Using CRM to Manage Marketing Productivity

Robert P. Bush
University of Louisiana, Lafayette

James H. Underwood III

University of Louisiana, Lafayette

ABSTRACT. The appropriate tool for measuring and managing marketing productivity is the present value of the total dollar contribution produced, divided by the total dollar value of the marketing effort expended to produce it. This ratio is referred to as the contribution return on marketing effort or CRM ratio. CRM integrated with activity based costing (ABC) and activity based management (ABM) systems, value analysis and value engineering (VA-VE) techniques offer a viable and practical foundation for managing customer relationship efforts and linking them to customer- and share holder value. The article offers a systematic approach for integrating contribution return on marketing (CRM) with customer relationship management (CRM). doi:10.1300/J366v06n02_07 [Article copies available for a fee from The Haworth Document Delivery Service: 1-800-HAWORTH. E-mail address: <docdelivery@haworthpress.com> Website: <http://www.HaworthPress.com> 2007 by The Haworth Press, Inc. All rights reserved.]

KEYWORDS. Contribution return on marketing, CRM, return on marketing, activity based costing, customer relationships, value analysis, customer value, shareholder value
Robert P. Bush, PhD, is Associate Professor, Department of Marketing and Legal Studies, Moody College of Business Administration, University of Louisiana, Lafayette, Lafayette, LA 70504 (E-mail: rpb8337@louisiana.edu). James H. Underwood III, DBA, is affiliated with the Department of Marketing and Legal Studies, Moody College of Business Administration, University of Louisiana, Lafayette, Lafayette, LA 70504 (E-mail: jhu3873@louisiana.edu). Journal of Relationship Marketing, Vol. 6(2) 2007 Available online at http://jrm.haworthpress.com 2007 by The Haworth Press, Inc. All rights reserved. doi:10.1300/J366v06n02_07

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INTRODUCTION For some time scholars and practitioners from a wide variety of disciplines have been concerned with the productive use of economic resources. Productive use of natural, human, and capital resources is important to human welfare and endeavor. Productive resource use defines standards of living and guides their allocation through the mechanisms of a market economy. Marketers, as other users of resources, have sought to define, measure, and improve the productivity of the resources deployed in marketing effort. This paper summarizes recently reported efforts in marketing and related literatures that seek to define and measure the productive, effective, and efficient use of marketing effort. It advances three propositions. One, the appropriate measure of marketing productivity is the total dollar contribution margin produced by the effort divided by the dollar value of the marketing effort used to produce it. This ratio is referred to as the contribution margin return on marketing effort or CONROME. Two, marketers can measure and manage marketing productivity, effectiveness, and efficiency using traditional cost or activity-based accounting tools. And, three, CONROME, integrated with traditional cash flow analysis and coupled with return-on-investment (ROI) and internal-rate-of-return (IRR) analysis provides the appropriate rationale for deploying marketing effort. Productivity Concepts Sevin (1965) addressed the issue of marketing productivity in the middle 1960s. He and subsequent writers viewed marketing productivity as the relationship between inputs and outputs. Writers in other disciplines such as economics, accounting, engineering, as well as production and operations management, to name a few, saw productivity in much the same way. Economists usually define productivity as the measure of real output per unit of input. McConnell and Brue (1996) provide a typical example. Attempts to measure productivity thus require measures or estimates of input and output variables. In the simplest case, the flow of output can be measured physical quantities of output produced per period of time and the flow of inputs can be measured by the physical quantities (of inputs) used or consumed (for the same period). Situations arise however, when simple measurement is not possible (e.g., when output consists of multiple products or services, when inputs can-

