WCC Core Connector 2008-2009

Wharton
Consulting Club
Core Connector
Quarter 1
FNCE 601 | MGEC 621 | ACCT 601 |
MKTG 621
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FNCE 601|Present Value and NPV

Present Value: The value in todays dollars of a future payment or a future stream of payments. The formula
for determining present value is: PV = C/(1+r)t where C is the value of the future payment, r is the discount
rate, and t is the number of years in the future that the payment is received. Sometimes a future stream of
payments is unfixed in length and goes on indefinitely. This is known as a perpetuity. The formula for
determining the PV of a perpetuity with the first payment coming one year in the future is: PV=C/(r-g), where
C is the value of the initial payment, r is the discount rate, and g is the rate at which the payments are
growing. Present value is useful as a way to compare payments and cash flows at different times on an
apples to apples basis.

Sample Problem: You will receive a payment of $5 in three years time. If the discount
rate is 10%, what is the present value of this payment?

Solution: PV = $5/(1+0.10)3

= $3.76

So, for example, you would prefer to receive a payment of $4 now instead of $5 three
years from now because the present value of that future payment is less than $4.

Net Present Value Rule (NPV): The net present value of a stream of payments is the present value (PV) of
those payments minus the cost of generating those payments. NPV is a measurement of how much value an
investment or project adds to the worth of a firm. The formula for NPV is: PV (stream of payments) Cost of
generating stream of payments. In general, firms should invest in projects that have a positive NPV.

Sample Problem: A firm can invest in Project X. The cost of Project X is $15, to be paid
immediately. Once Project X is online, it should generate revenues of $5 a year for four
years. The first revenue payment is collected at the end of year one and at the end of
each subsequent year for four years. The interest rate is 10%. Should the firm invest in
Project X?

Solution: NPV = $5/(1.1) + $5/(1.1)2 + $5/(1.1)3 + $5/(1.1)4 - $15

= $0.85 The firm should invest in Project X because the NPV is positive.

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FNCE 601|Valuation of Firms

Discounted Cash Flow (DCF): This method of valuation is based on the idea that a firm has value because it
generates cash. The stream of cash flows and the rate at which they should be discounted are the factors that
determine what the firm is worth. Thus, the discounted cash flow involves two steps: The first is to determine
the cash flows and the second is to discount them at the appropriate discount rate. The most common method
for finding the appropriate discount rate is to use the weighted average cost of capital. The formula for
finding the weighted average cost of capital is: rWACC = [D/(D+E)]*(1-Tc)rD + [E/(D+E)]rE where rD is the cost
of debt, Tc is the firms corporate tax rate, D is the market value of the firms debt, E is the market value of
the firms equity, and D+E is the total value of the firm.

Sample Problem: A firm will generate cash flows of $10 a year for the next three years.
Revenues will grow at 3% a year starting in year four and will continue growing in
perpetuity. Assuming the average weighted cost of capital is 11% and the PV of the
firms debt is $50, what is the value of the firm?

Solution: Start by finding the PV of the firms cash flows:

$10/(1.11) + $10/(1.11)2 + $10/(1.11)3 + [$10*(1.03)/(.11-.03)]/(1.11)3 = $118.58

Next, subtract the PV of the firms debt to find the value: $118.58 - $50 = $68.58

Note: The final term in the PV of the cash flows is the PV of the cash flows that occur at
year four and beyond. These must be treated as a perpetuity and calculated accordingly
(see PV section above).

Comparable M&A Deals: This method of firm valuation looks at acquisitions of comparable firms in order to
find a value for the firm in question. The idea behind this method is that in competitive markets similar firms
should sell for similar amounts. The first step in this method is to identify comparable firms. There are at least
eight points of comparison used in these comparisons:
1. Type of business activity in which the firm is engaged
2. Size of the business
3. Form of ownership closely held or publicly held
4. Capital structure

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5. Degree of profitability
6. Competitive position within the industry
7. Historical growth rate
8. Physical facilities
Having found comparable firms using these criteria, it is then usual procedure to look at various ratios of the
comparable firms and then determine what this means for the value of the firm in question. For a comparable
firm that was acquired, it is possible to find the ratio of the selling price to the stock price before the
acquisition was announced. This ratio can then be multiplied by the current stock price of the firm in question
in order to find the selling stock value. Other ratios that are sometimes used include the multiple of sales, the
multiple of book, the multiple of earnings and the multiple of cash flow.

