Marketing Math

• Introduction
• Three C’s
Professor Carl Mela – Company
BA 360 Marketing Management – Consumer
– Competition
Fuqua School of Business
• Four P’s
• Summary

Marketing Math–1
Overview

• Objectives
• Techniques
– Break even analysis and cannabalization
– Mark up
– Economic value calculation
– Price response
– Expected value calculations
• Advice
Marketing Math–2
Objectives

• Marketing is a rigorous discipline.

– Those that substantiate and analyze get
more resources and make fewer mistakes.
– Those that do not tend to get fired.
• Qualitative analysis precedes
quantitative analysis
– Why is this analysis needed?

Marketing Math–3
Break Even Analysis

• Question: how much do I need to sell

to break even?
– This implies profit=0.
• Profit = (P-VC)Q-FC
– Set profit = 0
– Q=FC/(P-VC)=FC/Contribution

Marketing Math–4
Break Even Analysis

• IBM has a new PC.

– $10,000,000 in marketing
– $10,000,000 in R&D
– Corporate overhead is 20%.
– Retail price is $1,000
– How many PCs does IBM need to sell?

– Note to me - answer will be wrong as no

one considers retail margins. Marketing Math–5
Mark-up

• Need wholesale price to solve previous

problem.
• If retailer markup (margin) is 100%, what is
wholesale price?
• (Retail-Wholesale)/Wholesale=markup
– wholesale=retail/(1+markup)=$1000/2=$500

Marketing Math–6
Cannabalization

• New product sales also affect existing

product sales, and this must be
considered in break even analyses.

Marketing Math–7
Cannabalization

• IBM has a new PC.

– $10,000,000 in marketing
– $10,000,000 in R&D
– Corporate overhead is 20%.
– Retail price is $1,000, markup is 100%
– Reduces $2,000 PC sales by 10%
– How many PCs does IBM need to sell?

Marketing Math–8
Economic Value Calculation

Slicing the
Value VIU Customer Surplus
(Economic Driving Force)
Salami

Margin
Price
(Profit)

Cost Cost of Production

(Loaded)

Marketing Math–9
 Economic Value-in-Use

Example: A chemical plant uses 200 O-rings to seal valves carrying corrosive
materials. Those O-rings cost $5.00 each and must be changed during
regular maintenance every two months.
A new product has 2 × the corrosive resisting power. The value-in-use
of the material might be:

1. Annual cost of incumbent

= 200 (rings) × 6 changes/year × $5/O-ring
= $6,000
versus
= 200 (rings)×3 changes/year× $???/O-ring => VIU of $10/O-ring

Marketing Math–10
Value-in-Use Tips

Be sure to include all costs when doing a VIU

calculation.
Use costs = (Annual)
✧ Purchase cost + Fabrication cost + Finishing cost + Inventory
cost + Maintenance/Service cost Scrap adjustment + Level-of-
requirement adjustment + Changeover cost + Risk premium +
other
Use the user’s cost of capital when making multi-year calculations.

VIU ➔ be a customer!

Marketing Math–11
Example of Value Based Selling
AT&T beats IBM & Lockheed for
$1.4B TMAC Award

Washington—The Treasury Department last week awarded a $1.4

billion Treasury Multiuser Acquisition Contract (TMAC) to an
AT&T led team which reportedly came in as high bidder over
lower bids from IBM Corp. and Lockheed Corp.

Industry sources last week said that AT&T’s bid of $1.4 billion
for the contract was nearly $500 million more than the lowest bid
of $931 million reportedly submitted by the Lockheed led team.
It is believed that IBM Corp.’s bid fell in the middle of the two at
approximately $1.1 billion.
—Electronic News
Monday, July 22, 1991.
Marketing Math–12
IBM & Lockheed
Protest AT&T Win
Washington—IBM Corp. and Lockheed Corp last week told
the GSA Board of Contract Appeals that the government
cannot justify the more than $500 million premium it will
pay for awarding high-bidder AT&T the Treasury Multiuser
Acquisition Contract (TMAC).

In separate protests filed last week with the GSA Board,

unsuccessful bidders IBM and Lockheed asked that award of
the massive Internal Revenue Service contract to AT&T be
overturned. An initial hearing on the protests will likely be
held early this week.
—Electronic News
Monday, July 29, 1991.

Marketing Math–13
GSA Board Halts
$1.4B AT&T Pact

Washington—The GSA Board of Contract Appeals last

week halted a potential $1.4 billion computer contract
award to AT&T, charging the Treasury Department
failed to adequately justify the selection of a far more
costly proposal by AT&T over a much lower bid by
IBM and Lockheed Missiles and Space.

The board upheld the protests of IBM and Lockheed,

and ordered the Treasury Multiuser Acquisition
Contract (TMAC) sent back to the agency for further
consideration.
—Electronic News
Monday, September 30, 1991.
Marketing Math–14
IRS Reinstates $1.4B AT&T Pact

Washington—The Internal Revenue Service last week re-awarded a $1.4 billion

computer contract to AT&T six months after the first award was ordered
overturned by a contract appeals board.

