Our Marketing Finance 101 gets Marketers to use price, costs, share and market size drive brand profit. We provide financial formulas needed to run your brand.
Anyone who does not include “profit” in their definition of brand likely has never run a brand before. To me, a product is a basic commodity you sell. The only reason you would ever invest in a brand is you believe you can get more back than the investment. Otherwise, just sell the product as a commodity.
If you wish to succeed in Brand Management, you have to understand brand finance. After all, you are running a business. If you just like the activity of Marketing, then you should become a subject matter expert, because you will not get promoted past Brand Manager.
A Quick Dissection of the Financial Statement
When your Finance Manager hands you the brand’s Profit and Loss (P&L) statement, here are the first three things you should look at:
The first thing to look is the gross margin percent, which you figure out by dividing the overall gross margin by the overall sales. While it is a good starting indicator of the financial health of the brand, compare it over time to see the trend line, and then compare the rate with other brands in your portfolio or competitive brands in the category. In this example, the gross margin % is down from 43% to 37% over the last 3 years.
This would prompt you to go a layer deeper to see if the margin decline is due to pricing or cost of goods. In terms of pricing, it could be an overall price decrease, increases in trade spend or shifts in the sales mix to lower margin items. For the cost of goods, it could be driven by factors outside the brand’s control such as foreign exchange, raw material cost increases, duties and transportation costs. It could also be strategic decisions by changing a raw material, increasing quality control, changing suppliers or changing the location of your production.
Next, look at Contribution Margin percent by dividing the bottom line contribution income by the overall sales. As you can see in the example above, Contribution Margin percent has fallen from 26% to 17%. The declining bottom line contribution margin lost dollars going from $5,763 to $4,772. The increased gross margin dollars were not enough to cover off the increase in the spending.
Then look at the comparison between the sales growth rate and the spending growth rate. In this example, the sales are growing at a healthy 12%, while the total spend is growing at 22%. There are now two issues with profits: the falling gross margins and the increased spending is not paying off
Tool for doing a quick assessment of your brand’s financials
The eight ways you can drive brand profits
- Premium pricing
- Trading up on price
- Lower cost of goods
- Lower sales and marketing costs
- Stealing competitive users
- Getting loyal users to use more
- Entering new markets
- Finding new uses for the brand
Profit = (Price – Cost) x (Market share x Market Size)
1. How to use premium pricing
While many Marketers think of price as a defensive reaction to counter inflation or something happening in the trade channels, the smartest Brand Leaders should use price as a weapon to drive brand value. It is crucial to understand the price/quality relationship of the brand and look for ways to increase the perception of quality, by separating the brand from competitors and then work to tighten the bond with consumers.
Brands at the beloved stage are more capable of driving profits through pricing; leveraging their power with consumers to ensure the price premium is never perceived as excessive. For instance, consumers are certainly willing to pay $5 for a Starbucks latte, $500 for an iPad or $100,000+ for a Mercedes. It is also crucial to understand the competitive pricing situation because price/value is always relative to other options the consumer could choose. Look at the average pricing as well as the average promotional pricing and the percent that is sold on deal.
- Price increase: Brands can execute a price increase when the market or the consumers allows the brand to do so. When the brand holds power over consumers and distribution channels, they can push price increases through. However, when going through retail channel partners, brands usually require proof of explanations when the brand is passing along cost increases. Factors that help the brand story, include the health of the brand, health of the market as well as the power of the brand versus consumers, competitors or the channels. A beloved brand would have an inelastic price, which means the quantity demanded does not change much when the price changes.
- Price decrease: This is used when battling a competitor, in reaction to sluggish economic conditions or retail channel pressure. You can also use an aggressive price decrease is when you have a cost advantage, whether that’s manufacturing, materials or distribution, and you choose a strategy to aggressively deplete the resources of your competitor.
There are watch outs for price changes. Make sure you understand the power relationships, especially with consumers, competitors, and retailers. Price changes through retailers can be very challenging, as they will always be heavily scrutinized by retailers requiring proof of why you are changing the price. Price changes carry a risk of a competitive over-reaction. Always consider various potential competitive reactions when doing your financial analysis. Never take a price increase for granted, because as difficult as it is to implement a price change, it is almost impossible to change it back.
2. Trading the consumer up or down
Another strategy is to create a range of products at various price levels, with a good/better/best approach that allows the brand to reach up or down to a new segment of consumers. Make sure that you are doing this for the right reason or it could backfire on you.
- Trading up: Make sure the brand can carve out a meaningful difference to create a second or third tier, so the consumer can see a clear reason for wanting to move up. Make sure the brand’s bond with the consumer, the brand reputation and the product performance allows loyal consumers to trade up.
- Trading down: When the brand sees a potential unserved market, where the move will bring minimal damage to the image or reputation of the brand. In a tough economy, creating a lower priced set of products can be a smarter strategy than lowering the overall price of your main brand.
There are a few watch outs around trying to trade up or down. For a mass brand going through retail channels can be challenging to manage multiple price levels. The products with lower sales may receive poor shelf placement, and miss out on retailer-owned merchandising options. For the trading down, try to take costs out of the product to ensure margins rates stay consistent. Be careful not to lose focus on the brand’s core business or image. Stay focused because brands struggle when they try to be all things to everyone.
Here is one of the Financial formulas for a price increase.
3. Using product costs as a strategic weapon
Marketers usually assume that managing the cost of goods (COGs) is someone else’s job. However, product costs can be an effective strategic weapon that marketers should utilize.
- Decrease cost of goods: There are a few ways to drive down COGs. First, you can use your brand power and higher values to negotiate with suppliers. You can also find lower-priced raw materials, drive process improvement or explore offshore manufacturing.
