As a refresher, revenue on an income statement is referring to the product or services that were delivered during a period of time. It's not closed opportunities; it's what was actually delivered. Now that we understand revenue and liabilities, what exactly is profit and how does marketing factor into profit?
Profit is simply revenue minus expenses. This is typically the topic that makes marketers a bit uneasy because marketing has traditionally been viewed as an expense, a cost center. And when profits are down, companies are quick to cut costs. So, how can marketers demonstrate their contribution to profit, as well as eradicate low profitability while still keeping their jobs?
Companies typically calculate multiple measures of profit on an income statement. Gross profit shows the total revenue minus the cost of goods sold (COGS). Operating income and non-operating activities are added or subtracted to gross profit to determine total profit for a given period.
So, what is marketing's contribution to COGS or COS? Well, that's dependent upon how your company classifies services. Gross profit is a key number for most companies. It tells you the basic profitability of your products or services. Understanding why gross profit is changing, if it is, helps managers figure out where to focus their attention. This is especially relevant to marketers when considering which products to pursue in various regions and which channels to invest in like events, advertising, and social media.
The profitability index (PI) is a tool used to compare capital investments. When evaluating marketing technology, the business may be more interested in the PI versus the potential ROI of the tool. Calculating a PI helps the business understand which investments are likely to be most valuable to the business.
To calculate the PI, you must calculate the NPV calculations for the marketing technology investment. This will require some understanding of what value the technology can deliver in the future. Take the net present value and add back the initial investment of the marketing technology to get the present value. Then, take the present value of the technology and divide by the initial investment.
In marketing we've become very focused on measuring Return on Investment. But when you analyze profitability ratios like profit margin, return on assets and return on equity, ROI isn't included.
Why isn't ROI included? The problem is ROI has many different meanings. This is one of the challenges marketers have when demonstrating ROI. Traditionally, ROI was the same as ROA: return on assets. But it can also mean return on a particular investment.
What is the ROI on that technology? What's the ROI on our display ads? What's the ROI of our creative team? These calculations will be different depending on how people are measuring costs and returns.
3 fixes to low profitability
When companies are faced with consecutive quarters of low profitability, the most immediate fix is to lower headcount. By lowering headcount, companies can decrease cost which will increase profit. Of course the challenge with this is that it's a temporary fix. Lowered headcount can ultimately increase the COGS overtime. To avoid cutting headcount, marketing must figure out how they can increase profitable sales and/or lower production costs. Below are 3 considerations for improving profitability.
Increase profitable sales sooner: Companies must deliver products and services quickly, but do so in a cost effective way. Demand Prediction Reporting is becoming a highly requested feature. Manufacturers want to build out data models that track (or pull data over from an existing system) inventory, purchase history, frequency of purchase, quantities of assets, partner they buy from, average delivery time per partner and per asset. Based on the data model, they want to create dashboards that demonstrate trends in purchase (time of year, geography, etc), opportunities for up-sells and add-ons, and sales cycle duration. This information can be used to create automated trigger emails that send communications in the month or so leading up to when they typically order. Companies should integrate these systems and tie customer-facing channels into their sales, marketing, and production programs. Here are 3 marketing organizations that have recognized success in achieving demand insight.
Increase profitable sales through new markets and prospects and work them through the sales cycle: This is at the heart of marketing. By evaluating trends in digital engagement, companies can identify new regions to consider or new vertical markets to tackle. Social listening practices can hone in on industry trends and alert the marketing organization to potential new audiences. With a strong inbound strategy supported by strategic content practices, companies can identify new opportunities and guide them through a nurturing process. This nurturing program should deliver content aligned with their interests and personalized to the individual. By scoring both the implicit and explicit data, marketers can identify which opportunities sales should focus their efforts.
Lower production costs by finding and elevating the bottlenecks: Companies must shift from a cost world to a throughput world. With the rapid progress of technology, and the change in buyer behavior, the influence marketing has on throughput is increasing. Marketers must identify the system's bottlenecks, decide how to exploit the bottlenecks, subordinate everything else to the above decision, make sure everything marches to the tune of the constraints, and elevate the system's bottlenecks.
Now that we understand marketing's contribution to revenue and profit, next week we'll discuss how marketing can make a positive impact on cash flow and owner earnings.