Performance Management Blog

Posts Tagged ‘Metric’

When marketing meets finance: the break-even level of sales

Tuesday, February 16th, 2010

In a previous blog post we investigated the Return on Marketing Investment, a metric that analyzes the marketing activity from a financial point of view that is more complex than the revenue from sales generated by marketing.

The current blog post aims at exploring another area where finance meets marketing: the break-even analysis. In this area, we consider that finance actually needs marketing: the break-even analysis aims at determining from which point on (i.e. volume of sales), a business begins to generate profits.

Calculating the break-even level of sales is done by following the steps below:

Calculate your fixed production costs. These include the costs to produce that do not vary upon the volume of production and generally include the administrative costs (rent, secretary etc.)
Calculate the variable unit costs. These are costs that depend on the production volume (such as: salaries for the operational employees, utilities in the plant, raw materials etc.), that are divided to the volume of production to obtain the cost per unit.
Estimate the price that will be charged for each unit of the product or service. There are various price-setting strategies, such as adding a margin to the production costs, considering competition prices and even the break-even analysis itself can be used at setting the right price.

The break-even level of sales is then calculated as:

# Break-even level of sales = $ Fixed costs / ($ Price per unit – $ Unit variable cost)

The calculation formula is derived by the equation that reflects the zero profits:

$ Total revenue = $ Total costs

The result indicates the sales volume that needs to be achieved in order to attain the break-even – at which the revenues cover the costs, but no profits are obtained. From this sales level on, the business begins to generate profits.

After having calculated the break-even level of sales based on mostly financial inputs, the marketing department can estimate when and whether these levels of sales can be achieved and in which conditions.

Thus, the contribution of the break-even level of sales is considerable in what regards several financial decisions:

Finding the optimal fixed to variable costs combination
Comparing the estimated profitability of various options for investment
Setting optimum price levels

To take the analysis a step further, finance managers can even set targets for the profits they intend to achieve and calculate the expected level of sales that would generate these profits. This is done by adjusting the break-even calculation to include the profit targets, meaning we will now calculate the level of sales that will generate an expected amount of profits, not zero profits (as in the case of the break-even level of sales):

# Target volume = ($ Fixed costs + $ Profit) / ($ Price per unit – $ Unit variable cost)

For further reading and examples of calculating the break-even level of sales, you can follow:

Break-Even Analysis, Weatherhead School of Management

David Kinard (2009), Metric Monday – How Much is that Marketing Effort Worth?

Tags: Finance, Marketing, Measures, Metric, Performance Measures
Posted in Measure, Performance Measurement, Targets | No Comments »

When marketing meets finance: Return on Marketing Investment

Sunday, February 14th, 2010

One of the greatest challenges for marketing professionals is to “probate” the results of their activity in terms of financial numbers. To do so, a simplistic approach that might still be in use in organizations which lack an accurate performance measurement system is looking into the value of sales. Fair enough, marketing efforts should, in the end, lead to selling as much as possible. Brand building, image construction, client relationship optimization and all other marketing directions aim, in the end, at generating sales.

However, sales can be due to other reasons than marketing actions, on one hand, and on the other hand, measuring only the result is of no relevance, if not compared to the effort. The metric that integrates this comparison is the Return on Marketing Investment, or briefly, the ROMI.

Return on Marketing Investment is constructed on the same logic as ROI, in general, the difference being that marketing spent is more “easily gone”. If you invest in buying a plant for production, its value depreciates over time, but you can always resell it whereas marketing spent can hardly be recuperated, thus being more risky. From this point of view, it is argued even that marketing is not an investment, but simply an expense. However, as long as the marketing expense is done to generate future cash-flows, it is an investment, although not materialized in a tangible asset.

Although a subject of many opinions, there is a widely accepted calculation formula for ROMI:

% Return on Marketing Investment =

[($ Revenue attributable to marketing * % Contribution) - $ Marketing cost] /

$ Marketing cost

The purpose of measuring the return of the marketing effort is not just that of validating an expense in terms of returns generated, but also that of making comparisons between various marketing projects to outline their effects. And, not least, to impose a “discipline” in marketing actions that are somehow more difficult to quantify, both in terms of expenses (they might not require so much money spent on well defined marketing elements, but lots of time and less common expenses) and in terms of revenue. It can be the case of the below-mentioned social marketing.

