 689 794 493 47219 Supplies 160,623 27,716 + 2,24? -2,023 183 28 2,101 126425 Rent 188,605. 79,186 8,200 © 5,300 15,100 23,400 12,150 45270 $1,628,357. $999,914 $80,633 $78,185 $80,222 $56,122 $43,087 «$290,194 Salaries were spread to the functional areas where the recipients work, As Table 13.11 indicates, about $590,190 went to salespeople and the sales manager, $21,400 to a sales promotion specialist employed part-time in the sales office, $25,650 to an advertising specialist, $64,250 to two people in sales administration, $31,000 to a billing clerk, $27,340 to a marketing research staff specialist, and $71,280 to two people in the shipping department. Besides their regular salaries, all salespeople received a commission of 2 percent on sales. Since these commissions were directly related to sales, the entire $169,334 was charged off to the direct selling function. Travel expenses included $151,491 for food, lodging, and entertainment expenses incurred in direct selling efforts, and $1,003 spent by the marketing research specialist while coordinating a market study. As both natural and functional accounts, advertising in selected trade magazines required $45,000, and sales promotion materials cost $20,115. Postage expenses were incurred to some degree for every functional cost center but largely for the packing and shipping area. Expenditures for supplies, which were also spread over all the functional accounts, amounted to $160,623—again mainly for packing and shipping. Finally, the sales department had to pay $188,606 in rent, and these costs are allocated to the functional areas in proportion t6 the floor space used by each activity. Allocate Functional Costs to Segments. To discover the profitability of separate organizational units or particular market segments, the sales manager must allocate the functional costs incurred by the unit or in serving the segment. He or she needs to examine each marketing function or activity to find the factor that most affects the volume of work. In making the cost allocations, the sales manager can consider several bases, including selling time, number of sales calls, and actual space occupied. Another frequently used but improper basis is to allocate functional costs according to sales volume. This approach tends to penalize sales productivity and efficiency. For example, if one sales territory accounted for 20 percent of total regional sales, it would be charged with 20 percent of the sales administration function €osts of $80,222 in Table 13.10, regardless of the actual expenses and proportion of time spent by the sales manager and his or her staff in working with that territory. In contrast, a particularly worrisome territory may have taken up 40 percent of total sales administration expenses and personnel time but be allocated only 5 percent of those functional costs to match its lowF Sales Volume, Costs, and Profitability Analysis 357 sales volume. Using sales volume to allocate functional costs contravenes the very purpose o} marketing costs analysis, since it ignores the actual costs incurred in different business segments while relying on a simple but irrelevant basis, Therefore, sales managers should allocate functional costs according to measurable variables that have a cause-and-effect relationship with the functional cost category. That is, the costs should change in proportion to the performance of the activity; so direc selling costs, for instance, should increase directly with the number of sales calls. Several bases for allocating functional costs to different identifiable segments are provided in Table 13.12. PS ee Cue Aree aos) ea Functional Costs Direct selling costs Salaries, incentive pay, Direct Selling time devoted to each Number of sales calls travel, ard other product multiplied by average time expenses of salespeople Indirect selling costs Sales administration, sales Equal charge to each sales- training, marketing, person research, field supervision Sales promotion costs Consumer or trade Direct Direct Direct Promotions, e.g., trade discounts, coupons, contests, and pointof- purchase displays Advertising expenditures ing department Director by circulation of Direct or by media space Charged equally to each media given each product account Marketing research Cost of gathering Time spent researching each Time spent researching each Time spent researching each information territory product customer Transportation Cost of delivering goods to Classification rate x weights Classification rate x weights Bill of lading customers of