hours” is a more accurate indicator of cost. The former base was used because it in-
volves less record keeping and computation.
Far more serious is another judgmental element affecting profitability analysis.
The issue is whether to allocate full costsor only direct and traceable costsin evaluat-
ing a marketing entity’s performance. The lawnmower company sidestepped this prob-
lem by assuming only simple costs that fit in with marketing activities. But the
question cannot be avoided in real-world analyses of profitability. Three types of costs
have to be distinguished:- Direct costs:These are costs that can be assigned directly to the proper mar-
keting entities. Sales commissions are a direct cost in a profitability analysis
of sales territories, sales representatives, or customers. Advertising expendi-
tures are a direct cost in a profitability analysis of products to the extent that
each advertisement promotes only one product. Other direct costs for specific
purposes are sales force salaries and traveling expenses. - Traceable common costs:These are costs that can be assigned only indirectly,
but on a plausible basis, to the marketing entities. In the example, rent was
analyzed in this way. - Nontraceable common costs:These are costs whose allocation to the marketing
entities is highly arbitrary. To allocate “corporate image” expenditures equally
to all products would be arbitrary, because all products do not benefit
equally. To allocate them proportionately to the sales of the various products
would be arbitrary because relative product sales reflect many factors besides
corporate image making. Other examples are top management salaries, taxes,
interest, and other overhead.
No one disputes including direct costs in marketing cost analysis. There is a small
amount of controversy about including traceable common costs, which lump together
costs that would change with the scale of marketing activity and costs that would not
change. If the lawnmower company drops garden supply shops, it will probably con-
tinue to pay the same rent. In this event, its profits would not rise immediately by
the amount of the present loss in selling to garden supply shops ($310).
The major controversy concerns whether the nontraceable common costs should be
allocated to the marketing entities. Such allocation is called the full-cost approach, and
its advocates argue that all costs must ultimately be imputed in order to determine true
profitability. But this argument confuses the use of accounting for financial reporting
with its use for managerial decision making. Full costing has three major weaknesses:- The relative profitability of different marketing entities can shift radically
when one arbitrary way to allocate nontraceable common costs is replaced by
another. - The arbitrariness demoralizes managers, who feel that their performance is
judged adversely. - The inclusion of nontraceable common costs could weaken efforts at real cost
control. Operating management is most effective in controlling direct costs
and traceable common costs. Arbitrary assignments of nontraceable common
costs can lead them to spend their time fighting arbitrary cost allocations
rather than managing controllable costs well.
Companies are showing a growing interest in using marketing-profitability analy-
sis or its broader version, activity-based cost accounting(ABC), to quantify the true prof-
itability of different activities. According to Cooper and Kaplan, ABC “can give
managers a clear picture of how products, brands, customers, facilities, regions, or dis-
tribution channels both generate revenues and consume resources.”^30 To improve prof-
itability, managers can then examine ways to reduce the resources required to perform
various activities, or make the resources more productive or acquire them at a lower
cost. Alternatively, management may raise prices on products that consume heavy
amounts of support resources. The contribution of ABC is to refocus management’spart five
Managing and
Delivering Marketing(^704) Programs