The IRS said its decision to re-confirm the original award of the Treasury
Multiuser Acquisition Contract (TMAC) to AT&T was based on “an in-depth
analysis” of the proposal offered by AT&T as well as those from competing
bidders IBM Corp. and Lockheed Missiles and Space.
“While the cost of the AT&T proposal was the highest of the three, it
represented the best value to the government when all factors, including
technical capabilities, management and support services, the risk of future
additional costs, and the impact on productivity of the IRS user
workforce were considered for each of the three different proposals,” the IRS
said Friday. —Electronic News, Monday, March 23, 1992.

Marketing Math–15
Economic Value Calculation

• Using EVC, how much should be

charged for your MBA (note, we lose
money on each MBA, so clearly we are
not a regular business with regular
customers)?

Marketing Math–16
Price Response

• What should I charge for my product?

• When economic value varies across
consumers (thus creating an aggregate
demand curve), prices must be set to
optimize profits
– Tradeoff: lost unit sales with higher
prices, but higher margins

Marketing Math–17
Price Response

• Exercise: How much would you pay

for HDTV?
• Constant Elasticity Model
– Qty = 1000*price-2
– Elasticity = dQ/dp * p/Q = -2
• Constant Elasticity Model
– Qty = 1100-200*price
– Elasticity = p/Q
Marketing Math–18
Constant Elasticity Model

1000

800

600
Demand
400

200

0
$1.00
$1.40
$1.80
$2.20

$2.60
$3.00

$3.40

$3.80

$4.20

$4.60

$5.00
Price

Marketing Math–19
Linear Demand Model

1000

800

600
Demand
400

200

0
$1.00
$1.40
$1.80
$2.20

$2.60
$3.00

$3.40

$3.80

$4.20

$4.60

$5.00
Price

Marketing Math–20
Optimizing Price

• Set d(Profit/dp) = 0
• Qty = 1100-200*price
• Variable Cost=0.10
• Fixed Cost = 0
• p* = 1100/400 - 0.5*0.1 = 2.70
– more generally, (a/2b)-0.5c where q = a-
bp

Marketing Math–21
Optimizing Price

$1,600.00
$1,400.00
$1,200.00
$1,000.00
Profits $800.00
$600.00
$400.00
$200.00
$-
$1.00
$1.40
$1.80
$2.20

$2.60

$3.00
$3.40

$3.80

$4.20

$4.60

$5.00
Price

Marketing Math–22
Expected Value Calculation

• Expected Value (x) = Σ (x*prob (x))

• Two market segments exist, business
class and leisure class.
– There are 200 business travelers and 100
leisure travelers.
– Business travelers pay $1000/ticket
– Leisure travelers pay $200/ticket
– What is the expected price of the ticket?
Marketing Math–23
Expected Value Calculation

• Prob (ticket holder is business) =

(200/(200+100)) = 2/3
• Prob (ticket holder is leisure) = 1/3
• Expected Value (x) = Σ (x*prob (x))
• Expected Revenue = (2/3)*$1000 +
(1/3)*$200 = $667 + $67 = $734

Marketing Math–24
Advice

• In cases, there are many, many

numbers and many, many analyses.
– The foregoing are only a small set.
• Without structure you will quickly get
lost (sometimes even with structure).
• Even harder in real world, because
numbers are not so readily available.
• So, how to proceed?
Marketing Math–25
Advice

• Read “How to Avoid Getting Lost in

the Numbers.”
• Step 1: Define the problem that is
trying to be solved
– For example, if the goal is to determine,
will this idea fly, then a break even
analysis makes sense.

Marketing Math–26
Advice
• Step 2: Break the problem into smaller
pieces
– E.g., what does one need to know to do a
break even?
• Fixed costs, then variable costs, then prices
• Solve these one by one
• What are all the variable costs? Are they
known, if so, great. If not:
– Can they be determined?
– Assembly line produces 1000 units per year but
costs $1000
Marketing Math–27
Advice

• Step 3
– Once all the pieces are there, and have
been solved one by one, add them back
up, BE=FC/(P-VC)
• Do not try to do everything at once
• Last, remember, the analyses must
have some purpose, otherwise you will
get lost. Always start with the
objectives.
Marketing Math–28
Advice: Guest Speaker

• Former senior partner at McKinsey will

speak to the ubiquity of marketing
math and cases in management

Marketing Math–29
Summary

• Assessing the merits of a business

opportunity invariably means working
the numbers
• Marketing combines precise numbers
with rough assumptions
– Vaguely right beats precisely wrong
• But so does finance - what is the cost
of capital?
Marketing Math–30
Key Take Aways

• Break Even
• Sensitivity Analysis
• Cannibalization
• Economic Value
• Pricing Techniques & Mark Up
• Expected Value

Marketing Math–31