TOPIC 2- STRATEGIC ANALYSIS AND BUDGETING

STRATEGIC MARKETING ANALYSIS AND BUDGETING

Marketing is all about the consumer and competitors all the time.

Marketing had only been around for 60 years. Before the Marketing emerge: it is known to be:

1. The production Sales Era- before the WW2

a. Production oriented Industry- sources and supplies of goods were limited. Usually the
source of the goods came from England. Customer demands were relatively
unsophisticated (less freedom of choices). Limited competition meant that goods were
generally bought and not sold.
b. Production dealing in such products were termed to have a “Sales Orientation” means
that people come to the store and seller push the product.

Marketing Myopia by Theodore Levitt

- Marketing was short sighted

- It puts the entire discipline of marketing
- Coined the word Globalization
- Look at what business are you in, the mission and vision

2. After WW2, Levitt come with the new Marketing Concept

a. Marketing Oriented Industry- competition intensified, more attention paid to needs of
customers (start with customer and work towards product)
b. People in such industries were termed to have a “marketing orientation”

Simply, the goods produced in production oriented industry is focused on giving the best product that
they fail to see that it isn’t what the consumer wants, as the new marketing concept emerge, it is not all
about the quality but also the convenience that it could bring to the consumer that is why even with the
less quality, people will entertain it because it aid their short problems and bring such convenience.

STEPS IN THE MARKETING CONCEPT

1. Define the customer needs (Marketing Research required)

o How are the products bought? Who is doing the buying? Why do people buy?
2. Define the Target Segments
a. Broad market (size, growth rate vs. company capability). Distinguish the market
segment (similarity of needs)
b. Economy = Income Function = Use Quality = Taste Use = Image
c. This is known as Psychographic Segmentation
3. Create a differential Advantage (Competitive Advantage) the advantage is about finding the
customers geographic, demographic, and psychographic. In means of differential, company
must see the competitors and check their product, price, promotion, and place {physical
distribution})
 o Process of creating a monopoly for the company and use of marketing mix variables “4
Ps)
4. Formulate Company’s Competitive Positioning Strategy
a. Look at all possible “differential advantages” and make a choice of exactly where it
hopes to specialize in. This will depend on the company’s production market
combination.

Product Life Cycle (PLC)

- In Research and Development, you will only gain negative profit or losses.
- Introduction,
- Growth- Accountants use cost value profit approach marginal testing for short term decision
making.
- Maturity
- Decline, market stretching happens like market development and product development

5. Strategic Focus of the Product-Market Mission

a. The main decision that marketing does is whether to aim for increased productivity or
increased volume. Its clear-cut Financial Implication.
b. Increasing productivity, this decision is usually required for existing products.
Productivity increased may be done through increasing prices, improving sales mix, or
reducing costs.
c. Increasing volume, this decision could pertain to both existing and new products. The
main volume-growth alternatives for achieving long-term profitability are given in the
following model:

New market Market development Diversification

Present markets Market production Product development
Present Products New products

Strategic Focus of Present Products

a. The strategic focus shifts along with the PLC.

a. As the focus shifts- the various combinations of the marketing mix must also change.
b. Usually the focus shifts from left to right as one moves from one stage of the life cycle to
the next.
THE FINANCIAL DIMENSION OF MARKETING PLANNING

1. The factors that affect “profitability” in a business

a. Extending the learning curve phenomenon- if costs decline predictably with units
produced, the competitor who has produces the most units will probably have the
lowest costs. Since products of all competitors in a certain segment have about the
same market price—the competitor with the most “unit experience” should enjoy the
greatest profit (Thus highest ROI)
b. Hypothesis: There is a close relationship between market share and profitability.