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not be directly associated with outputs, or when the output results from an aggregate of individual economic units). Economics writers concern with productivity usually applies to production activities or functions, but the concepts apply equally to other business functions or processes. Accountants, likewise define productivity as the ratio of output to input (Blocher et al., 2005). Productivity measures can be operational, where both numerator and denominator are physical measures, or financial, where numerator and denominator are in dollar terms. Horngren, Datar, and Foster (2003) affirm that productivity measures the relationship between actual inputs used (in quantities and costs) and the actual outputs produced. Production and operations management researchers agree with economists and accountants. Stevenson (1999, p. 38) provides a typical definition: Productivity is an index that measures output (goods or services) relative to the input (labor, materials, energy, and other resources) used to produce them. Researchers in all these disciplines agree that productivity concepts apply to total outputs produced relative to total inputs used, total factor productivity or TFP, as well as to partial productivity that compares the quantity of a specific output produced to the quantity of a specific input used. Marketers adopt a similar notion of productivity, the ratio of outputs to inputs. According to Sevin (1965, p. 72) . . . Marketing productivity refers to the ratio of sales or net profit (effect produced) to marketing cost. . . . Others argue that logistics costs and (other marketing costs) can be controlled through the use of productivity ratios that express various output-to-input relationships (e.g., Kearney, 1978; Armitage, 1984; Stock and Lambert, 2001). Specific output and inputs contained in the ratios depend upon the concern of the managers involved. On a periodic basis warehouse managers, for example, might develop and use measures such as number of orders shipped/number of direct hours worked. Transportation managers might use ton-miles transported/total freight costs. Logistics managers can develop and use numerous partial productivity measures (ratios) for a variety of logistics activities. For example, company operated warehousing activities may include receiving; put away; storage; stock replenishment; order selection; packing and marking; order staging; and the like. For a private fleet, line-haul transportation activities may include loading, line-haul, and unloading activities. For a private pickup and delivery fleet, transportation activities would include pre-trip; stem-driving; route-driving; at-stop; and

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end-of-trip activities. Outputs may include aggregate measures such as orders or units shipped for warehousing operations; ton-miles transported; number of stops or customers served; number of shipments transported to destination for transportation activities. Inputs might include unit measures of labor; equipment; storage space; and energy or dollar cost. Stock and Lambert (2001) point out that productivity ratios, while easily understood by managers and employees, have several shortcomings. First, the difficulty of predicting future logistics costs and actual dollar losses due to inefficiencies make it hard to cost-justify system changes that will improve productivity. Second, calculated productivity ratios are seldom compared to productivity standards (i.e., what the ratios ought to be). Third, changes in output levels will distort productivity measures if the fixed and variable elements are not delineated. This distortion will occur if the output measure represents full utilization of a particular resource. In such a case the ratio measures utilization of the resource. These shortcomings, while noteworthy, are not inherent in the productivity measures themselves, but result from their naive use. Forecasts, while imperfect, represent the best estimates of expected outcomes. Enlightened budgeting procedures using activity based management and costing systems specify standards of performance and seek to delineate clearly fixed and variable components. Total Factor Productivity Total Factor Productivity (TFP) is the ratio of a particular aggregate measure of total output produced to an aggregate measure of all inputs used to produce it. The numerator in the TFP ratio can be expressed in units or monetary values reflecting the total units produced or their total monetary value. The denominator in the TFP ratio is aggregate value or cost of all inputs used in the production of the outputs. If the numerator and the denominator are both expressed in physical units, the ratio measures operational productivity. If the numerator or the denominator is expressed in monetary terms, the ratio measures financial productivity (Blocher et al., 2005). By definition, then, TFP measures financial productivity since the denominator, total inputs, must be expressed in monetary terms. Using a total productivity measure has the advantage of making it difficult for personnel to manipulate selected input factors to improve the apparent productivity of others. However, a total productivity measure also has several disadvantages.

