Marketing Math

Forecasting and Demand Measurement Market Demand measures Potential market: Every one you could sell to Penetrated market: Every one you are selling to (i.e. sales) The potential market is the set of consumers with a sufficient level of interest in a market offer. The available market is the set of consumers who have interest, income, and access to a particular offer. Eligible adults constitute the qualified available market—the set of consumers who have interest, income, access, and qualifications for the market offer. The target market is the part of the qualified available market the company decides to pursue. The penetrated market is the set of consumers who are buying the company’s product.

Estimating Future Market Demand – Some Methods Survey of buyers’ intentions Purchase probability scale: How likely are you to purchase…? Composite of sales force opinions Expert opinion Marketing Research (i.e. BASES) Past-sales analysis Econometric Methods Market-test method All forecasts are built on one of three information bases: what people say, what people do, or what people have done. Using what people say requires surveying buyers’ intentions, composites of sales force opinions, and expert opinion. Building a forecast on what people do means putting the product into a test market to measure buyer response. To use the final basis—what people have done—firms analyze records of past buying behavior or use time-series analysis or statistical demand analysis. Forecasting is the art of anticipating what buyers are likely to do under a given set of conditions. For major consumer durables such as appliances, research organizations conduct periodic surveys of consumer buying intentions, ask questions like Do you intend to buy an automobile within the next six months?, and put the answers on a purchase probability scale.

Forecasting Demand Chain-ratio method Total market potential is the maximum sales available to all firms in an industry during a given period, under a given level of industry marketing effort and environmental conditions. A common way to estimate total market potential is to multiply the potential number of buyers by the average quantity each purchases and then by the price. A variation on this method is the chain-ratio method, which multiplies a base number by several adjusting percentages.

Avg # Algebra Classes/School Forecasting Demand Bottom-up Method – used when you have specific “granular” data Example: What is the total market potential for a new algebra textbook in California high schools? District # High Schools Avg # Algebra Classes/School Avg Students/Class Total Books Needed A 9 3 25 675 B 4 5 17 340 C 22 440 ⁞ TOTAL 959 4.3 21.7 89,484

Activity: Estimating Demand Estimate the Total Market Potential for: Annual number of hamburgers consumed in the state of Oregon Users of an app that provides real-time traffic data throughout the United States The total yearly number of male haircuts in the state of California The total number of Gluten-Free food consumers in New York state The total demand for baseball bats in the state of Arizona

Customer Lifetime Value Customer Lifetime Value (CLV) The net present value of the stream of future profits expected over the customer’s lifetime purchases Customer lifetime value (CLV) describes the net present value of the stream of future profits expected over the customer’s lifetime purchases. The company must subtract from its expected revenues the expected costs of attracting, selling, and servicing the account of that customer, applying the appropriate discount rate (say, between 10 and 20 percent, depending on cost of capital and risk attitudes).

Why Calculate CLV? Shows whether we are actually profiting from customer acquisition and retention in the long run Useful tool for comparing multiple “competing” marketing initiatives Establishes a maximum acquisition cost baseline (i.e. “not to exceed”)

CLV Formula – Finite Time Horizon CLV = Σ [GCt * rt] / (1 + i)t – AC CLV = Customer Lifetime Value GCt = Gross Contribution from Customer at time t (revenues – servicing and retention costs) rt = Retention Rate of customer at time t i = interest or “discount rate” AC = Acquisition Cost

Customer Lifetime Value (finite time horizon) Gupta and Lehmann illustrate their approach by calculating the CLV of 100 customers over a 10-year period (see Table 5.3). In this example, the firm acquires 100 customers with an acquisition cost per customer of $40. Therefore, in year 0, it spends $4,000. Some of these customers defect each year. The present value of the profits from this cohort of customers over 10 years is $13,286.52. The net CLV (after deducting acquisition costs) is $9,286.52, or $92.87 per customer.

CLV(finite time horizon) – Acme Inc. Example Acme, Inc. uses a four-year time horizon to calculate Customer Lifetime Values of its customers. Here are some facts related to Acme's Customer Lifetime Value model: - It costs $400 (on average) to acquire a customer - Revenues per customer are $1,000 in year 1 and are expected to increase by 10% each year thereafter. - Variable costs to service and retain each customer are $300 in the first year and decrease by 5% each year thereafter. - Acme uses a discount rate of 7% for its CLV calculations.

Customer Lifetime Value (finite time horizon) See “Excel CLV Tutorial” video

CLV Formula – Infinite Time Horizon CLV = [(GC * r) / (1 + i - r)] – AC CLV = Customer Lifetime Value GC = Annual Gross Contribution from Customer (revenues – servicing and retention costs) r = Average Retention Rate of Customer i = interest or “discount rate” AC = Acquisition Cost

CLV (Infinite Time Horizon) - Example Acme, Inc. is trying to determine the Lifetime Value of its customers. Here are some facts related to Acme customers: - A study of historical sales data reveals that the average customer brings in about $800 of sales revenues each year. - A study of historical cost data reveals that the average cost to service and retain a customer is about $200 per year. - Acme spends about $150 to acquire a new customer, on average. - Acme retains approximately 65% of its customers from one year to the next. - Acme's discount rate is 4%. CLV = [(GC * r) / (1 + i - r)] – AC CLV = [(800-200) *(.65)] / (1 + .04 - .65)] – 150 CLV = [(600*.65)/ (.39)] – 150 CLV = 1,000 – 150 = $850

CLV “Multiple” – Infinite Time Horizon MM = r / (1 + i - r) MM = Margin Multiple r = Average Retention Rate of Customer i = interest or “discount rate” CLV = MM x GC CLV = Customer Lifetime Value GC = Annual Gross Contribution from Customer (revenues – servicing and retention costs)

CLV “Multiple” (Infinite Time Horizon) - Example Calculate the margin multiple for a company that has a 5% discount rate and a 80% retention rate. MM = r / (1 + i - r) MM = .80 / (1 + .05 - .80) = 3.2 Calculate the CLV assuming the company’s annual gross contribution per customer is $700. CLV = MM x GC CLV = 3.2 x $700 = $2,240

Customer Lifetime Value - Multiples Table 5.4 shows the margin multiple for various combinations of r and i and a simple way to estimate CLV of a customer. When retention rate is 80 percent and discount rate is 12 percent, the margin multiple is about two and a half. Therefore, the future CLV of an existing customer in this scenario is simply his or her annual margin multiplied by 2.5.

