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10/1/15 We have learned that Marke+ng Investment and Financial Hurdle Rates •  Profit Func+ons associated with Financial Investments and Profit Func+ons associated with Marke+ng Investments are totally different in character Ted Mitchell Financial and Marke+ng Profit as Func+ons of Investments MROR at a point
Quadratic
Relationship
Z = aI –bI
Profit, Z Direct
Relationship
Z = r(I)
Profit, Z Slope of Direct
relationship has
constant value
r=k
Financial
Investment, I
(I, Z)
MROR = ∆Z/∆I
Rates of Return Are Different •  There are Average and Marginal Rates of Return with Financial Investments •  However, with Financial Investment the AROR = MROR = a constant value, k •  AROR and MROR with Marke+ng Investments are not equal and don’t have constant values Marketing
Investment, I
AROR at a Point (I. Z)
AROR = Z/I
Rates of Return from Financial Investments and Marke+ng Investments Are Very Different Financial AROR and MROR are equal to the constant rate, k Rate of Return, r Rate of Return
has constant
value, r =k
k Rates of Return Average Rate of
Return,
AROR = a–bI
Area AROR(I) is
the Profit,
Z = (a–bI)I
Area k(I) is the
Profit, Z = r(I)
Financial
Investment, I
Marginal Rate
of Return,
MROR = a–2bI
Marketing
Investment, I
The Financial Marginal Rate of Return •  Which is called the interest rate is oNen given to marke+ng managers as a Hurdle rate •  A Hurdle rate, h, is an interest rate which the marginal rate of return on marke+ng, MROR, must be larger than •  For a marke+ng Investment to be approved the MROR on the Marke+ng Investment must be greater than the hurdle rate, h, MROR ≥ h 1 10/1/15 MROR on Marke+ng ≥ Financial Hurdle Rate, h Do NOT get caught in the •  Conceptual Trap that the MROR on Marketing
Investments is equal to the AROR on
Marketing Investments
•  In Marketing MROR ≠ AROR
Marginal Rates of Return h Marginal Rate
of Return,
MROR = a–2bI
Marketing
Investment, I
Do not assume that the Marke+ng MROR is the same value as the AROR! Rates of Return Rates of Return Average Rate of
Return,
AROR = a–bI
h Marketing
Investment, I
Marginal Rate
of Return,
MROR = a–2bI
Using the AROR on marke+ng to determine when you reach the hurdle rate leads to very poor investment decisions MROR at a point
Average Rate of
Return,
AROR = a–bI
Quadratic
Relationship Z
= aI –bI
Profit, Z (I, Z)
MROR = ∆Z/∆I
+ Marginal Rate
of Return,
MROR = a–2bI
Average Rate of
Return,
AROR = a–bI
h Marginal Rate
of Return,
MROR = a–2bI
Rate of Return Do not base decisions regarding the level of marke+ng investment on the False assump+on that a financial hurdle rate is an AROR Marketing
Investment, I
Marketing
Investment, I
Example of finding the •  Expenditure Level for the Marke+ng Investment that will have the MROR at that level equal to the hurdle rate, h, provided by the firm Marketing
Investment, I
AROR at a Point (I. Z)
AROR = Z/I
2 10/1/15 The quadratic equation which describes the
relationship between the financial gain, Z,
and a Marketing Investment, I
Marketing Profit, Z
The quadratic equation implies an optimal
level of marketing investment, I, will
maximize marketing profit, Z
Marketing Profit, Z
Z = 0.61I – 0.0002I2
Z = aI –bI2
0, 0
Amount of Seller’s Investment, I
0, 0
Amount of Seller’s Investment, I
I Where the MROR = 0 Market research provides the es+mates for a and b With a Quadratic Profit Function, Z = aI –bI2
•  The Marginal Rate Of Return at any point on
the marketing profit function is written as
•  MROR = a – 2bI
•  Remember values ‘a’ and ‘b’ have been
provided by market research
What is the level of marketing investment, I, that
makes the MROR equal to zero, 0?
Rates of Return Average Rate of Return,
AROR = 0.61–0.0002I
O I
Marketing
Investment, I
Marginal Rate of Return,
MROR = 0.61–2(0.0002)I
Op+mal level of marke+ng Investment •  Will maximize the profit being returned is
where MROR = 0
•  In general
MROR = a – 2bI and set equal to zero
•  a – 2bI = 0
•  –2bI = –a
•  I = a/2b
For our specific example •  Where the
MROR = a – 2bI set = 0
•  0.61 – 2(0.0002)I = 0
•  –(0.0004)I = – 0.61
•  I = 0.61/0.0004
•  I = $1,525 as the optimal level of investment
for maximum profit
3 10/1/15 To find the level of marke+ng investment that makes What is the level of marketing investment, I, that
makes the MROR equal to hurdle rate, h?
Rates of Return h = 15% Average Rate of Return,
AROR = 0.61–0.0002I
O I
Marketing
Investment, I
•  MROR on the marketing investment equal to the
financial hurdle rate, h, is
•  To set the MROR function equal financial hurdle rate, h
•  MROR = h
•  a – 2bI = 15%
•  0.61 – 2(0.0002)I = 0.15
•  – 2(0.0002)I = 0.15 – 0.61
•  (0.0004)I = 0.46
•  I = 0.46/0.0004 = $1,150, the hurdle rate investment
Marginal Rate of Return,
MROR = 0.61–2(0.0002)I
Example of Calcula+ng AROR •  The value of a = 0.61 and b = 0.0002
•  When the firm is spending the amount needed to have
MROR = hurdle rate, 15%
•  What is the average rate of return on that $1,150
investment
•  Answer
•  AROR = a – bI
•  AROR = 0.61 – 0.0002(1,150)
•  AROR = 0.61 – 0.23
•  AROR = 0.38 or 38% average rate of return
•  When the MROR is only 15%
AROR = Z/I
AROR = $437/$1,150 = 38%
AROR = a – bI = 38%
Profit, Z $437
+ MROR = ∆Z/∆I
MROR = a – 2bI = 15%
Observed
Point
(I, Z)
Profit function,
Z = aI – bI2
$1,150
Investment, I
Where a = 0.61 and b = 0.0002 When you have a hurdle rate, h AROR = Z/I
AROR = $437/$1,150 = 38%
AROR = a – bI = 38%
•  You will never reach the op+mal level of marke+ng investment Profit, Z $437
+ MROR = ∆Z/∆I
MROR = a – 2bI = 15%
Observed
Point
(I, Z)
Profit function,
Z = aI – bI2
$1,150
Investment, I
$1,500 4 10/1/15 Any ques+ons on Hurdle Rates •  That Finance may throw at us •  Marketers get frustrated with financial hurdle rates! •  We fail to achieve op+mal marke+ng profits 5