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First, total productivity is a financial productivity measure, which may make it hard for operating personnel to link it to their daily activities. Second, declines in total productivity can result from resource cost increases or productivity decreases in inputs beyond a managers control. Third, ambiguous relationships between controllability of operations and a productivity-based performance measure may defeat the purpose of measuring productivity. Fourth, using different base periods for assessing productivity may make it difficult to compare changes over time. Fifth, total productivity measures can ignore effects of changes in demand, selling prices, and the effects of special purchasing or selling arrangements which may affect the size of the operation, the mix of resources used or their relative prices. Consequently, they may affect productivity (Blocher et al., 2005). Partial Productivity Partial productivity is the most commonly used productivity measure. It compares the quantity of output produced to the quantity of an individual input used (Horngren et al., 2003). Most often the inputs and outputs of interest are those that of concern to a particular functional manager. Numerous partial productivity measures exist. Partial operational productivity is measured by describing the relationship between the output or some of its components and part of the required input resources employed in producing the output. Partial operational productivity equals number of output units produced divided by number of input units used. Total units produced/total labor hours used (i.e., output per labor hour); total units produced/total machine hours used (i.e., output per machine hour), and similar measures are common examples of partial operational productivity. Operational productivity provides the means by which to compare and evaluate the rates at which selected resource inputs are converted to outputs and their productivity from one period to another. If the value of the output or the cost of the inputs are stated in monetary terms the ratio measures partial financial productivity. Partial operational productivities can be converted to their financial counterparts by expressing them in terms of their respective dollar costs or values. If the numerator is in units and the denominator is in dollars, the ratio reflects the units of output for each dollar spent on the input. Partial productivity measures enable decision makers to determine if changes in performance are due to changes in outputs, input costs, or productivity. Partial operational productivity measures that have physical units in

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both numerator and denominator are easier to benchmark, since the effects of price changes are excluded. Partial financial productivity measures can be used in operations that produce multiple products and use multiple resource inputs (using dollars as common terms), but have the disadvantage of ignoring other factors that may affect resource productivity and imply no efficiency standards. Efficiency Efficiency is typically a dimension of performance evaluation. Efficiency is the relative amount of inputs used to achieve a given level of output, the ratio of outputs to inputs. Fewer amounts of inputs for a given level of output or greater outputs, for a given level of inputs, mean greater efficiency (Horngren et al., 2003). Efficiency is a narrower concept than productivity. Efficiency pertains to getting the most out of a set of resourcesa plant of given size, a sales force of a given number, or another resource of a given amount. Productivity is concerned with the overall use of resources. Efficiency is concerned with the magnitude of the output produced with a given level (and mix) of inputs using a given technology. For example, analysis of sales force efficiency would focus on the best way to deploy the current sales force using present sales technology. Analysis of sales force productivity would include the possibility of sales force automation using computer- and information-related technology to improve sales results. Effectiveness Effectiveness is the degree to which a predetermined objective is met (Horngren et al., 2003). Firms are effective if they meet or exceed the goals they establish (Blocher et al., 2005). The hinge pin of managing effectiveness is a budget or plan that operationally defines, spells out, and sets quantitative goals for performance and the use of resources. For a detailed discussion of budgets, interested readers may refer to any standard treatment of budgeting procedures. The difference between the planned or budgeted results and the actual results measures the extent to which the firm was effective in its performance. An organization can be effective in reaching its goals (i.e., it attains them). It can be inefficient, however, in their attainment in that it uses more resources than planned or budgeted for the results produced. Both ineffectiveness and inefficiency occur when an operation fails to achieve a quantitative goal, a sales volume objective in dollars or

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units, for example, and uses more resources, sales salaries, for example, than budgeted for the volume produced. Establishing appropriate budgets or standards of performance is central to measuring and improving productivity. Standards for financial productivity must establish effective levels of marketing budgets and effective allocation of marketing expenditure among marketing mix elements. Effective levels of marketing effort require the minimum return on marketing effort (i.e., capital invested) should be at least equal to the return generated by alternative uses of the capital. The firms historical internal rate of return (IRR) would typically represent its opportunity cost and the basis for a return on investment (ROI) objective. Firms with established ROI objectives typically use a hurdle rate that specifies a minimum required rate of return consistent with past internal return rates or expected future financial performance. This hurdle rate applies to all capital uses and all expenditures including marketing budgets. Under capital rationing, the optimal level of marketing budget (expenditure or effort) should be established by comparing the ratio of the value of the return produced by marketing expenditures (in economists terms, its marginal revenue product) to the amount of the expenditure on marketing. The marketing budget or expenditure should be increased to the level that maximizes profit. Under capital rationing, the profit maximizing level of marketing expenditure is the point where marketings ratio of return to expenditure is equal to the returns-to-expenditure ratios for the firms other activities (e.g., production and operations, engineering, R&D, and so forth). Optimal allocation of the marketing budget to mix elements requires the same optimality criterion, equality of the ratios of dollar value of the marginal output produced (marginal revenue product) by each mix element to the marginal amount spent (marginal cost) on each element for all elements of the marketing mix. Allocation of the marketing budget to various target markets such as sales territories, customer groups, marketing channels or other segments also requires that the marginal dollar spent in each target market earn the same marginal profit. Effective Efficiency Sheth and Sisodia (2002) endorse the notion advanced by Thomas (1984), that marketing productivity is related to two dimensions of marketing performance, first, effectiveness, which relates to marketing management creating the right marketing mix, (i.e., the mix that produces customer satisfaction), and second, the efficiency of market-

