A couple of years ago teaching introductory marketing I told my students they must have calculations in the final exam. They listened and gave me numbers. My students were mostly aim for investment banking. They thought finance had the “best” numbers and so used these. They gave me some marvellous numbers, e.g., EBITDA and NOPAT. These are important financial metrics but they aren’t “better” than marketing metrics. Indeed, many of the complicated calculations performed by the students were wrong for the choice being made in the exam. What then does a marketer need? Often marketers prefer contribution.
Your Choice Of Metric Depends Upon The Decision
The metric to use depends upon the decision. For instance imagine a product launch, head office rent will be the same regardless of whether you launch the product. My point is your decision does not impact head office rent. This makes rent irrelevant to the decision. If a cost is irrelevant the advice is simple, ignore it. For most marketing decisions what matters is contribution, revenue less variable costs.
“Contribution represents the proportion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs.“Farris, Bendle, Pfeifer and Reibstein (2010)
Note contribution is revenue less only variable costs. Fixed costs don’t change with the decision and what doesn’t change doesn’t matter to a choice. Of course, in the long run a CEO can change nearly all costs. Still, if you are a mid-level marketer taking medium term decisions many fixed costs aren’t under your influence. They don’t change whatever you choose.
Not Just Simpler: Often Better
Contribution doesn’t require complex cost allocations of fixed costs. This makes contribution easily explained but this isn’t just about simplification. Imagine a campaign with positive contribution but negative ‘profit’ because of allocated fixed costs. Positive contribution shows the proposed campaign makes money but using the profit yardstick means abandoning the campaign because of a paper loss generated by wrongly considering costs you’ll have to pay either way.
Marketers Prefer Contribution
In marketing it is usually contribution that matters (e.g. for product launches, advertising campaigns, social media strategies). The lesson is that more complex metrics aren’t necessarily better. Adding irrelevant items to a calculation at best confuses people, at worst leads to bad decisions. (Mostly) marketers prefer contribution.
For more on profit measures see here.
Read: Paul Farris, Neil Bendle, Phil Pfeifer and David Reibstein, Marketing Metrics: The Definitive Guide to Measuring Marketing Performance, Pearson Prentice Hall, 2010
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