Sample Problem: You are trying to determine the value of a firm and have researched
M&A deals for comparable firms. You have determined that the average ratio of selling
price to price before the merger was announced for these deals was 1.55. If the firm you
are valuing has equity valued at $300MM, what will the selling price be?

Solution: Multiply the ratio of selling price to stock price by the overall value of equity to
calculate value: $300MM * 1.55 = $465MM

Note: This implies a 55% premium paid for the firm.

Comparable Publicly Traded Firms: This method looks at the stock market value of comparable firms to find
firm value. The principles for finding comparable public firms for use in valuations are similar to those used in
comparable M&A deals (see above). An important point to remember, however, is that when an entire
business is being sold, it generally sells for more than its stock market valuation because the price per share
on the stock market does not include the control premium that is paid when purchasing an entire company.
One way to value companies is to look at the price to earnings ratio (P/E) for similar publicly traded
companies and to multiply this value by the earnings of the company in question.

Sample Problem: You are trying to value Firm A. You have researched three other similar
firms that are publicly traded and have calculated an average P/E ratio of 15. If the
earnings per share of Firm A are $50, what is the per share value of Firm A?

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Solution: Value per share of Firm A = $50 * 15 = $750

Liquidation Values: This valuation method looks at a business as the sum of its component parts. The first step
is to compile a list of the firms assets. These assets are then valued at either their replacement value or their
liquidation value. The replacement technique provides an upper bound to firm value and the liquidation
technique provides a lower bound. Total firm value can then be divided by the number of shares to calculate
total value per share.

Sample Problem: You are valuing Firm K and have calculated the value of its four
divisions at $40MM, $20MM, $13MM and $7MM. The PV of the firms debt is $15MM. If
Firm K has 2MM shares, what is the value per share?

Solution: Value of the firm = $40MM + $20MM + $13MM + $7MM - $15MM = $65MM

Dividing the total value of the firm by total shares gives per share value:

$65MM/2MM = $32.50

MGEC 621 | Supply and Demand

Supply - The market supply curve is a boundary line, it represents the locus of points showing
maximum quantities sellers are willing to produce (and sell) at a given price.

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Demand - The market demand curve shows the total market sales at any given price. Demand
curves generally slope downward (to the right) because sales increase as price decreases.
(Demand curves have negative slopes.) Market demand curves are also boundaries. Sales may
be lower at a given price, but they can never be higher.
Fig. 1.6

Market equilibrium occurs where the supply and demand curves intersect. The market clearing
price is an equilibrium because any movement from this price will cause market forces (the
infamous "invisible hand") to adjust the price back toward the equilibrium. For example, if the
market price should increase to $1.20, production is higher than sales, so firms will have
commodities they cannot sell at $1.20. When this occurs, managers will often lower their prices.
As prices fall, the market will experience higher sales and lower production levels. Prices will
continue to fall until they hit $1.10. Conversely, if the price were to fall to $1.00, the market
would demand more than producers are willing to produce. A shortage will occur and managers
will begin to increase their prices. Prices will increase until they hit $1.10.

Shifts in Demand and Supply

When the demand curve moves to the left, market sales at a given price decrease. When the
demand curve moves to the right, sales increase for a given price. FIGURE 1.8 (pg. 29) shows the

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effects of shifts in the supply curve. When a supply curve shifts to the right, more commodities
are produced at a given price. When it shifts to the left, sales decrease for a given price.

Fig. 1.7
Effect of shifts in demand curve for copper

Effect of shifts in supply curveFig.

for copper
1.8

Elasticity of Demand

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Generally, the elasticity of any function (relationship) is defined as the % change in the dependent
variable in response to a 1% change in the independent variable.