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ing spending. In the pursuit of effective efficiency, marketing managers (should) advance marketing productivity first, by striving for effectiveness, followed by seeking efficiency in the achievement of effectiveness (Sheth and Sisodia, 2002). Using these dimensions of productivity, Sheth and Sisodia (2002) identify four classifications of marketing performance: Premium Marketing, where effectiveness is high and efficiency is low. Premium Marketing results in satisfied customers and high marketing cost; Death-Wish Marketing, where both effectiveness and efficiency are low. Death-Wish-Marketing alienates customers and has high marketing cost; Hit-and-Run Marketing, where efficiency is high and effectiveness is low. Hit-and-Run Marketing has low marketing cost, but alienates customers; and Effectively-Efficient Marketing, where both effectiveness and efficiency are high. Effectively-Efficient Marketing generates satisfied customers at low marketing cost. Because effectiveness revolves around a specified output goal or objective, appropriate measures must be employed to set quantitative output goals, and to determine and manage the inputs that produce them. Marketers decision makers thus must clearly conceptualize and operationally define the outputs that marketing effort produces. Measures of Outputs Researchers in the business and marketing literatures conceptualize the outputs of business and marketing processes in a variety of ways and from several points of view. In so doing, one may adopt the perspective of the firm and its major internal interest groups, managers, owners or employee, or the point of view of the firms major outside publics: financial, regulatory, political, or the general public may be of primary concern. The perspective of strategic partners, suppliers, and channel and supply chain participants may also play a role in defining a firms or organizations output. Customers of the firm or organization certainly have an important perspective in conceptualizing its output. All interests view and conceptualize the firms output in terms of the way it affects them. Owners and managers typically concern themselves with their firms performance in terms of financial returns and are likely

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to define outputs and inputs accordingly. Lending institutions and funding sources are also likely to consider outputs and inputs in financial performance terms. Strategic partners are likely to consider outputs and inputs according to how collaborating firms actions contribute to their own mission and objectives. Regulatory and political publics are likely to see a firms output in ways consistent with their own regulatory responsibilities or political agendas. The Environmental Protection Agency and OSHA, for examples, may be more concerned with a firms production of negative externalities such as environmental pollution or work place hazards than its delivery of positive benefits through the goods and services produced. The general public and political action groups may see a firms output as a mix of positive and negative consequences of its actions. For example, some may acknowledge limited positive benefits from fast food, but see the output of some firms in the fast food business primarily as obesity and poor health, or in the case of tobacco and alcohol firms, as lung cancer and traffic fatalities. Customers, likewise, see a firms output largely as its ability to produce satisfaction of their needs and wants. It seems clear that concepts of output depend on the perspectives, needs and perceptions of constituencies. Table 1 summarizes several of the major ways that scholars and researchers conceptualize, define and measure an organizations output, relevant inputs and the perspective or primary point of view each approach assumes. Output Concepts and Metrics Customer satisfaction: Satisfaction, measured from the customers point of view is the feeling that a product or service has met or exceeded the customers expectations. Measured from the organizations point of view, satisfaction can be measured as percentage of the organizations customers giving the firm or its products a specified target satisfaction rating. Customer retention: A measure of the extent to which a customer remains a customer (i.e., is loyal) to a company or brand over the customers buying life. Customer Lifetime Value (CLV): A metric that measures customer equity. Rust et al. (2004) define CLV as the future profit flows from the customer to the firm, adjusted for the customers future probability of purchasing from the firm, appropriately discounted to the present. CLV is comprised of customer value equity (CVE), Brand equity, and Relationship equity:

