340 likes | 463 Views
Exam Question on Advertising Elasticity. Return on Advertising Expense is always falling. Profit. Z. 0. Z = ROAE x Advertising Z = (Z/A) x A . Advertising. Elasticity of Return on Advertising
E N D
Return on Advertising Expense is always falling Profit Z 0 Z = ROAE x Advertising Z = (Z/A) x A Advertising
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
Elasticity of Return on Advertising Profit -0.5 -0.75 -1.0 -1.25 -1.5 -1.75 -2.0 Z 0 Advertising A*
Elasticity of Promotion Productivity • How to estimate the arc elasticity of return on ANY or total promotional expenditure
ROME The Relationship between total promotion expenditure and the return on promotion expenditure Promotion Expenditure
ROME = NMC/TP Net Marketing Contribution= Total Promotion Expenditure x the Return on Total Promotion Expenditure 200% NMC = ROME x TP = 200% x $200 = $400 $200 Promotion Expenditure
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 ROME* Maximum NMC* = ROME* x TP* A* Promotion Expenditure
ROME = NMC/TP ROME x A = the non-maximum NMC ROME* ROME A* Promotion Expenditure A
ROME = NMC/TP Decrease in NMC due to change in ROME Increase in NMC due to change in Promotion, ∆A ROME* ROME A* Promotion Expenditure A
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? Quantity Q = kAa PROMOTION, A
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?
Profit NMC 0 ????? Promotion $1,500,000 $1,700,000
An Example • What is the ∆A? • What is the ∆ROME? • These will help explain the change in Profit after Promotion, NMC
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?
An Example • What is the ARC Elasticity of ROME?
Elasticity of our Promotional Productivity is equal to -0.96 • If we spend more on promotion, then will we make more profit?
Elasticity of Return on Promotion Profit -0.96 NMC 0 Promotion $1,700,000
Elasticity of Return on Promotion Profit -0.5 -0.75 -1.0 -1.25 -1.5 -1.75 -2.0 NMC 0 Promotion A* $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
Profit Function can be very flatThus Small Errors From Optimal can have little Impact Profit Z 0 Advertising A*