% Change in quantity demanded

a- Price Elasticity of Demand = ---------------------------------------------
% Change in price of product

P Q
This relationship is expressed mathematically as: ( )
Q P

price total revenue

> |1| up down
down up
= |1| up constant
down constant
< |1| up up
down down

b- Income elasticity of demand - measures the sensitivity of quantity demanded to changes in

income. It is expressed mathematically as:

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Q I
I ( )
I Q

where I = income.
Income elasticity is either positive or negative. Products with positive elasticity are called normal
goods those with negative elasticity are inferior goods. Most goods are normal goods and hence
have positive income elasticity. Most normal goods have long-run income elasticity that is higher
than short-run elasticity. Exceptions are durable goods (e.g., autos, large appliances) whose long-
run income elasticity is substantially less than their short-run elasticity. This occurs because
consumers do not always replace these items when their incomes increase.

c- Cross elasticity of demand - Managers must know how consumers perceive their goods relative
to those of rivals. Cross elasticity of demand is one measure of this relationship. It measures the
percentage change in the quantity of product X demanded relative to a slight change in the price
of product Y. Mathematically, the formula is:

Q X PY
XY ( )
PY Q X

When cross elasticity is positive, products are substitutes -- they compete against one another, so
an increase in the price of one will increase the quantity demanded of the other. A high positive
cross elasticity usually indicates products, and hence the firms producing them, compete in the
same market. If cross elasticity is negative (the numerator is positive and the denominator is
negative) then products are complements. An increase in the price of one will cause the quantity
demanded of the other to decrease. Finally, small or zero cross elasticity indicates products (or
their markets) are effectively independent of one another since variations in the price of one
product results in no appreciable changes in demand for the other.

d- Short versus long run elasticity: For many products, demand is more price elastic (an increase in
price will cause more consumers to shift demand) in the long run relative to the short run. One
reason is that it takes time for consumers to change their preferences and hence their buying
patterns. For durable goods however, demand is more elastic in the short than in the long run.
For example, an increase in the price of new autos usually causes consumers to repair their current
autos. However, at some point consumers must eventually replace their vehicles.
For most products the long-run supply is more price elastic than the short run. This occurs because
managers face capacity constraints (and it takes time to build new plants).

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MGEC 621| Analysis of Costs

a. Opportunity Costs: The cost of inputs is their values when they are put to the best possible
use. For example, if you invest a resource and get a return of $5, and you could have
invested in another project and gotten a return of $7, then you have incurred an
opportunity cost of $2.
b. Sunk Costs: Resources that are spent and can't be recovered. All future decisions should
ignore this initial outlay.
c. Short Run vs. Long Run Costs: In the short run, some costs are fixed, they cannot be
changed. Managers should consider short-run costs as an operating concept because some
costs are fixed. Only variable costs can be managed, and in the short-run, managers
want to minimize variable costs. Long-run cost management is more of a planning concept.
Since all inputs can be varied in the long-run, and there is a least-cost combination of
inputs for any given output level, managers can construct a plant of optimal size for any
output level.

(1) Total costs (TC) = Total fixed (TFC) and variable (TVC) costs
(2) TC = f(Q) = TFC + TVC where, Q = quantity of output

a. Fixed Costs: Fixed costs are constant they do not change as output varies in the short run
(although in the long run managers can alter them). Even if output is zero, fixed costs are
still incurred. Fixed costs include plant costs, plant maintenance, insurance
d. Variable Costs: are directly proportional with output -- they vary with output. If output is
zero then variable costs are generally zero.
e. Marginal Cost: (MC) or incremental cost is the increase in cost that results from producing
one additional piece of output. Mathematically, it is the slope of the total cost function.
f. Average Cost: Average fixed costs (AFC) = TFC/Q
Average variable costs (AVC) = TVC/Q
Average total costs (ATC) = TC/Q or AFC + AVC

MGEC 621 | Economics of Scope and Scale

Economies of Scope: Occur when the joint production function of two or more products is less than
the sum of the individual production functions

Cost of F(x1 + x2) < cost of H(x1) + G(x2)

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For example, Coca-Cola enjoys economies of scope in delivering its product to stores. One truck
can carry all Coke brands. If each brand was produced by an individual firm, each firm would
have a delivery truck deliver its product. Hence, many times multi-product firms have a
competitive cost advantage over single-product firms because of scope economies in production.