- The hypothesis has been accepted as a result of Profit Impact Marketing Strategy (PIMS) Study.
o ROI goes up steadily as market shares increases

2. The “Maximize-Market Share” Goal

a. For the controller, the implications of the PIMS Study seem to be… “Forget all controls
initially and allows the new product manager to go for market share at all costs.”
b. If done incorrectly,
i. investment in market share generally requires large cash resources- such cash is
usually “internally generated” therefore it must have balanced product portfolio
i.e. have cash generating products that are able to finance new products that
are usually cash absorbers.
ii. The nature of the competition and the structure of the market must be
considered- it is easier to obtain leadership in a growth market than take it away
 from someone who owns it in a non-growth market, e.g. if a company maintains
volume when the market is growing will actually be losing market share
c. Before segment managers go about blindly seeking “maximum Market Share” the
controller must make them aware of the relationship between:
i. Market shares
ii. Market growth
iii. Cash flow
d. The relationship is very clearly displayed in a chart that is known as “The product
Portfolio Matrix”

Market Growth High Problem Child (cash Star (Cash Absorber

Rate absorber) or Cash generator)
Low Dog (modest cash Cash cow (large
generator or cash generator)
absorber)
Low High
Market Share Relative to Largest Competitor

Invest money on a product that has a potential to be a stock—something different from

the competitors. Don’t invest in your weakness but rather pour it in the strength.

BUDGETING FOR MARKETING ACTIVITIES

- Segmental Direct Costing there is a large amount of marketing costs which one has to regard as
“uncollectible indirect overhead,” because they are not objectively allocable to marketing
segments.
- Traditionally, accountants arbitrary (or subjective) bases of allocation. These bases are often
volume based. In other instances, the cause-effect relationship may be questionable.

Steps:

- Map “natural expenses” into “functional expenses”

- Assign functional expenses to marketing segments
o Start with lowest level segment
o Attach only if expensed fully for that level (direct)
o Allocate only if there is a cost driver at that level (indirect)
o If not, see if they attach/ allocate at next level

THE MARKETING BUDGET MODEL (FOR SALES SEGMENTS)

- This is a multiple regression formulation incorporating

o Product and customer related variables and constant representing attachable/ allocable
fixed cost.
POINTS TO NOTE

- This is based on the Economic Value Added (EVA) or Residual Income approach.

Performance Evaluation

ROCE (ROI) = Profit Return/ Investment (Capital employed) the sum will be compared to the cost
of capital and see if it is profitable or not.

Return
Less: Cost of Investment x Weighted Average Cost of Capital
Residual income (EVA)

- Thus, a charge for Cost of Capita; is levied against the segment. This includes variable Cost of
Capital (Debtors; Stock) and Fixed cost of Capital (fixed Assets)
- Accountants should know that Promotion cost is different from any other cost because
Promotion cost is demand creating. That is why promotion cost should be treated as separate
demand because other cost like transportation and such are all supplied. Buyer supply to the
consumer, but through the Promotional Cost, one is bringing customer to the company.
STRATEGIC BUSINESS ANALYSIS
TOPIC 3: FINANCIAL ANALYSIS IN PRODUCT PORTFOLIO MANAGEMENT

FINANCIAL ANALYSIS IN PRODUCT PORTFOLIO MANAGEMENT

Product Management and Life Cycle
- Project management is an ‘on-going’ activity: from the collection of ideas for new products to
the maintenance of existing product or the abandonment of products from the range.
- The two divisions of Product Management
o New Product Development (NPD)
o Current Mix – maintenance and abandonment.
- These divisions must be considered as products proceed through what is known as a “Life Cycle”