products of products Order processing and billing Number of customer orders Number of customer orders Number of customer orders Packing and shipping Number of shipping units, Number of shipping units, Number of shipping units, weights, or size of units weights, or size of units weights, or sizeof units Full Costs or Contribution Margin? Since marketing costs contain direct, indirect, fixed, an variable amounts, another major decision is whether to allocate full costs or only marginal cost (direct and variable) ro the segments. Costs that are fixed and indirect are usually impossible ¢ assign to segments except arbitrarily. Advocates of the full-cost (or net profit) approach argue thé all costs can be allocated on some reasonable basis. Using the full-cost approach, we allocate tot: costs (whether variablg, fixed, direct, or indirect), and determine the profitability of each segment b deducting cost of goods sold from net sales to arrive at gross margin. Then we deduct all other cos or operating expenses to derive net income for the segment.358 Sales Management On the other side of the controversy, proponents of the contribution margin (the sales price less direct costs and variable costs equals the amount the sale contributes to profits) approach claim that it’s misleading to allocate costs that are not controllable and, therefore, not considered in marketing decisions. They believe only costs that are controllable (direct and variable) and traceable to a particular segment should be subtracted from the revenue produced by that segment. The reasoning is that these variable and direct costs would disappear if the segment were eliminated, while all other costs (fixed and indirect) would continue and have to be absorbed by other segments. Moreover, any segment that produces revenues in excess of its direct and variable costs is making a contribution to profits by helping cover the organization's fixed expenses or common costs. In Table 13.13, we can see the essential differences between the full-cost and the contribution margin approaches to marketing costs analysis. Under the contribution margin concept, costs are categorized as either variable or fixed without regard to whether they pertain to manufacturing, marketing, or adminis- trative activities. Then all the variable costs are deducted from dollar sales to determine the segment’s contribution margin. a TABLE:13.13.. Marketing Profitability Analysis: Full-Cost Approach WaT wu Keay oe eet Less: Cost of goods sold Less: Variable manufacturing costs Equal: Gross margin Less: Other variable costs directly traceable to the Less: Operating expenses (including the market segment segment’ allocated share of company Equal: Contribution margin administrative and general expenses) _Less: Fixed costs directly traceable to products; Equal: Segment net income Fixed costs directly traceable to the market segment Equal: Segment net income Advantages of Contribution Margin. The trend in marketing profitability analysis favors the contribution margin approach, for two primary reasons. First, arbitrarily allocating fixed and indirect costs to segments merely confuses profitability analysis, since these costs continue even if the apparently unprofitable segments are eliminated. Second, the contribution margin approach considers the-interrelationships among marketing activities and the synergism of their efforts. One marketing activity, such as advertising, both benefits from and supports other activities such as personal selling or sales promotion. Similarly, one product in a multiproduct line helps promote the image and sell the entire line. We'll use the income statement for the CENTREX Company, depicted in Table 13.10, to compare the two approaches to allocating functional costs. As you can see in Table 13.14, the full-cost method shows product A suffering a net loss of $1,488 and product B earning a net profit of $682,154. From this analysis, management might decide to de-emphasize or even drop product A. However, the full- cost approach allocated $1,027,718 of administrative expenses on the basis of product A’s percentage of total sales ($5,287,141 product A sales + $11,466,683 total sales = .46 x $2,234,169 total administrative expenses = $1,027,718 product A administrative expenses). Thus, the arbitrary allocation of fixed costs was responsible for product A’s net loss. Switching to the contribution marginsapproach (sce Table 13.15) reveals that product A contributes $1,026,230 to covering totalSales Volume, Costs, and Profitability Analysis 359 see ali En