Economies of Scale: are realized whenever the percentage increase in output is greater than the
percentage increase in inputs.
- quantity discounts on purchases
- more efficient use of labor in large plants, managers are able to gain efficiencies in labor
via subdivision and specialization of tasks.
- the use of specialized and higher capacity machines
- centralization and integration of manufacturing stages - Large firms can perform several
manufacturing stages at one location, hence saving on transportation and transaction costs.
- longer production runs

MGEC 621 | Breakeven Analysis

Breakeven analysis is commonly used in managerial accounting to evaluate potential investments. In

marketing however, we usually do not use the traditional investment form of the analysis because we
want to focus on pricing, not investment decisions. For example, traditional breakeven analysis focuses on
total revenues and costs. Today we examine breakeven analysis for pricing decisions as it relates to the
change in revenue in excess of variable cost (i.e., the contribution margin).
Key terms include:
Unit contribution margin ($CM):
$CM = P - k, Where P = price and k = marginal cost
Percent contribution margin (%CM):

$CM
%CM (100)
Pr ice
The percent contribution margin measures the leverage between a firm's sales volume and its
profit. It indicates the importance of sales volume as a marketing objective.
Total contribution: total contribution = total revenue (TR) - total variable cost (VC)
Think of total contribution as the monies available to "pay off" your fixed costs, and hopefully (if some is
left after paying off fixed costs) to create a profit.
Margin: margin = price you receive for good or service - your cost/unit

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margin
Expressed in percentage terms: %margin
price

Breakeven analysis - A primary use of breakeven analysis is to analyze the consequence of a

pricing decision. The basic question to be answered is, "How much would sales have to increase to
realize gain from a price cut, or how much would sales have to decrease to make a price increase
unprofitable?"

Sample Problem

SleepRite is a pillow manufacturing company. Average monthly income and costs

are:

sales - 4, 000 units price per unit - $10

variable cost - $5.50/unit fixed costs - $15,000

Management is considering a 5% price cut, and has asked you to determine how
much sales would have to determine how much sales would have to increase for
them to benefit from the price cut.

Step 1: Calculate contribution margin

$CM = $10 - $5.50 = $4.50

%CM =($4.50/$10.00) X 100 = 45%

Step 2: - Calculate breakeven sales change

- (-5.0)/(45 + (-5.0)) = 5/40

.125 X 100 = 12.5%

unit breakeven sales change = .125 X 4000 units = 500 units

If SleepRite wants to increase its current profit level, managers should use the price
cutting strategy only if they believe it will increase sales by more than 500 units.

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MGEC 621: Profit maximization & Perfect Competition

Perfectly competitive markets have the following characteristics:

- the market consists of many firms which produce identical products (homogenous products)
- each seller is small relative to the total size of the market so no one seller can influence price.
Hence, each seller is a price taker.
- prices are established in the market by the interaction of supply and demand curves
- firms are free to enter and leave the market -- there are no restraints like barriers to entry,
limited raw materials, the presence of trade associations, or patents (the market is frictionless)
- there are no constraints on the movement of prices either upward or downward.
- both buyers and sellers have complete information about prices and technologies.
- managers strive to maximize profits.

Sample Problem

The White Company produces lamps. The industry is perfectly competitive. The
current market price for lamps is $50. The total cost function for White is:

TC = 1,000 + 20Q 5Q2

a. What output maximizes profits?

P = $50

TR = PQ = 50Q

MR = dTR/dQ

= $50

MC = dTC/dQ = 20 + 10Q

Let MR = MC

50 = 20 +10Q

10Q = 30 or Q = 3

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B. What is the firms economic profit at this output?