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Customer Value Equity (CVE): CVE emanates from value delivered to the customer. Measured from the customer point of view value is the customers objective assessment of the utility of a brand based on perceptions of what is given up for what is received. CVE equals the customers perception of the objective quality, price and convenience benefits of a brand less customers perception of its objective costs in terms of money, time, and nuisance. From the firms point of view, the firms total CVE is the sum for all brands for all customers. Brand Equity (BE): The customers subjective, intangible assessment of the brand above and beyond its objectively perceived value. This intangible assessment includes awareness, attitudes and associations, and corporate ethics (image). Relationship Equity (RE): RE represents the strength of the relationship between the customer and the brand, above and beyond the customers objective and subjective assessments of the brand. Obvious problems with sales or net profit as financial output measures and marketing costs as input measures lead to the argument that a successful marketing operation obtains the highest contribution margin for a given investment over the long run. The objective is profit contribution, not maximization of sales alone or minimization of costs alone. That is why the contribution approach to the analysis of marketing performance is superior to full-costing approaches, which fail to distinguish vital influences of various cost behavior patterns (Horngren, 1967). Value Concepts and Value Metrics Value Added (by production): The gross value of the output of a firm less the value of goods and services use in creating output, or the market value of a firms output less the cost of inputs it has purchased from others (Seo, 1991). Value added might be treated as the measure of output, which simplifies output measurement. Input measurement, however, remains problematical particularly in measuring flows of indirect inputs (overhead) and capital (fixed) inputs. Customer Value Added (CVA): Customer value focuses on producing satisfaction to customers beyond price (Gale, 1994; Naumann, 1995; Stock and Lambert, 2001). From the customers point of view the customers value added is market perceived quality (i.e., all non-price attributes) of the firms products adjusted for their relative prices. CVA

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is measured by computing the ratio of a customers perceived value of the firms offer to the perceived value of competitive offers. To the customer, the value of the customers doing business with a firm is the present value of the difference between what the customer would be willing to pay for the firms product and what the firm receives as revenue from the customer, i.e., what the customer actually pays. This concept of value to the customer is identical to the concept of consumer surplus as defined by Seo (1991): the difference between what the consumer is willing to pay and what the consumer actually pays. Shareholder or Market Value Added (SVA / MVA): From the shareholders point of view, shareholder value added is the difference between the current market value of the firms total assets (debt plus equity) less the value of total capital (debt plus equity) invested in the firm at a particular point in time. Estimated market value of the firms capital at a particular point in time based on the proposition that a business is worth the net present value of its future cash flows, discounted at the appropriate cost of capital that correctly reflects its investment risk. The business worth is reflected in the current trading value of its equity plus the value of its debt (Rappaport, 1986; Stock and Lambert, 2001; Hawawini and Viallet, 2006). Thus, a business creates value when its activities meet or exceed its cost of capital. Value created or added is measured by the change in market value from one point in time to another. Drivers of share holder or business value include sales growth rate, operating profit margin, cash tax rate, fixed capital needs, working capital needs, cost of capital, and the firms planning period (Stern, 1990; Stock and Lambert, 2001; Hawawini and Viallet, 2006). Economic Value Added (EVA): An alternative approach to SVA, EVA derives total shareholder value by determining the difference between return on invested capital and the cost of capital (Mills and Print, 1995). This difference, called a performance spread and expressed as a percentage of invested capital, is then multiplied by the capital invested for each forecasted (planning) period. After deducting capital expenditures for maintaining plant and equipment and for dividends in each period, these cash flows thus derived are then discounted and summed to produce a premium, which amounts to the EVA for the planning horizon. In short, EVA seeks to convert market value to an economic value. Market value added is distorted (overstated) by accounting profits that only take into account out-of-pocket capital charges but fail to include a charge for employed capital that does not incur an out-of-pocket cost. To reduce the market value added to economic value added, management must apply a capital charge to