eins eer TinMUoe ue aac Line 3 Full-Cost (YO : See TOA ; $11,466,683 $5,287,141 $6,179,542 Cost of goods sold 6.923.491 3.562.734 2:360.757 Gross margin $4,543,192 $1,724,407 $2,818,785 Expenses: Sales expenses $1,628,357 698,177 $930,180 Administrative 2,234,169 027,718 1.206.451 Total expenses $3,862,526 $1,725,895 $2,136,631 Net Profit (loss) $680,666 $(1,488) $682,154 ali TABLE-13.15 . CENTREX Company Income Statement by Product SS pT WED ps $11,466,683 $5,287,141 $6,179,542 Variable costs: Cost of goods sold 6,923,491 3,562,734 3,360,757 Sales expenses 1,628,357 698,177 930,180, Total variable costs $8,551,848 $4,260,911 $4,290,937 Contribution margin $2,914,835 $1,026,230 $1,888,605 Fixed cost Administrative expense $2,234,169 Net Profit $680,666 fixed administrative expenses of $2,234,169. If product A were eliminated, current total net profit of $680,666 would turn into a net loss of $345,564 because product B’s contribution margin would be insufficient to absorb the additional burden of administrative costs. Prégressive companies keep track of the profit contribution of sales regions and products on a monthly basis so timely marketing mix adjustments can be made. Determine Profit Contribution of Segments. Although some sales managers still avoid cutting costs because they fear sales will simultaneously decline, more astute sales managers want to identify unprofitable customer accounts, products, or territories that can be served less frequently o dropped. Unprofitable segments are endemic problems in virtually all sales organizations. In som companies, up to 50 percent of business elements lose money. Illustrating the concentration principle studies have found thawoften one-third of products, customers, orders, sales territories, and sales people account for two-thirds of profits. Studying profit contributions by segments invariabl rewards the sales manager far beyond the time spent in the analyses. ‘We can examine profit contributions by segments in two basic ways: (1) by individual segment or (2) by cross-classification of segments. When we study them individually, we examine segmen360. Sales Management categories sequentially; thus, the analysis may proceed from determining the profitability by one segment category, such as product class, and then move to territory or customer type, and so on until we have investigated all segments. In a cross-classification analysis, we relate one segment to or define it more specifically by other segments. For instance, the sales manager may want to know the profitability of product X, sold to customer B, in territory 2. In Table 13.16, we analyze the profitability of segments separately. All segments (products, terri- tories, and customers) appear profitable when examined one at a time. But when we conduct cross-classification analysis of the three segments in Table 13.17, we learn that product Y is losing money with customer A in territory 1, and product Y is yielding only a low-profit contribution with customer D in territory 2. An alert sales manager would probably want to probe further by requesting a cross-classification that includes a breakdown by salesperson as well. Without seeing the interrelationships of segment profitability as provided in a cross-classification analysis, a sales manager might erroneously assume that all the individual segments are profitable. HE een ace mau ee i $2,150, $710. Variablecosts.. 520-2340. -1,210«-1,650-.-540 Direct fixed -198 460 -308 -350 -138 costs Market 37 $155 $92 $150 $32 segment profit contribution SUP TERRTORY 1 Product X Customer A Customer B ‘Customer D sales 190 siz0 s310 Variable costs -15 3 -204 Direct fixed costs -32 86 Market segment profit contribution $15 sie s20 : TERRITORY 1 © STERRITORY2 < Product Y Customer” CustomerB. Customer C—-Customer D sales $520 780 $615 $1,080 Voriable costs ~425 ~507 -422 ~896 Direct fixed costs -97 138 =106 -9 Market segment profit contribution -82 sas $87 25 Underlying Problems+ : Merely determining that certain cross-classified segments are unprofitable is not sufficient. ‘The sales manager must next discover why. Have the salespeople been adequately motivated? Are they makingSales Volume, Costs, and Profitability Analysis 361 efficient and effective use of their time? Is the competitive situation in these segments unique? Are product quality, customer service, and warranties. satisfactory? Are prices competitive? How compatible and effective is the marketing mix supporting the field sales representatives? These plus many other questions should be asked and