- Increase cost of goods: The biggest reason to increase COGs is when going after a premium market or looking to offer an added benefit. In a high technology business, you need to keep investing and may need to cover off those investments. Watch out for suppliers trying to pass along costs, beyond inflationary rates.
When lowering product costs, make sure the product change is not significantly noticeable. Where there is a noticeable product change, understand the potential impact on the consumer perception of the brand’s performance or quality. When costs go up, make sure the increases can be covered through other parts of the profit statement, whether through price increases, volume increases or the cutting of Marketing costs. Managing your margins helps drive the long-term success of your brand.
Here is one of the Financial formulas for a determine the cost of goods sold (COGS).
4. Managing the sales and marketing costs
Marketers get protective of their Marketing Budget. They usually hope to have as much money as possible to carry out the long list of activities on their priority list. Brand Leaders should act like the Owner/CEO in terms of managing budgets, not like a subject-matter expert trying to protect their turf. As brands mature and move along the Brand Love Curve, you should be able to leverage that added power to shift to a more efficient marketing spend level. The more loved a brand, the more efficient the ‘spend to sales ratio’ for the brand.
The biggest impacts on the Marketing budget level are:
- Where does your brand stand in the product lifecycle?
- Where does your brand sit on the Brand Love Curve?
- What is the degree of competitive warfare in the category?
- What is your brand’s power over the trade channels?
Even though we think beloved brands have endless spending possibilities, they usually have a lower marketing investment to sales ratio. For example, as Apple’s sales exploded over the last decade, the Marketing spend remained fairly stable, giving Apple huge profit gains each year
- Marketing cost decrease: Many times companies look at cost-cutting to counter short-term changes happening within other parts the P&L (price, volume or COGs). However, many of the best-run brands keep the investment strong, aligning with the longer-term strategy, not the short-term budget situational needs.
- Marketing cost increase: This should be used when there is an opportunistic chance to gain share against a competitor or as a defensive position trying to hold share. The brand should see opportunity where significant revenue gains can cover off the lower profit ratios.
Always bring a Return on Investment (ROI) mindset to spend. Be careful of competitive warfare situations as the competitor might over-react leading to spiraling spend escalations. Like a price war, marketing investment wars can drain resources, with very little market share change after the war.
Here is one of the Financial formulas for calculating Return on Investment (ROI)
5. Stealing other users
Externally, the share and volume game are traditional tools for a brand.
- Offensive share gains: Look to make share gains using a significant competitive advantage to steal share or when the brand sees an unmet need in the market. Use first mover advantage on new technology.
- Defensive share stance: Use this to hold your market share until your brand can catch up on technology, by protecting your loyal base of consumers from a competitive attack.
Be careful when trying to gain share. As discussed in the competitive thinking section, attacking competitors can prove difficult. Many times, an attack could result in a spend escalation with neither brand making any gains. Yet, after a share war, which is not based on a substantive competitive advantage, there may not be any winners, just losers.
6. Getting users to use more
Going after frequency can be a difficult strategy. It means telling consumers, who have already decided how to use your brand; they should use your brand more.
- A share of requirements: In many categories, even loyal consumers will work within a competitive set of favorite brands. You need to provide a reason, through claims, experiences, or emotions, to persuade loyal consumers to use your brand for every usage occasion.
- Get current users to use more: Look for opportunities with loyal users to create a potential routine around your brand.
Changing behaviors is more difficult than enticing trial, which may make it a slow and expensive strategy. It is a good strategy to use when there is a real benefit to your consumer using more. It is hard to just get them to use more without a real reason. There has to be a real benefit connected to using more or it may look like a hollow or shallow money grab by the brand. Driving routines or rituals can be difficult. Even with lifesaving medicines, the biggest issue for consumers is compliance.
The best strategy is to link your brand to a part of their current life. Two great examples are Special K’s “Use for 2 meals a day for 2 weeks and you will lose 5 pounds” and McDonald’s “Free coffee for 15 straight days”, both brilliant ways to drive the routine.
Using the brand funnel to help your sales forecast
7. Enter new categories
Use when the brand sees an untapped consumer need that fits the brand. Make sure the new category feels like a natural fit with your brand’s Big Idea and you are able to transfer your brand’s reputation to gain entry into the new category. You must have a strong bond with your loyal users to bring them into a new category. There should be something within the new product that fits with the brand, enough to fuel success past any initial trial. Do not let it distract you from protecting the base business. For example, McDonald’s coffee entry has been successful, however, they took their eye off their food businesses, where they have lost significant sales.
8. Create new uses
Take the brand and create similar experiences into a new format or new offering. Need to make sure current brand is in order before you divert attention, funding and focus on an expansion area. Be careful of the temptations, because the legendary stories (Arm & Hammer or one-a-day Aspirin) do not come along as much as you might hope.
Here is one of the Financial formulas for calculating compound Annual Growth rate, otherwise known as CAGR
10 probing questions to assess your brand’s worth
- Your Compound Annual Growth Rate (CAGR)?
- What are your contribution margins over last 5 years? Have margins broken out by product line?
- What is your budget breakout? Variable direct costs versus indirect fixed dollars? Media versus production? Consumer spend versus trade spend?
- Pricing Elasticity studies?
- How are you performing overall and by the line of business?
- What are your current brand/business performance measures?
- Which programs are driving the highest Return on Investment (ROI)?
- What is driving your profit? What are you focusing on right now?
- Forecasting error rates? How good are your inventory rates?
- What are the financial pressures you face? Quarterly results?
Love = Power + Profit
To get better at Brand Finance, here is our Workshop we run to help Brand Leaders understand Accounting and Finance.
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