Rev. September 29, 1986
Basic Quantitative Analysis
Simple calculations often help in making quality marketing decisions. To do good “numbers work,” one needs only a calculator, familiarity with a few key constructs, and some intuition about what numbers to look at. This note has as its primary purpose the introduction of key constructs. The development of intuition about what quantities to compute can begin with this note, but is best accomplished by repeated analyses of marketing situations and application of the concepts and techniques presented here. Case study analysis provides that opportunity. The organization of the note is as follows. First we define key constructs such as variable cost, fixed cost, contribution and margin. Following definition of these basic constructs, we discuss a most useful quantity: the “break-even” volume. We show how to calculate and use this quantity in marketing decision making.
As marketers, we are usually concerned with understanding the market or demand for the product or service in question. However, if we are to assess the likely profit consequences of alternative actions, we must understand the cost associated with doing business as well. For example, consider a firm choosing a price for its new videocassette tape. The manager estimates weekly sales for different prices to be
Weekly Sales Estimate
Which price is best for the firm? From the data given so far, we cannot answer the question. We can calculate the expected revenue generated by each pricing strategy, but without cost information, it is not possible to determine the preferred price. This is the reason we begin this marketing note by considering key cost concepts.
The cost concepts we introduce are variable cost, fixed cost, and total cost. Second, we combine the cost information with price information to determine unit contribution and total contribution. Figure A shows the relationship between a typical firm’s unit output and total cost of producing that output.
Associate Professor Robert J. Dolan prepared this note.
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Basic Quantitative Analysis for Marketing
The first important feature of Figure A is that the total cost line (the solid line) does not go through the origin, i.e., for a zero output level, total cost is not zero. Rather, total cost is OA dollars as shown by the length of the double headed arrow in Figure A. We call OA the firm’s “fixed costs.” Fixed costs are those costs which do not vary with the level of output. An example of a fixed cost is the lease cost of a plant. The monthly lease fee is set and would be incurred even if the firm temporarily suspended production.
Total Cost as Function of Output
Output in units
Although OA dollars are fixed, a second component of cost, called “variable cost,” increases as output increases. As we have drawn Figure A, total costs increase in a linear fashion with output produced. In reality, it is possible for the total cost curve to be as shown in either Figure B or Figure C. Figure B represents a situation where each unit is cheaper to produce than the previous one. This would occur, for example, if the firm could buy raw material at lower unit prices as the amount it bought increased. Figure C shows the opposite situation, i.e., each unit is more...