The financial aspects of the product line

1. Is the sales volume of the product (or product line) rising or falling?
a. This depends on the product’s life cycle and the stage in the “Product Portfolio” of the
organization
b. Products losing money and past their peak, it should be put to sleep quickly.
c. Variety reduction should be the key word (80/20 Rule)
d. ABC Costing System with Customer-Product Profitability Analyses could be used.
2. is the product making profit?
a. To answer, a company should have adequate product line cost information.
b. Marketing Oriented Reports (using ABC and Segmental Contribution Report)
i. Provide action-oriented information
ii. Resist temptations by the managers with poorly performing products to put
forward arguments that a product is under/over costed.
c. Another popular argument put forward is that it is a product line that the company has
had for years and that if a few changes in the mix were done it would again start making
money.
d. If a product cannot offer a distinct differential advantage, it is better to abandon it than
spend limited resources trying to revive it.
3. What are the product contributions of the different products? (important for short-term
decision making) (Selling Price minus Variable Cost)
a. If product contributions are low, considered increasing selling prices.
i. If this is not possible, there is a long upward struggle to improve operating
efficiency (i.e., Porter’s Cost Leadership Strategy). Because while a company
battles to reduce manufacturing costs, it can be sure that the competitors are
ploughing the field too.
b. A company’s hard-won improvement may only keep it from losing more ground.
c. If the contribution of a product (that is not into a low-contribution industry) cannot be
improved, it is better to abandon the product.
4. Is the Sales Department determining the pricing?
a. If the Sales Department dictates the price, then almost certainly, the prices are bound to
be too low.
 i. Salesmen rarely believe that they can get a higher price for the product until
they are told by the management that they have no choice.
ii. Consumer will pay more with little or no complaint—despite all the salesmen
warning that to raise price is suicide.
5. Does your Sales Program, offers a wide variety of options and extras?
a. Customized always cost more (i.e. adds to the Cost Complexity)
b. Unless the volume is large enough (so that economies of scale can be realized) they are
certain to lose far more money than the cost analysis show.
c. This is due to the increasing complexity such products bring (this is the reason for
introducing ABC Systems)

THE FINANCIAL ASPECTS OF THE PRODUCT LIFE CYCLE

1. The Pre-Lunch Phase

o The important characteristics of this plan are: It suggested that it would be useful to
classify costs into five categories (table). Costs are usually incurred with the expectation
that the primary economic benefits will be derived in future periods.
o There are huge costs involved in this phase
 First, there is a cost of maintaining a new product development and research
and development team.
 Seconds, there is a cost marketing research.

Table 1: Financial Aspect of the Pre-Lunch Phase

Phase
Determination Bases
Product Evaluation
Cost Classification
Some Characteristics
Some Budget Considerations
1. Clear Definition
2. Clear description of elements of identifiable cases
3. Capitalize or Expense Decision
1. Individual
2. Industry Guidelines
1. Importance to terms of usefulness?
2. Viability in the market place?
3. What is the expected benefit?
4. How much will it cost to develop?
5. Target Costing and Value Engineering Considerations
1. Basic Research
2. New Product Development
3. Product Improvement
4. Cost and Capacity Improvement
5. Safety, Health, and Convenience
1. Incurred with the expectation that primary economic
benefits will be derived in future periods.
2. Concerned with improving or developing future
benefits for itself.
1. Discounted net future cash flow equals future gain
2. What is the source of Capital? (Cash cow; loans; new
issue)
3. Capital Equipment—what should be used during;

Marketing Strategy
what should be done with it after?
4. Ongoing research; technological changes
1. Examine needs of the market and find means to
satisfy it
2. Establish market potential through salespersons

o Risk and Uncertainty

 The difference between a ‘risk’ situation and an ‘uncertainty’ situation.
  In the former situation (risk) a company has the experience to assign
probabilities to future events.
 In the uncertainty, it does not have the experience to do so.
 This type of situation (i.e. risk or uncertainty) that a launch of a particular
product would bring about depends on the position of the product on the ‘new
products classification chart’
Figure One: Classification of New Products by product objective
Increasing Technology Newness
No Technological Improved New
Change Technology Technology
Increasing No market Same (1) Reformation Replacement
Market Change (2) (3)
Newness Strengthened Remerchandisin Improved Product Line
Market g (4) Product (5) Extension (6)
New Market New Issues (7) Market Diversification
Extension (8) (9)

Ansoff Model
Products New Product Development Diversification
Existing Market Penetration Market Development
Existing New
Market (Customers)