P = $50

TR = $50(3) or $150

TC = 1,000 + 20(3) + 5(3)2

= 150 1,105 or -$955

MGEC 621 | Monopoly

A monopoly market exists when there is only one seller. Relative to pricing and output decisions in
competitive markets, the monopolist will produce less output and charge a higher price.
Managers want to produce where profit is at a maximum; this occurs where the incremental increase to
profit given an incremental increase to output (Q) is zero or:

d dTR dTC
- 0
dQ dQ dQ
- or MR - MC = 0 -

Sample Problem

You work for Nuxo Lighting Company. Nuxo produces specialized lighting fixtures,
generally acknowledged as the best in their class, and there are no close substitutes.
A market-research firm has estimated the market demand to be:

Q = 2,000 5P

You estimate Nuxo's total cost for producing storing, and marketing it's lighting line to
be:

TC = 100 + 4Q = 0.4 Q2

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You are asked to estimate how many lights should be manufactured, and how should
they be priced to maximize profits?

Invert demand function:

Q = 2000 - 5P so, 5P = 2000 - Q; hence, P = 400 - .2Q

Find TR

P(Q) = 400q - .2 Q2

derive MR ; MR = 400 - .4Q

derive MC; MC = 4 + .8Q

Set MC = MR

400 - .4Q = 4 +.8Q

1.2Q = 396

Q = 330; P = 400 - .2(330) or 334

ACCT 603|Balance Sheet | Income Stmt | Cash Flow

Balance Sheet: Reports a companys financial position at a point in time

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ASSETS = LIABILITIES + EQUITY (common stock dividends + revenues expenses)

Accounting Relationship for Balance Sheet Debit Credit
Assets (A) + -
Liabilities - +
Equity - +

Income Statement: Reports results of a companys operating activities over a period of time
Accounting Relationship for Income statement Debit Credit
Revenue - +
Expense + -

Statement of Cash Flows: Reports net cash flows from operating, investing, and financing activities of a
period of time
- Indirect Method: Cash flow from operations begins with net income and a series of
adjustments is made to net income to convert it to cash-basis income number (net cash flow
from income activities)
- Indirect Method Adjustments: Depreciation expense, Changes in Accts Rec., Changes in
Inventory, Changes in Accounts Payable

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Key Relationships to Note:

- Statement of cash flows links beginning and ending cash in balance sheet

- Income statement links beginning and ending retained earnings in the statement of
stockholders equity

- Statement of stockholders equity links beginning and ending equity in balance sheet

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MKTG 621|Situation Analysis: 5Cs

The 5Cs (Customer, Company, Competitors, Collaborators and Context) together comprise a framework used
to analyze the market situation that a product faces. The framework ensures that one will comprehensively
analyze all the essential aspects when facing a product marketing problem.

Pringles Potato Chips:

Customer: Potato Chip consumers, specifically those who prize convenience

Company: The product is produced by Proctor & Gamble, a global consumer goods
conglomerate

Competitors: Other snacks

Collaborators: Distributors, including convenience stores and supermarkets

Context: The industry for Potato Chips faces huge problems with distribution. Chips are
typically sold in packets because of their non-uniform shape and size; however this makes for
difficulty in shipping because they are easily crushed

MKTG 621|Market Segmentation

Different groups of consumers seek different benefits in products. Market segmentation allows one to properly
spilt up the market using a methodology that is relevant, and that yields a chosen segment that is measurable,
of sufficient size, accessible and compatible with the companys resources/strengths. Possible segmentation
methodologies include geographic, demographic, psychographic (eg. Religion; personality), attitudinal (eg.
Price sensitivity; benefits sought in a product) and behavioral (eg. Actual usage rate, buying locations)

Unilever in Brazil

Segmenting the market into Northeast and Southeast consumers (geographic) is most
appropriate because this takes into account different ways of using detergent, as well as
different income levels and distributional challenges in the two market segments. It is relevant,
measurable, of sufficient size, accessible and fits Unilevers resources.

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MKTG 621|Market Positioning

After a market segmentation scheme is chosen, the next step is to choose which specific segment to target. The
act of Market Positioning then formalizes the strategy for marketing to this targeted segment. A good
positioning statement will include a description of the product, the benefit it provides to the a consumer in the
targeted segment, and a comparison that such a consumer would be comparing the product against

Unilever in Brazil

A new low-cost detergent will target consumers in the north-east by providing them with a
superior cleaning and whitening product as compared to current laundry soaps in the market.

