Exam Question on Advertising Elasticity

1. Exam Question on Advertising Elasticity

2. Return on Advertising Expense is always falling Profit Z 0 Z = ROAE x Advertising Z = (Z/A) x A Advertising

3. 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

4. Point Elasticity of ROAE Defined • Elasticity of Return on Advertising Effort • Ratio of (Percentage Change in ROAE) ÷ (Percentage Change in Advertising Expense) • %∆ROAE / %∆A

5. 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

6. Elasticity of Return on Advertising Profit -0.5 -0.75 -1.0 -1.25 -1.5 -1.75 -2.0 Z 0 Advertising A*

7. Elasticity of Promotion Productivity • How to estimate the arc elasticity of return on ANY or total promotional expenditure

9. ROME The Relationship between total promotion expenditure and the return on promotion expenditure Promotion Expenditure

10. 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

11. 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*

12. ROME = NMC/TP ROME* Maximum NMC* = ROME* x TP* A* Promotion Expenditure

13. ROME = NMC/TP ROME x A = the non-maximum NMC ROME* ROME A* Promotion Expenditure A

14. 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

15. 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

16. How do we estimate the Elasticity of the Return on Promotion? Quantity Q = kAa PROMOTION, A

17. 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?

18. Profit NMC 0 ????? Promotion $1,500,000 $1,700,000

21. An Example • What is the ∆A? • What is the ∆ROME? • These will help explain the change in Profit after Promotion, NMC

24. 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?

27. An Example • What is the ARC Elasticity of ROME?

30. Elasticity of our Promotional Productivity is equal to -0.96 • If we spend more on promotion, then will we make more profit?

31. Elasticity of Return on Promotion Profit -0.96 NMC 0 Promotion $1,700,000

32. 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

33. 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

34. Profit Function can be very flatThus Small Errors From Optimal can have little Impact Profit Z 0 Advertising A*