 If the new product is in categories of 1, 2, 4 and 5, this means that the company
has some relevant experience in both the market and technology of the new
product.
 Hence, it most probably will be able to assign probabilities to the possible
outcomes of such launch (i.e. a risk situation)

o Making Decisions in Risk Conditions

 The ability of the marketing manager to assign probabilities, indicates that this is
a risk situation.
 The accountant can therefore use the concept of expected value to help the
marketing manager to make the required decisions.
o Making Decisions Under Uncertainty Conditions
 For products in categories 6 and 8, it is unlikely that the marketing manager will
be having adequate previous experience to assign probabilities to the various
possible states of nature.
 Therefore, the pay-off matrix will not contain any probabilities
 This is then an uncertainty situation and the accountant have three
available criteria to apply to the pay-off matrix
 The first criteria assume that the worst outcome will always come about.
Therefore, the alternative is to select that which gives the largest minimum
 payroll. The philosophy behind this reasoning is that the actual outcome can
only be an improvement.
 The second criterion, that of ‘Optimism Maximax’ is the converse of the above
and is based on the assumption that the best payroll will result from the
selected strategy.
 The last criterion is that of ‘regret’. This is based on the fact that, having
selected strategy that does not turn out to be optimal one, the decision marker
will regret not having chosen another strategy, when he or she had the
opportunity. Under this criterion, one must first draw a ‘regret matrix’. This is
done for all states of nature and the ‘regret totals’ are added. The choice is the
product with the least regret total.

3. (2) The Introductory Phase

Table Eight: Financial Aspects of the Introductory Phase
Product Evaluation 1. Limited number of models
2. Attention on quality control
Cost Characteristics 1. Losses Anticipated
Some Budget Considerations 1. Enough funds to create widespread awareness
2. Much personal selling—requires extra funds
3. High Advertising Expense (if consumer product)
4. Product giveaways; reduced prices; trade discount
5. Estimate actual fixed cost
6. Determine contribution to fixed cost after removing
variable costs
Distribution 1. Limited; Exclusive; Selective
2. Move towards heavy inventory at all levels
Marketing Strategy 1. Heavy Promotion
2. Use emotive factors
3. Strengthen brand preference
4. Inform as many market segments as possible

3. The Growth Phase

The following are the important financial characteristics of this phase.

Table Nine: Financial Aspects of the Growth Phase

Product
Cost Characteristics
Some Budget Considerations
Marketing Strategy
1. Differentiate product in terms of quality, design
performance, durability, packaging, and distribution.
1. Short-term
2. Heavy emphasis on the contribution approach
particularly to spot rapidly trends by segment
(Profits or Losses)
1. Promotion expense gets progressively lower per unit
2. Highest stage of distribution costs as new channels
is opened
1. Determine maximum level of sales that will be
reached during next (maturity) stage.
 2. Program investment schedule for the future
3. Estimate price that covers cost and meets
competition
4. Improve product and offer services.

5. (4) The Maturity Phase

Important financial characteristics of this phase

Table Ten: Financial Aspects of the Maturity Phase

Some Budget Considerations
Cost Characteristics
Marketing Strategy
1. Advertising expenses to hold market share
(minimum)
2. Cash Cow; use to finance new products
3. Reinvest considerations (if consumer products)
4. If differentiation is possible and could extend the life
of the product, capital investment would increase in
he short and possibly long run.
5. If differentiation is not possible, no capital
investment should be made
6. Cash generation ability depends on market share
1. Distribution costs minimum
2. Product cost depend on “Experience Curve”
1. Intense competition for market share
2. Price Competition
3. Hold market share

4. (5) Decline Phase

o It is the real art to be able to know when to withdraw a product from the market.
o Many companies are reluctant to phase out yesterday’s breadwinners:
 Sometimes due to not recognizing the situation
 Sometimes due to sentimental reasons
o Shrinking the number of “dog” products or product lines is, however, usually the surest
route to better profit and higher return on investment. Therefore, it is vital to obtain
some indication of the point at which we began to enter the decline of the life cycle.