answered. As important as marketing profitability analysis is, it merely uncovers symptoms. It’s up to the sales manager to discover the specific underlying problems before attempting to improve profitability by making various decisions, such as dropping segments, changing incentive plans, retraining or firing salespeople, or altering the marketing mix. Sales managers should not hesitate to obtain the help of marketing research specialists to identify problems and recommend solutions for improved segment profitability. Return on Assets Managed (ROAM) Profitability analysis is invaluable for comparing sales productivity by segment with the cost of activ- ities performed to achieve those sales. Yet a critical financial management tool missing from profitability calculations is the total value of company assets (working capital in the form of accounts receivable and inventory) required to support the sales force functions. The return on assets managed (ROAM) by each segment of the business measures how productively the assets have been employed. We avoid using the term return on investment (ROI) here, since it usually refers more narrowly to capital investment (non-current assets) and owner’s investment (net worth or equity capital). As shown in Table 13.18, ROAM is the product of the profit margin on sales (net profit/sales) and inventory turnover (sales/toral assets). A EUTERERE eeu ceca kue csen ie uey cs eeeeen ROAM = _netprofit” 4 sales sales total assets used When applied to segment analysis on the basis of the contribution margin, the formula becomes: segment ROAM = Contribution margin segment sales = ‘segment sales additional assets, used by the segment $1,026,230 $5,287,141 _ 9 gor 46 ROAM = A x $5,287,141 ~ $11,257,387 - Using the data in Table 13.15, we can compute ROAM for product A (see Table 13.18)Assume product A required an investment in accounts receivable of $2,493,889 plus an inventory of $8,763,498 (for total current assets of $11,257,387) in order to achieve its sales of $5,287,141 and its contribution margin of $1,026,230. By substituting these figures in the formula (see Table 13.18), we derive a ROAM of 9.12 percent. Despite the obvious usefulness of ROAM calculations, one study found that only about 1 of 10 industrial firms regularly use the tool, although nearly one-third analyzed profitability by customer, salesperson, and territory.) One criticism aimed at the ROAM approach is that it tends to neglect the opportunity costs for capital invested in the assets.!” Nevertheless, the most successful sales managers of today and tomorrow may gain a winning edge on other sales managers (in the eyes of superiors) by conducting marketing, profitability analyses by market segments and making full use of ROAM.362 Sales Management Improving Return on Assets Managed. To increase the return on assets managed for specific segments, the’sales manager has three options: (1) to raise the profit margin on sales, (2) to increase total sales. while maintaining profit margins, and (3) to decrease the relative dollar value of assets necessary to achieve sales. Raising the profit margins on sales requires the sales manager to conduct profitability analyses by segments to identify those that are yielding inadequate contribution margins. Then, he or she must decide to de-emphasize or eliminate efforts in these segments. Increasing total sales while maintaining profit margins on sales requires the sales manager to seek more effective and efficient marketing mixes, so that the sales organization operates near its minimal average costs per unit of sales (as discussed earlier in this chapter). Market testing, under reasonably controlled conditions, may be necessary to find this optimal mix of headquarters and field marketing efforts. Therefore, it is vital for sales managers to include on theit sales department staff a marketing research specialist who works closely with the headquarters marketing research department as well as with the field marketing representatives. Decreasing the assets needed to obtain sales requires sales managers to cooperate with inventory managers to find that optimal trade-off between inventory levels and out-of-stocks. Both sales managers and accounting managers need to monitor the level of accounts receivable to ensure they remain within predetermined standards. INCREASING SALES FORCE PRODUCTIVITY AND PROFITS Revolutionary and evolutionary changes in analytical software and telecommunications technologies are helping sales managers in.their unrelenting efforts to lower selling costs and increase sales force productivity,!