However, using this metric requires careful attention as many implications can arise when dealing with the subordinate measures used for calculation. For example, as we have outlined in a previous blog post on Marketing program performance appraisal, $ Revenue attributable to marketing, or $ Incremental sales has to be estimated accurately, which can be a difficult task. In what concerns the marketing cost, inaccuracies can arise also, as organizations have different ways of allocation the marketing budget (by marketing function, by objective etc.), thus being difficult to isolate the part of marketing expense we are interested in.

In order to overpass these cautions, marketers measure marketing ROI for a particular campaign (that has a well defined budget and envisages one product).

Marketing ROI faces criticism in several respects, one of the most popular being that it does not take into account the carryover effect, which defines long term effects of marketing spending on revenue, generated mostly by brand-related aspects. It is considered that marketing spending contributes to brand consolidation, which can have effect on sales for long future periods, that are out of the marketing ROI measurement horizon.

Trend and statistics on marketing ROI:

There is an increasing need for marketing ROI and other measurements due mainly to the economic pressures (2009 Lenskold Group / MarketSphere Marketing ROI and Measurements Study)
The greatest ROI is gained in email marketing – $43.52 for every dollar spent (Direct Marketing Association, 2009)
However, 42% percent of email marketers do not know their return on investment from email marketing (Econsultancy & Adestra, Email Census 2009)

Further data on marketing ROI can be found on various sources. You can follow:

The Mckinsey podcast on Improving Return on Marketing Investment in High Tech
Marketing ROI Dead article from Michele Eggers, Customer Intelligence marketing strategist at SAS Institute
Return on Marketing Investment book from Guy R. Powell

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Tags: Key Performance Indicator, Marketing, Metric
Posted in Measure, Performance Measurement | No Comments »

The case for using a Performance Management Glossary

Friday, January 29th, 2010

smartKPIs.com Performance Architect update 4/2010

Some of the most asked questions in performance management discussions, either online or during conversations are:

What is the difference between a mission and a vision?
What is a KPI? How is it different from a measure?
What is the difference between Key Success Factors and Key Results Indicators?

They are generally centered on clarifying terms such: Mission Statement, Vision Statement, Goal, Objective, SMART Objective, Critical Success Factor (CSF), Value Driver, Key Result Indicator (KRI), Metric, Performance Measure, Performance Indicator, Key Performance Indicator (KPI), Initiative and Milestone.

It is a positive thing to ask such questions and engage in discussions to clarify them. It is surprising how many different views are expressed on the similarities or differences between these terms.

What is interesting is that generally such discussions take place outside organizational boundaries. It is as if within organizations it is expected that staff have an understanding of them. Or as if such discussions are intentionally avoided within organizations.

The logical deduction is that if such discussions take place outside organizational boundaries, staff still have a need to clarify such concepts that is not fulfilled internally.

While this cross-polenization of opinions helps in building an informed view at individual level, in an organizational context things are different. While diversity of views is welcomed, a united common understanding of key terms used across the organization enables good internal communication. It also helps in understanding strategy and the contents of performance management reports.

However, glossaries of terms are rather the exception than the norm in the use of performance management systems. This is rather surprising considering that the expected benefits to effort ratio is one of the highest of all the components of a system.

The possible benefits of using them are:

Conceptual clarity – Facilitate a clear understanding of the nuances of the cluster of performance management concepts
Alignment of corporate vocabulary – Provide a single point of reference to clarify terminology used across the organization
Building perspective – Paints a rich picture of available elements to be used as part of the performance management system and raise questions about the relationship between them.

The effort should be minimal as generally such glossaries average 50-80 terms, with 1-2 paragraphs of explanation each.

One of my favorite examples illustrating the importance of clarifying concepts through a glossary is the TOGAF 9 manual, containing The Open Group Architecture Framework (The Open Group, 2009). In version 8.1.1 of the manual, the glossary was a component of the Resource Base (additional to the manual itself). In the latest edition (9), the glossary is incorporated in Part 1: Introduction. It represents the third chapter of this part, following the Executive Overview (Chapter 1) and the clarification of core concepts (Chapter 2). The glossary is not considered an appendix anymore, but an important component of the manual, included in the introduction part, to facilitate the understanding of the rest of the manual.

Perhaps performance management implementations should have a similar approach, by considering the glossary not a nice to have, but a key initial step.