Table Eleven: Financial Aspects of the Decline Phase

Problems 1. Determine proper amount of promotional costs to allocate
product
2. Determine whether or not to expand research and
development funds on product in order to extend effective life
ore terminate entirely.
Cost Characteristics 1. If cash flow would be negative in both long- and short run-, the
product should be considered for deletion.
2. Sales and profit declining
3. Cost increasing to stimulate sales
4. Consider opportunity costs
Distribution 1. Concentrate on market segments that are easy to reach
 (focus)
2. Choose one of three
- Continuation
- Deletion (reduce costs of complexity)
- Milking

PRODUCT ABANDONMENT APPROACHES (PRODUCTS IN DECLINE PHASE)

o Product Review Team- it has been suggested to appoint a high level and broadly
representative management team which holds meeting at least once a year (or more
frequently depending on the industry): to set objectives and procedure for identifying
weak products, to evaluate them, and to develop a phasing out program for product
pruning.
o Contribution to resource ration- this approach has been proposed to assist in product
abandonment decisions. A fully developed and up-dated cost accounting system (ideally
based on ABC principles) is the critical requirements for such an approach. It also relies
heavily upon marketing performance data for its inputs. Only cost and revenues for
which an acceptable cause-effect’ relationship can be found or are directly associated
with the product or sales of specific product are considered relevant to the analysis.
Therefore, segmented analysis based on the residual income (EVA) approach is
appropriate for such.
 The basis for product comparisons is a Contribution to Resources Ratio which
can be expressed as follows
GRR= (Net contribution of Product A + Contribution of All Products)
GRR= (Use of resources by Product A + Use of Resources by all Products)
o Anything that is less than one is initially abandoned.

METHODS OF DROPPING PRODUCT LINES

o Sell of the line to a competitor, or someone who wants to get into their business.
 If this is not possible, one can stop making it.
 Another alternative is to put effect a large, across the board price increase. If
the line has been grossly underpriced, one may not lose much business, and
may have turned a bad line into a good one. Even if most sales are lost, a few
may continue to buy for a while; thus, enabling one to favorably dispose off
one’s inventory.

CONSEQUENCES OF DROPPING A PRODUCT LINE (COST VS. BENEFITS)

o The loss of contribution (if any), because sales volume has dropped, however, a number
of hidden benefits accrue:
 The debtors in that line turn to cash
 The purchase of raw materials and direct labor is stopped and this saves more
cash.
 The personnel working on the line are transferred or made redundant (except
those needed for the final salvage operation), saving more cash.
 The total operation become less complex and more savings happen
  The machinery may be sold, for second-hand value or scrap and both cash and
space are freed.
PACKAGING
The promotional aspects of packaging are important.
o Aspect of Packaging
 Packaging should be treated as an essential part of product development. Since
the pack has more significance than being merely a means of enabling a product
to be transported from the point of manufacture to the point of sale.
 Along with the product features, packaging and after-sales service feature at the
top of the order of marketing decisions, and these all form part of product
management.
o Three aspects of packaging: Functionalism, Convenience, and Image.
o The first two aspects are physical and the third is promotional.
o Of the physical aspects, Functionalism merely packs a product safely, while convenience
takes the following factors into account:
 Opening and closing case
 Size, shape, and storability
 Adequacy of instructions
 Ease of carrying
 Subsequent use of container for storage
 Ease of disposal
o The Promotional or image aspects of packaging are equally important as the
convenience aspects. This centers around the ability of the package to attract the
customer’s attention. This is especially important in the case of packaged food stuffs and
other frequently purchased items which retail in supermarkets and self-service stores.

o Cost Aspects of Packaging, the controller must be aware of the costs and economic
factors of package:
- material cost
- impact of storage
- Distribution cost
- Allowance or refunds for returned containers and damaged packs
- risk associated with trends (in materials, methods, machinery, marketing
requirements)
- designing and testing costs.