® and the possibilities for the future seem virtually unlimited.’? With increasingly sophisticated software tools, the sales department and other functional areas (marketing, accounting, finance, operations) throughout a company can work synergistically to identify unprofitable market segments and take timely corrective actions that will significantly increase profits. To motivate him to regularly conduct in-depth sales volume, marketing costs, and profitability analyses, one sales manager keeps a plaque on his wall with Benjamin Franklin's famous quote: “A penny saved is a penny earned.” A REVIEW AND APPLICATION QUESTIONS 1. Define a sales audit, and explain the four areas that constitute a sales force organization audit. 2. Identify arid describe some sources and types of sales information that can be used for conducting a sales volume, marketing costs, and profitability analysis. What is the need to conduct these analyses? 3. How might the sales manager obtain greater cooperation with the accounting manager or marketing controller? Do you think sales managers have a communication problem in dealing with accounting managers? Explain. 4, Why has accounting generally focused on production costs instead of marketing costs analysis? 5. Do you think that we will ever develop standardized costs for marketing activities? Why or why nov? 6. Discuss the benefits of conducting a sales volume, marketing costs, and profitability analysis. 7. Which side of the controversy between full-cost and contribution margin approaches to allocating marketing cost’ do you%Support? Why? 8. Why aren't more sales managers concerned about their return on assets managed (ROAM)? What would you suggest to increase their use of ROAM?Soles Volume, Costs, and Profitability Analysis 363 CASE 13.1 a Pasta Company: The Value of Financial Reports Fab The Fabrizia Pasta Company was started in 1999 by Anthony (Little Tony) Columbo in Hackensack, New Jersey. Little Tony had previously worked for Mama Corlini’s restaurant for six years as an assistant to the chef and was promoted to head chef after three years. As head chef for Mama, Little ‘Tony received many awards for his pasta and sauces and had several newspaper articles written about him. In fact, he became a local celebrity in the restaurant business in the Hackensack area, and many of his friends and family members believed he should start a business to market his pasta and sauces. After considering it for a couple of years, Little Tony quit his job and put all his savings into the Fabrizia Pasta Company. At first Little Tony concentrated his efforts on establishing his business on a regional basis. He made all the pasta and sauces himself, while his brothers Vinnie and Franco called on grocery stores and supermarkets in the New Jersey and surrounding East Coast area. Sales of Little Tony's pasta and sauces were better than anyone expected. Many of the grocery store managers who purchased the pasta were quite taken by his products and suggested that Little Tony sell them to national super- market chains. Within two years after Little Tony started the company, his pasta and sauces were being sold in all of the forty-eight contiguous states. Over the years Little Tony added several new sauces and related product lines to his menu of Products. A line of pizzas, olive oil, spumoni, and spices soon carried the “Little Tony's” trade name. By 2007 Little Tony had sixty-two employees, including twenty-eight salespeople and three regional sales managers. Gino Biagio had been one of the three regional sales managers for the past five years, and when Little Tony decided he needed a national sales manager he picked Gino. The first month on the new job went smoothly as Gino traveled through the other two regions to introduce himself. Bur after returning to the home office, Gino began to realize being national sales manager involved a lot of paperwork and required him to spend much more time in the office as well as in scheduled and unscheduled meetings. He did not like the paperwork or the time in the office, but he knew being national sales manager required him to grasp the “big picture” and to prepare and understand numerous reports. At the end of the first three months, Gino received several reports from Fabrizia’s financial department summarizing quarterly sales and profits (see Table 1). In reviewing these reports, Gino saw that two of the company’s regions have earned healthy net profits for the quarter, but the Midwestern region has a