Ultimately, not what is written matters, but what and how is understood and used. However, every little bit of help in building clarity and alignment helps. While strategy management is compared to a safari in a savanna (Mintzberg et al, 2005), finding one’s way in performance management is more like an expedition in a jungle. The abundance of theories, frameworks, concepts and terms is much denser and requires a wider skill set to navigate. Performance Management glossaries have the potential to act as attenuators in reducing complexity. Ultimately it is all about getting smarter as the level of complexity increases.

Stay smart! Enjoy smartKPIs.com!

Aurel Brudan
Performance Architect,
www.smartKPIs.com

References

Mintzberg H., Lampel J., Ahlstrand B., (2005), “Strategy Safari: A Guided Tour Through The Wilds of Strategic Management”, London, UK, Financial Times-Prentice Hall
The Open Group (2009), “TOGAF version 9“, Van Haren Publishing, Zaltbommel

Tags: Critical Success Factor, Enterprise Architecture, Glossary, Goal, Initiative, Key Performance Indicator, Key Result Indicator, KPI, Metric, Milestone, Mission Statement, Objective, Performance Indicator, Performance Management, Performance Measure, SMART Objective, Target, The Open Group, TOGAF, Value Driver, Vision Statement
Posted in Performance Architect update, Performance Management | No Comments »

Performance Management IQ Test or a hermeneutic dialectic process

Saturday, January 23rd, 2010

smartKPIs.com Performance Architect update 3/2010

A new feature available on http://www.smartKPIs.com starting with this month is the smartKPIs Performance Management IQ test.

It consists of a set of 24 statements that appear on the screen one at the time. The task on hand is to decide what each of these statements represents from a set of 12 options:

Mission Statement
Vision Statement
Goal
Objective
Target
SMART Objective
Critical Success Factor (CSF) / Value Driver
smartKPI / Key Result Indicator (KRI)
Metric / Performance Measure / Performance Indicator
Key Performance Indicator (KPI)
Initiative
Milestone

Only one option can be selected as there should be only one option closest to the way the statement is understood and perceived.

The term “IQ test” is pretentious and used to illustrate that being smart in performance management transcends the mechanistic approach of being right or wrong. Having this in mind, the test should be used more as a guide to discover the rich diversity of views on how key terms are or should be used in performance management. Overall the test should be a fun way to rediscover the basics of a performance management glossary. Ideally it should also raise questions about what actually happens in practice, away from the prescribing nature of management books, academic articles and management consultant’s opinions.

To me there are three key learning points illustrated by the test:

1. Performance Management as a discipline contains elements that closely link it to a multitude of other disciplines and organizational capabilities: Strategy Management, Project Management, Human Resources Management, Accounting and Psychology, to name a few. Understanding such linkages and the origins of key terms are an important step in building a robust basis for architecting organizational performance.

2. The popular understanding and perception of certain terms in practice may be very different compared to academic and consultant’s viewpoints. What matters in the end is how such concepts are used in practice to generate value and not necessarily which is the “perfect” definition of what a KPI is.

As Stringer (2007) put it: “Constructions are created realities that exist as integrated, systematic, sense-making representations and are the stuff of which people’s social lives are built. The aim of inquiry is not to establish the truth or to describe what really is happening but to reveal the different truths and realities – construction – held by different individuals and groups. Even people who have the same facts or information will interpret them differently according to their experiences, worldviews and cultural backgrounds.”

3. Have an open mind in terms of rediscovering performance management through the lens of various viewpoints and be prepared to change perspectives or shift entire paradigms. According to one view, by completing the smartKPIs Performance Management IQ test you have completed a test and reviewed different opinions on specific topics. From another viewpoint (Guba and Lincoln, 1989), you have just completed a hermeneutic dialectic process, as new meanings emerge as divergent views are compared and contrasted.

Stay smart! Enjoy smartKPIs.com!

Aurel Brudan
Performance Architect,
www.smartKPIs.com

References

Stringer, E. T. (2007) “Action Research, 3rd Edition“, Thousand Oaks, CA, Sage Publications.
Guba, E. G. and Lincoln, Y.S. (1989), “Fourth generation evaluation“, Newbury Park, CA, Sage Publications.

Tags: Critical Success Factor, Goal, hermeneutic dialectic process, Initiative, IQ test, Key Performance Indicator, Key Result Indicator, KPI, Metric, Milestone, Mission Statement, Objective, Performance Indicator, Performance Measure, SMART Objective, smartKPI, Target, Value Driver, Vision Statement
Posted in Performance Architect update, Performance Management, smartKPIs.com | No Comments »