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such cost-free working capital items, accounts payable (interest-free short term debt), accrued expenses, or reductions in cash that support sales and profits. This charge should be the firms weighted average cost of capital. Linkages Between Marketing Efforts and Value The objectives of marketing strategies and tactical actions (activities) are to provide value to customers that result in their satisfaction beyond price (value equity). Value equity, combined with brand equity and relationship equity comprise customer equity. Customer equity is the total of the discounted lifetime values summed over all of the firms current and potential customers (Rust, Lemon, and Zeithaml, 2004, p. 110). That is, customer equity is the future profit flows from the customers to the firm, adjusted for the customers future probabilities of purchasing from the firm and appropriately discounted to the present (Rust, Lemon and Narayandas, 2005). Future profit flows are appropriately measured in terms of the flow of total net dollar contribution to overhead and profit, (the flow of revenue less the flow of direct costs). Figure 1 shows these linkages. Total customer equity is directly linked to the firms value creation as measured by market value added or MVA. MVA is the market value of the firms total capital (assets or debt plus equity) less the value of total capital originally invested (employed) in the firm. If MVA is positive, the firm has created value; the firm has destroyed value if MVA is negative (Hawawini and Viallet, 2006). MVA increases when the firm undertakes projects that result in positive net present values. Capital employed is the total amount of capital the firm has invested in its past and present investment projects. Accordingly the present value of the expected future stream of cash produced by such projects and activities is the market value of its capital. Investment projects and marketing activities that increase customer equity have a corresponding direct impact on future cash flows that translate into increased MVA. Maximizing MVA is consistent with maximizing shareholder value added (SVA). Reducing MVA to SVA simply requires subtracting the difference between the market value of the firms debt and its reported book value. Rust et al. (2004) see marketing productivity in terms of a chain of relationships connecting marketing strategies and tactical actions (inputs) to the value of the firm (outputs). Marketing mix strategies and tactical elements impact upon customers attitudes and actions, which

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in turn impact sales and market share, through their influence on off-balance-sheet marketing assets such as customer and brand equity. The impact of customers on marketing assets in turn impacts sales and market position, which produce financial results and performance that determine the value of the firm and shareholder value. Tactical actions that arise from marketing mix strategies comprise the firms marketing activities. The fundamental purpose of these activities is to provide value to customers that favorably impact customer attitudes, behavior, and satisfaction, thus increasing marketing assets, and improving sales and market share. These improvements, consequently, should boost the firms financial performance (i.e., ROI, MVA, and EVA). Marketing activities are the concrete drivers of the value the firm provides to its customers and the drivers of its revenue, cost, and gross dollar contributions. Marketing activities therefore, constitute the basis for evaluating productivity, efficiency, and effectiveness of the firms marketing effort. The next section explains using techniques of activity-based management and accounting for managing marketing productivity. MANAGING PRODUCTIVITY THROUGH ACTIVITY-BASED MANAGEMENT (ABM) The second proposition advanced in this paper is centered on the idea that techniques of traditional activity-based management (ABM) systems that use activity-based accounting methods are appropriate tools for managing marketing productivity by effectively and efficiently deploying marketing resources. An ABM system describes a management system that uses activity-based costing information to satisfy customers and improve profitability. Broadly defined, ABM includes decisions about pricing; product mixes; cost reduction; and process improvement decisions, along with other marketing management activities such as outsourcing; adding or dropping business segments; product and service design and reengineering; downsizing; managing customer profitability; managing quality improvement; and supplier evaluation (Horngren et al., 2003). This section discusses activity-based cost analysis, activity-based revenue analysis, and merges these concepts into activity-based contribution analysis and activity-based value analysis.