Contribution Analysis / ROMI Return on Marketing Investment (ROMI) Both used to measure the “worth” of marketing initiatives (i.e. how much they “contribute” to company profits) Provides guidance on whether to proceed with (i.e. “greenlight”) the initiative Can be calculated prospectively (future projection) or historically (based on actual data)

Contribution Analysis Contribution = (Incremental Sales Volume) x (Sales Price) x (Contribution Margin %) – Incremental Marketing Initiative Costs Contribution = ISV x SP x CM% - IMIC CM% = The % of sales revenue retained as profit after accounting for variable costs. Incremental means “additional”, traceable to the initiative

Contribution Analysis - Example Contribution = (Incremental Sales Volume) x (Sales Price) x (Contribution Margin %) – Incremental Marketing Initiative Costs Contribution = ISV x SP x CM% - IMIC Starbucks launches a social media campaign to promote its new (mythical) “Le Mix” line of coffee-tea mixture beverages. Starbucks expects the campaign to generate 750,000 units in incremental sales in its first year at a campaign cost of $1 million. Sales price per beverage is $3.75 and the contribution margin % for the drink is 60%. Determine the annual contribution expected from the Le Mix social media campaign. Contribution = ISV x SP x CM% - IMIC = 750,000 x $3.75 x 60% - $1,000,000 = $687,500

Return on Marketing Investment ROMI % = (Contribution / Incremental Marketing Initiative Costs) x 100% ROMI % = [(Incremental Sales Volume) x (Sales Price) x (Contribution Margin %) – Incremental Marketing Initiative Costs] / (Incremental Marketing Initiative Costs)] x 100% ROMI % = [(ISV x SP x CM% - IMIC) / (IMIC) ] x 100% ROMI % = [(Contribution) / (IMIC) ] x 100%

Return on Marketing Investment - Example ROMI % = (Contribution / Incremental Marketing Initiative Costs) x 100% ROMI % = [(Incremental Sales Volume) x (Sales Price) x (Contribution Margin %) – Incremental Marketing Initiative Costs] / (Incremental Marketing Initiative Costs)] x 100% Starbucks launches a social media campaign to promote its new (mythical) “Le Mix” line of coffee-tea mixture beverages. Starbucks expects the campaign to generate 750,000 units in incremental sales in its first year at a campaign cost of $1 million. Sales price per beverage is $3.75 and the contribution margin % for the drink is 60%. Determine Starbuck’s ROMI % for the Le Mix social media campaign. Contribution = ISV x SP x CM% - IMIC = 750,000 x $3.75 x 60% - $1,000,000 = $687,500 ROMI % = [ Contribution / IMIC ] x 100% = $687,500 / $1,000,000 = 69% (rounded)

Cannibalization Considerations

Cannibalization Considerations Cannibalization: When a company’s new products depress or “steal” the sales of its older products Many Contribution and ROMI calculations neglect to account for cannibalization Revised formulas to account for cannibalization are typically more accurate depictions of future reality

Contribution Analysis – with Cannibalization Factor Contribution = [(Incremental Sales Volume) x (Sales Price) x (Contribution Margin %) – (Incremental Marketing Initiative Costs)] – [(Cannibalized Sales Volume) x (Cannibalized Sales Price) x (Cannibalized Contribution Margin %)] + (Decrease in Marketing Initiative Costs for Cannibalized Brand(s)) Contribution = [(ISV x SP x CM%) – IMIC] – [(CSV x CSP x CCM%)] + ∆CMIC CM% = The % of sales revenue retained as profit after accounting for variable costs. Incremental means “additional”, traceable to the initiative

Contribution Analysis - Example Contribution = [(Incremental Sales Volume) x (Sales Price) x (Contribution Margin %) – Incremental Marketing Initiative Costs] – [(Cannibalized Sales Volume) x (Cannibalized Sales Price) x (Cannibalized Contribution Margin %)] + Decrease in Marketing Initiative Costs for Cannibalized Brand(s) Contribution = [(ISV x SP x CM%) – IMIC] – [(CSV x CSP x CCM%)] + ∆CMIC Starbucks launches a social media campaign to promote its new (mythical) “Le Mix” line of coffee-tea mixture beverages. Starbucks expects the campaign to generate 750,000 units in incremental sales in its first year at a campaign cost of $1 million. Sales price per beverage is $3.75 and the contribution margin % for the drink is 60%. The Le Mix launch is expected to cannibalize 500,000 units of tea beverages currently being sold at a price of $3.50 and having a contribution margin % of 55%. Marketing initiative costs for the cannibalized tea products are expected to drop by approximately $400,000. Determine the annual contribution expected from the Le Mix social media campaign after accounting for cannibalization of tea products. Contribution = [(ISV x SP x CM%) – IMIC] – [(CSV x CSP x CCM%)] + ∆CMIC = [(750,000 x $3.75 x 60%) - $1,000,000] – [(500,000 x $3.50 x 55%)] + $400,000 = $125,000 (is this high enough contribution to justify the campaign/launch?)