Exam Question on Advertising Elasticity. Advertising Profit Z 0 Return on Advertising Expense is...
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Transcript of Exam Question on Advertising Elasticity. Advertising Profit Z 0 Return on Advertising Expense is...
Exam Question on Advertising Elasticity
Advertising
Profit
Z
0
Return on Advertising Expense is always falling
Z = ROAE x AdvertisingZ = (Z/A) x A
• Elasticity of Return on Advertising• Is a metric that indicates if an increase in
advertising will result in an increase or decrease in the profit after advertising.
• Aka, Elasticity of Advertising Productivity
Point Elasticity of ROAE Defined
• Elasticity of Return on Advertising Effort
• Ratio of (Percentage Change in ROAE) ÷ (Percentage Change in Advertising Expense)
• %∆ROAE / %∆A
How to use Elasticity of ROAE
• If the Elasticity of ROAE is equal to -1, then the optimal level of advertising expense has been reached for maximizing profit after advertising
• If the Elasticity of ROAE is between 0 and -1, then a small increase in advertising should increase profits
• If Elasticity is more negative than -1.0 then a decrease in advertising will increase profits
AdvertisingA*
Profit
Z
0
-0.5 -0.75 -1.0 -1.25 -1.5 -1.75 -2.0
Elasticity of Return on Advertising
Elasticity of Promotion Productivity
• How to estimate the arc elasticity of return on ANY or total promotional expenditure
Period 1
Revenue, R $1,000
Cost of Goods Sold, COGS $400
Gross profit, G = R-COGS $600
Total Promotion, TP $200
Profit after Promotion, NMC = G-TP $400
Return on Marketing Effort, NMC/TP $400/$200 = 200%
ROME
Promotion Expenditure
The Relationship between total promotion expenditure and the return on promotion expenditure
ROME = NMC/TP
Promotion Expenditure
Net Marketing Contribution= Total Promotion Expenditure x the Return on Total Promotion Expenditure
NMC = ROME x TP = 200% x $200 = $400
200%
$200
What We Know so far
• 1) That there is an optimal level of promotion, A*
• 2) That maximizes Profit after Promotion, NMC
• 3) Therefore there is an optimal Return on Promotion Expenditure, ROME*
ROME = NMC/TP
Promotion Expenditure
Maximum NMC* = ROME* x TP*
ROME*
A*
ROME = NMC/TP
Promotion Expenditure
ROME*
A*
ROME
A
ROME x A = the non-maximum NMC
ROME = NMC/TP
Promotion Expenditure
ROME*
A*
ROME
A
Increase in NMC due to change in Promotion, ∆A
Decrease in NMC due to change in ROME
• When the decrease in NMC due to the impact of the change in ROME is greater than the positive Impact of the change in Promotion, ∆A, then the profit, NMC, must decrease
• How do we estimate the Elasticity of the Return on Promotion?
PROMOTION, A
QuantityQ = kAa
An Example
• Constant Price = $80• Constant Variable Cost = $20• Quantity sold, Q = 1600A0.29
• Total Promotion, A is changing• What is the Gross profit, G ?• What is the Profit after Promotion, NMC?• What is the ROME?
Promotion
Profit
NMC
0
$1,700,000
$1,500,000
?????
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G = (P-V)Q
$5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Profit after Promotion, G-A= NMC
$4,433,866 $4,453,206 $19,340
ROME = NMC/A
2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G = (P-V)Q
$5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Net Profit, G-A= NMC
$4,433,866 $4,453,206 $19,340
ROME = NMC/A
2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
An Example
• What is the ∆A?• What is the ∆ROME?• These will help explain the change in Profit
after Promotion, NMC
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G $5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Net Profit, NMC
$4,433,866 $4,453,206 $19,340
ROME 2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G $5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Net Profit, NMC
$4,433,866 $4,453,206 $19,340
ROME 2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
An Example
• What is the impact of the change in Promotion, ∆A, on the increase in the Profit after Promotion, ∆NMC?
• What is the impact of the change in ROME, ∆ROME, on the increase in the Profit after Advertising, ∆NMC?
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G $5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Net Profit, NMC
$4,433,866 $4,453,206 $19,340
ROME 2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G $5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Net Profit, NMC
$4,433,866 $4,453,206 $19,340∆NMC = I∆A + I∆ROME
ROME 2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
An Example
• What is the ARC Elasticity of ROME?
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G $5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Net Profit, NMC
$4,433,866 $4,453,206 $19,340∆NMC = I∆A + I∆ROME
ROME 2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
Period 1 Period 2 ∆ I∆ on NMC$Markup, P-V $60 $60
Quantity, QQ = 1600A0.29
98,898 102,553 3,656
Gross Profit, G $5,933,866 $6,153,206 $219,340
Promotion, A $1,500,000 $1,700,000 $200,000 I∆A = 2.62($200,000) =$523,906
Net Profit, NMC
$4,433,866 $4,453,206 $19,340∆NMC = I∆A + I∆ROME
ROME 2.96 2.62 -0.34 I∆ROME = $1,500,000(-0.34)= -$504,566
Arc Elasticity of ROME = I∆ROME/I∆A = -$504,566/$523,906 = -0.96
• Elasticity of our Promotional Productivity is equal to -0.96
• If we spend more on promotion, then will we make more profit?
Promotion
Profit
NMC
0
Elasticity of Return on Promotion
$1,700,000
-0.96
PromotionA*
Profit
NMC
0
-0.5 -0.75 -1.0 -1.25 -1.5 -1.75 -2.0
Elasticity of Return on Promotion
$1,700,000
What we learned!
• You can easily overspend your optimal advertising budget if you use the cost based average sales ratio as a straight line advertising rate.e.g. Q = Q/A x A
• Use estimates of the estimates of the elasticity of advertising and return on marketing effort
AdvertisingA*
Profit
Z
0
Profit Function can be very flatThus Small Errors From Optimal can have little
Impact