net loss of $40,269. Sales in the Midwestern region were $2.1 million less | EEE “227 REGION’ $8,697,328 $6,543,121 $9,214,864 Sales Variable costs: Cost of goods sold 5,128,540 5,210,533 6,420,432 Selling expenses 1,233,457 1,025,732 1,072,117 Fixed costs: Administrative expenses 433,163 347,125 416,274 Total costs * —* $6.795.160 $6,583,390 $7,908,823 Net Profit * $1,902,168 (40,269) $1,306,041Neen 364 Sales Management than those in the Eastern region and nearly $2.7 million fess than those in the Western region. Yet selling expenses clearly were too high in the Midwestern region Ninety percent of sales force compen xeon wes straight salary, and Gino remembered that the Midwestern ©2100 had a lot of senior salespeople who were highly paics Unless the compensation syste changed, there wasn't much Gino eld de about selling expenses in the region. One way to solve the problem might be siiply to close cen idwestern sales region. It certainly did not make sense to keep losing money there. Gino ine dered what the impact on the company would be if the Midwestern region were shut down. vnnother financial report dealt with sales and profits by product in ‘each region (see Table 2). The company grouped its products into two basic categories: pasta and other products. This report saonpd that the only unprofitable product was pasta sold in the Midwestern region. Again, Gino syonered what would happen to overall company profits if pasta were dropped in the Midwestern region. if Pasta Products Sales $5,362,192 ' $3,335,136 Variable costs: ; Cost of goods sold 3,347,134 1,781,406 Seling expenses 703,118 530,339 Fixed costs: "administrative expenses 245,791... 187.372 Total Costs $4,296,043 $2,499,117 Net Profit $836,019 Variable costs: Cost of goods sold 3,060,050 2,150,483 Selling expenses 678,694, 347,038 . Fixed costs: ‘Administrative expenses -«*189,987,—357,138 Total Costs $3,978,731 $2.654.659 Net Profit . ($316,285) __ $276,016 REGI Sales $3,791,347 Variable costs: Cost of goods sold 4,003,862 2,416,570 Selling expenses: 621,664 450,453 Fixed costs: ‘Administrative expenses 250,123-—_—*166,151 ral Costs $4875.52 $3,033,174 Net Profit, $547,865 $758,173Sales Volume, Costs, and Profitability Analysis. 365 While looking at several other reports provided by Fabrizia’s financial department, Gino was drawn to one that showed each region's investment in inventory and accounts receivable (see Table 3). He was not sure what to do with this report, but he was extremely surprised to see how high accounts receivable and inventory were. Overall, Gino recognized there were problems; but being new in this job, he was not sure how to analyze the data or what to do. Pasta Products Accounts Receivable’ $3,120,449.» °'$1,872,312' entoi ~ Accounts Receivable Inventory eee eelest ‘Accounts Receivable $2,311,483 Inventory 8,421,677 7,120,432, QUESTIONS 1. What else besides high selling expenses might be contributing to the Midwestern region’s problems? 2. What corrective action might Gino take, given the information provided in the reports? 3. Should Gino drop the Midwestern region? Or stop selling pasta in this region? Justify your recom- mendation. 4, What other financial reports should Gino request from the financial department to better under- stand the situation? Explain. Case prepared by Mark Leach, Loyola Marymount University. ENDNOTES Gary S. Tubridy, “Stay on Top of the Bottom Line!” Sales & Marketing Management, May 1990, pp. 56-60. 2 Jerome A. Colletti and Mary S. Fiss, “The Ultimately Accountable Job: Leading Today's Sales Organization,” Harvard Busimss Review, July-August 2006, pp. 125-31. Artur Baldauf, David W. Cravens, and Nigel E. Piercy, “Sales Management Control Research—Synthesis and an Agenda for Future Research,” Journal uf Personal Selling & Sales Management 25 (winter 2005}: 7-26. 4. Erin Anderson and Vincent Onyemah, “How Right Should the Customer Be?” Harvard Business Review, July-August 2006, pp. 59-67; Eric Fang, Kenneth R. Evans, and Timothy D. Landry, “Control Systems” Effect on Attributional Processes and Sales Outcomes: A Cybernetic Information-Processing Perspective,” » Journal of the Academy of Marketing Science 33, n0. 