MKTG 621|Consumer Decision Processes

Such processes help a marketer understand how consumers make decisions. The consumer typically goes
through five stages in his/her decision process: 1) recognition of need 2) search for information about
available alternatives 3) evaluation of alternatives 4) purchase 5) post-purchase evaluation

Invisalign

Customers recognize that they want to realign their teeth, then either go to dentists,
orthodontists, or magazines for information. They subsequently search for their alternatives
with the help of dentists, before deciding to purchase. Finally they evaluate if the product has
met their needs by looking at the end-product.

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MKTG 621|4Ps: Product

The 4Ps (product, price, place, promotion) describe a set of 4 tactical aspects that a marketing plan must
consider. Under product, one must consider brand equity, which is the net worth of a brand as determined by
brand awareness, loyalty, level of satisfaction and brand franchise (which is when a critical mass of positive
sentiment has been reached in the market). Brand equity can be measured by two methods. First, if one
subtracts tangible assets (or replacement cost of assets) from a firm's stock market value, the remainder can
be taken as brand value. Second, one can estimate the price premium that the brand attracts over the
store/generic brand.

Uno: Unilever in Brazil

Unos brand equity was very high. Its brand awareness was close to 100%; its loyalty was
high (derived from the 57% market share); its level of satisfaction was by far the highest in
the market, and it had certainly reached brand franchise.

The 4Ps (product, price, place, promotion) describe a set of 4 tactical aspects that a marketing plan must
consider. Under product, one must consider brand extensions, which are extensions of the brand into new
products. This allows a company to leverage brand awareness and enhance the core brand, but result in a
dilution of the core brand name and possibly damaging of the core brand name. In addition, the position of
the core brand matters significantly in the success of any attempted extensions. Extensions must be relevant
and suit the core brand (see example).

Honda vs Levis

Honda had successfully extended its brand from automobiles into lawn equipment, marine
engines and other. Levis, however, failed to extend its brand into tailored suits.

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MKTG 621|4Ps: Price

The 4Ps (product, price, place, promotion) describe a set of 4 tactical aspects that a marketing plan must
consider. Under price, one must consider pricing strategy. Effective pricing strategy leaves nothing on the
table, and must consider costs (margin analysis), product line issues, corporate image, competitive factors (eg.
Skimming vs penetration strategies- price high initially to profit from early adopters vs price low initially to
capture market share), and customer price sensitivity (EVC; pricing experiments) in mind.

Kathon MWX

Kathon MWX set too low a price because it failed to take into account EVC analysis of its
channel collaborators.

MKTG 621|4Ps: Place

The 4Ps (product, price, place, promotion) describe a set of 4 tactical aspects that a marketing plan must
consider. Under place, one must consider channel design. The chosen sales channels must be relevant and
appropriate. For instance, it should be able to reach the customer, know how to sell to the customer, be
consistent with the companys brand image, and other. One key issue is direct vs indirect channels. Reasons to
go direct include the importance of non-selling activities like after-sales service, as well as the need for control
in properly selling a specialized product, and other. In general, direct channels have high startup cost and low
variable costs; indirect channels are the opposite.

Startup companies

More and more startup companies are going direct because of the lowered costs of doing so
via the internet.

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MKTG 621|4Ps: Place

The 4Ps (product, price, place, promotion) describe a set of 4 tactical aspects that a marketing plan must
consider. Under place, one must consider channel conflict. Having more channels is not necessarily better:
competitors may decide not to invest in marketing the product; they may undertake strategies (like discounts)
not consistent with the brand, and other. One way to reduce channel conflict is to give certain channels
exclusive rights over certain products/ types of customers. Another is simply to reduce the number of channels

Invisalign

Invisalign could have introduced an advanced version of its product, with more customization,
exclusively for orthodontists to sell. The basic off-the-shelf model would in contrast be
available to all. This would reduce channel conflict.

MKTG 621|4Ps: Promotion

The 4Ps (product, price, place, promotion) describe a set of 4 tactical aspects that a marketing plan must
consider. Under promotion, one must decide on the right mix of above-the-line (advertising) activities and
below-the-line activities (short-term incentives for consumers). Another key issue is the type of promotion
wanted. Mass media is good for building brand awareness; interpersonal sources like salespeople are good
for building brand adoption. Finally one must come up with answers for: what is the market; what is the
message content; what is the mission of the promotional campaign; what is the best way to design the
message; what is the best way to get the message out; how much money to spend; and how to measure the
effectiveness of the promotion.