o After Sales Services

TOPIC 4: PRICING METHODS AND STRATEGIES

- The importance of the Pricing Decision

o The conventional marketing accounting link
 The pricing is the conventional marketing accounting link.
 The traditional accountant helps the pricing decision by quoting manufacturing
and selling costs (i.e. Cost of Goods Sold)
o But this is never enough for proper marketing decision because; it fails to consider
customer reactions to different price levels and how these reactions affect the
customers decision to buy or not to buy.
o Prices must be reasonable; in order to maintain a sales level against competition and yet
yield a satisfactory profit as well.
o Pricing policies must seek to reconcile these conflicting needs
o Pricing decision is thus a complex one and mistakes can be difficult to rectify.
o The internal lower limit in the short run may be marginal cost (but not always)
o However, the upper limit is set by the multitude of external factors such as:
 The value of the product to the buyer
 Range of buyer choice
 Number of buyers and sellers in the market
 Degree of buying skill
 Substitute available
 Image of the product
o All these may be represented in the economic concept of the elasticity of demand.
o Further, the government influences also have to be taken into consideration

PRICING METHODS

1. Cost-Plus Pricing; you find the cost it will put up the profit margin.
2. Target Pricing= Cost + % rate of return (ror)
o This is more sophisticated version of cost-plus pricing and takes into account:
 The volume fluctuations
 Cost of capital involved in the business
o This method fixes a definite ‘rate of return’ on an investment for a certain period.
o To fix this, one must be able to forecast for the particular period:
 Sales level (a knowledge of the product’s life cycle is needed for this)
 The average cost during that particular period.
o However, target rates of return prices are still based on internal costs and not on the
market thus taking very little account of competition.
3. Competitive Based Pricing
 oThis is basically “fixing a price that slots into the market’s competition”, thus external
factors are specifically considered.
o This method is needed in highly competitive markets where price sensitivity is so great
that anyone moving above the going rate is likely to go bankrupt.
o There are two-sub methods in competitive based pricing
 Head-on pricing where the prices is set exactly at that which the competition is
offering.
 Percentage Differential Pricing, where one bases one’s own price on a
percentage difference (higher or lower) from that of some level of competition.
o In normal conditions, this method becomes very mechanistic and does not allow
managers to:
 Build on their product’s unique strength
 Adjust for their unique weaknesses
o The problem period, is when one needs to change the price of a product for reasons
other than those caused by competition, such reasons may be
 Increased cost
 Low market penetration
4. Customer (Value) Based Pricing
o A product may have several different values
 Cost Value; which is the sum of all the costs incurred in providing the product
 Exchange Value; which is the price a purchaser will offer for the product. This is
the conventional purchase price, and it can be assumed to be sum of two parts
 Use Value; which is the price the purchaser will offer in order to ensure
that the purpose (or function) of the product is achieved.
 Esteem value; which is the priced offered for the product beyond the
use of value.
 Profit = Exchange Value – Cost Value
 Exchange Value = Use Value + Esteem Value
 Cost value; customer perceives are very diverse, this include:
 Clearly defined acquisition costs such as the seller’s price: incoming
freight: installation and order-handling costs
 The less clearly defined cost such as the risk to the customer of product
failure, the fear of late or inaccurate delivery; the fear of custom
modification after receipt of item.
 Use Value; this is subjective judgment and will differ depending on the decision
maker.
 In an industrial buying situation, where there are many people influencing the
decision, there can be different aspect to this subjective judgment, for instance:
 The “functional” utilitarian benefits might be attractive to the
production engineer:
 The “operational” benefits relating to the product’s reliability and
durability would be important to manufacturing and the operating
managers.
  The “financial” benefits will be attractive to purchasing agents and
accountants.
 Therefore, the cost-benefit trade-off an industrial buyer makes in arriving at the
“use value” is an exceedingly complex process involving perceptions and not
merely hard and fast realities.
 The consumer product buyer also goes through a similar process such a buyer,
however, is better able to arrive at one figure (i.e. it is not a team decision).
 The “Esteem Value”: in a purchasing situation the customer will take the sellers
price (exchange value) less the use value to arrive at the esteem value.
 Esteem Value = Price – Use Value
 (29mins)