4 (2005}: 553-74; David W. Cravens, Felicia G. Lassk, George S. Low, and Greg W. Marshall et xl., “Formal and Informal Management Control Combinations in Sales Organizations: The Impact on Salesperson Consequences,” Journal of Business Research 57, no. 3366 Soles Management 10 uw 13 14 15 16 17 18 19 (2004): 241-48; Charles H. Schwepker Je. and David J. Good, “Marketing Control and Sales Force Customer Orientation,” Jounal of Personal Selling & Sales Management 24 (summer 2004}: 167-79. Dianne Ledingham, Mark Kovac, and Heidi Locke Simon, “The New Science of Sales Force Productivity,” Harvard Business Review, September 2006, pp. 124~33. Alan J. Dubinsky and Richard W. Hansen, “The Sales Force Management Audit,” California Management Review 24 (winter 1981): 86-95, Ledingham et al., “New Science of Sales Force Productivity.” See, for example, Bulent Menguc and Tansu Barker, “Re-Examining Field Sales Unit Performance: Insights from the Resource-Based View and Dynamic Capabilities Perspective,” Evropeat Journal of Marketing 39, no. 7-8 (2005): 885-909; Robert A. Howell and Stephen R. Soucy, “Customer Profitability—As Critical as, Product Profitability,” Management Accounting, October 1990, pp. 43-47; Fred Selnes, “Analyzing Marketing Profitability: Sales Are a Dangerous Cost Driver,” European Journal of Marketing 216, no. 2 (1992): 15-26. Mark W. Johnston and Greg W. Marshall, Churchill, Ford, and Walker's Sales Force Management (New York: McGraw-Hill/Irwin, 2006); T. N. Ingram, R. W. LaForge, R. A. Avila, and C. H. ‘Schwepker et al., Sales Management: Analysis and Decision Making (Mason, OH: Thomson South-Western, 2006); T. N. Ingram, R. W. LaForge, W. B. Locander, and $, B. MacKenzie et al., “New Directions in Sales Leadership Research,” Journal of Personal Selling & Sales Management, (Spring 2005): 137-54. Ledingham et al., “New Science of Sales Force Productivity.” Artur Baldauf, David W. Cravens, and Nigel F. Piercy, “Sales Management Control Research—Synthesis and an Agenda for Future Research,” Journal of Personal Selling ¢ Sales Management 25 (winter 2005): 7-26; Donald W. Jackson, John L. Schlachter, and William G. Wolfe, “Examining the Bases Utilized for Evaluating Salespeople’s Performance,” Journal of Personal Selling & Sales Management 15 (fall 1995): 57-66. For more insights on marketing costs analysis, see Lisa M. Ellram, “Activity-Based Costing and Total Cost of Ownership: A Critical Linkage,” Journal of Cost Management (winter 1995): 22-30. See B. Rosenbloom, Marketing Channels: A Management View (Mason, OH: Thomson South-Western, 2004). Ledingham et al., “New Science of Sales Force Productivity.” For further insights, see Robin Cooper and Robert S. Kaplan, “Profit Priorities from Activity-Based Costing,” Harvard Business Review, May-June 1993, p. 130; Raghu Tadepalli, “Marketing Control: Reconceptualization and Implementation Using the Feedforward Method,” European Journal of Marketing 26, no. 1 (1992): 24-40. Donald W. Jackson, Jr, Lonnie L. Ostrom, and Kenneth R. Evans, “Measures Used to Evaluate Industrial Marketing Activities,” Industrial Marketing Management 11 (October 1982): 269-74. “William L. Cron and Michael Levy, “Sales Management Performance Evaluation: A Residual Income Perspective,” Journal of Personal Selling & Sales Management 7 (August 1987): 57-66. Ledingham et al, “New Science of Sales Force Productivity”; Earl D. Honeycutt, “Technology Improves Sales Pérformance—Doesn’t It? An Introduction to the Special Issue on Selling and Sales Technology,” Industrial Marketing Management 34, no. 4 (2005): 301-4. This section also draws heavily from Rolph Anderson, “Personal Selling, and Sales Management in the New Millennium,” Journal of Personal Selling Sales Management 16 (summer 1996): 17-32. Gary K. Hunter and William D. Perreault Jr, “Sales Technology Orientation, Information Effectiveness, and Sales Periormance,” Journal of Personal Selling & Sales Management 26 (spring 2006): 95-113; Devon S. Johnson and Sundar Bharadwaj, “Digitization of Selling Activity and Sales Force Performance: An Empirical Investigation,” Journal of the Academy of Marketing Research 33, no. 1 (2005): 3-18; Ko Dong-Gil and Alan R. Dennis, “Sales Force Automation and Sales Performance: Do Experience and Expertise Matter?” Jounal of Personal Selling & Sales Management 24 (fall 2004): 311-22. Michael Ahearne, Ronald Jelinek, and Adam Rapp, “Moving Beyond the Direct Effect of SFA Adoption on Salesperson Performance: Training and Support as Key Moderating Factors,” Industrial Marketing Management 34, no. 442005): 379-88; Michael Ahearne, Narasimhan Srinivasan, and Luke Weinstein, “Effect of Technology on Sales Performance: Progressing from Technology Acceptance to Technology Usage and Consequence,” Journal of Personal Selling & Sales Management 24 (fall 2004): 297-310. Dubinsky and Hansen “Sales Force Management Audit.” Colletti and Fiss, “Ultimately Accountable Job.”