Unilever in Brazil

In Brazil Unilever used a mixture of above-the-line (tv advertising) and below-the-line (road-
shows, painting on walls) to market their new product, with the message that their product was
for doting mothers to use for the good of their family.

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MKTG 621|Marketing Math

The first marketing math tool is break-even. Break-even analysis tells you what is needed for a new
marketing initiative to break-even. There are four ways it can be applied:

Break Even Analysis = Fixed Cost/Unit Margin

Price Discounts Break Even if: Discounted Unit Sales > Normal Profit Margin

Normal Unit Sales Discounted Profit Margin

New Products Break Even against Cannibalization if:
Cannibalization Rate < New Product Profit Margin

(% of new unit sales Old Product Profit Margin

coming from old unit sales)
Market Share Break Even:
Market Share after price discount should be > Normal Profit Margin x Normal Mkt Share
Discounted Profit Margin

Unilever in Brazil

In Brazil Unilever used a mixture of above-the-line (tv advertising) and below-the-line (road-
shows, painting on walls) to market their new product, with the message that their product was
for doting mothers to use for the good of their family.

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MKTG 621|Marketing Math

The second marketing math tool is economic value to consumer. This tells you the monetary value of the
benefits the consumer gets from the product by considering its incremental value over the next best
alternative:
ECONOMIC VALUE TO A CUSTOMER
EVCx = LCy SCx PPCx + IVx
X = Your product, Y = Reference product
Reference product = competitors product
LCy = Life Cycle Cost of competitor = Purchase Price + Start up cost (SC) + Post-Purchase
Costs (PPC) of competitor
Start-up Costs = Initial costs not included in purchase price (i.e. modifications, space, power, a/c,
training. etc.)
Post-Purchase Costs = Ongoing costs borne by customer once product is in use (maintenance, repair, continual
training, raw materials, operating costs, inventory costs, etc.)
Incremental Value = amount by which products potential dollar value to customer exceeds that available
from the reference product
Note: EVC is the price you can charge (since its the value to the customer).

IBM Mainframes

IBMs competitors cost $3000, and IBM has no additional start-up costs. There is a yearly
maintenance contract of $300 for 10 years, but customers save $500 per year.

EVC = $3000+ $500*10- $300*10= $5000

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MKTG 621|Marketing Math

The third marketing math tool is lifetime value of the average customer. This tells you the profit that each
consumer will bring to you over his lifetime as a consumer with your company. This is best suited for systems
rather than one-off products.
LIFETIME VALUE OF AN AVERAGE CUSTOMER
Value of Customer: Annual customer contribution + {annual customer contribution * [annual retention
rate/(1+discount rate)]} + {annual customer contribution * [annual retention rate/(1+discount rate)]2} + +
{annual customer contribution * [annual retention rate/(1+discount rate)]n} - Acquisition Cost
(Discount Rate given, or assume)

Gillette

A promotion for Gillette gives the customer a discount of $10 per blade system. Each lasts for
2 years, and must have blades replaced at $20 per year. 90% of customers typically stay
with the company. Ignore discount rate.

2-year LTVC = -$10 + $20 + $20*0.9 = $28

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MKTG 621|Marketing Math

The fourth marketing math tool is segment value. This tells you the potential revenue of each segment. It is
calculated using a chain model:
Segment Value = Number of customers in segment * value per average customer in segment
Where (for example)
Number of customers = population * segment size (%) * segment penetration (%)
Value per customer = usage rate * unit price ($) * unit contribution

Gillette (from class)

Population = 40m urban males over 18 years old

Percentage which shaves = 80% shave

Total number of shavers = 40m * 80% = 32m

Frequent shavers (50%) use 15 blades a year

Occasional shavers (50%) use 4 blades a year

Average number of blades use for shavers: 15 * 50% + 4 * 50% = 9.5

Urban Unit Market Potential = 32m * 9.5 = 304m

Average price of blade = $1

Value of urban segment = $304m

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