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Activity-Based Cost Analysis Activity based costing (ABC) focuses identifying activities as fundamental cost drivers. Activities are events, tasks, or units of work that have a specified purpose (Horngren et al., 2003). Examples of such activities include designing products; selling products; creating advertising copy; acquiring customers; retaining and maintaining customer relationships; distributing products, and so forth. The ABC approach is broadly applicable, not only to production and manufacturing operations within the factory, but to a broad spectrum of functions performed in the firm. By evaluating the use of resources and profits generated by various customers, product lines, brands territories and so forth, managers at all levels can clearly establish for process and profit improvement (Cooper and Kaplan, 1991). ABC techniques are concerned with improving the firms profit performance, not simply with identifying cost more precisely. Kennedy and Affleck-Graves (2001) affirm that firms using ABC techniques out perform matched non-ABC firms by about twenty-seven percent over the three years following ABC implementation. Firms using traditional cost accounting systems usually treat costs associated with activities such as product design; advertising; selling; managing customer relationships; distributing products and the like as overhead costs and allocate them on some aggregate basis they think reflects the pro rata share of resources used. Traditional costing may allocate design and engineering costs to products or product lines on the basis of machine hours used in their manufacturing, and advertising costs and other selling costs to products on the basis of percentage of sales accounted for by the products. An ABC system focuses on activities and identifies expenses of using indirect resources by activities performed. Activity-based costing is based upon the idea that overhead or operating expenses in the firm are generated by activities necessary to the processes of the firm (Roztocki and Needy, 1999). Since activities in marketing and distributing products to customers, channels, territories, or other end segments consume resources, managers can trace overhead costs directly to relevant end segments on the basis of the activities that drive them. The ABC costing system assigns costs of using indirect resources based on the drivers of those activities. Activity-based costing would allocate design and engineering costs on the basis of activities or measurable factors that drive them, for example the number of component parts in each product may measure product complexity, and be treated as the driver of labor hours

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spent designing each product. Similarly, activity-based costing would allocate advertising cost to products on the basis of drivers of creative cost; production cost and media cost for each product, including labor time for creative and production work; air time for broadcast media; and space cost for print and outdoor media. Similar drivers form the basis for applying ABC systems to institutional advertising. Otherwise, institutional advertising may be a facility-sustaining cost. ABC systems calculate costs of individual activities and assign them to cost objects such as products, services, customers or other segments that are meaningful to the managers concerned. The logic behind ABM and ABC systems is that finely structured activity-cost pools with activity-specific cost allocation bases that are drivers for the cost pools lead to more accurate costing of activities (Horngren et al., 2003). ABC systems use the notion that a refined costing system provides better measurement of the results of activities and therefore, better management than would be possible using broad averages to deploy overhead resources. For costing products, ABCs fundamental axiom is that accurate product cost includes the cost of all activities supporting the product and excludes unrelated costs (Ioannou and Sullivan, 1999). This axiom applies equally to other cost objects. The following discussion of ABC systems methodologies is based on Horngren et al. (2003). Cost systems are refined using three methodologies: 1. Direct cost tracing, which seeks to classify as many of the total costs of the cost object as direct costs as is economically feasible; 2. Expanding the number of indirect cost pools until each of the cost pools is more homogeneous (i.e., all the costs in the pool have the same or similar cause-and effect- (or benefits-received) relationships with the cost allocation basis); and 3. Using the cause and effect criterion whenever possible to identify the cost allocation base for each indirect-cost pool. ABC systems use these methodologies to establish a cost hierarchy that classifies cost into different cost pools on the basis of cost drivers. A common hierarchy contains four levels. 1. Unit level costs, which are the costs of activities performed on each individual unit of product or service. A per unit incentive paid to a sales person for selling a unit of a product is a unit level cost. The number of units sold drives this cost.

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2. Batch level costs are the costs of activities related to a group of units rather than to an individual unit. A sales call that results in a number of units sold would be a batch level cost. The cost of the sales call, travel, and other costs incidental to the sales call are batch level costs because they are related to the group of units or products sold during the call, not to the individual units of product. The number of sales calls not the quantity or value of products sold during the call drives these costs. In firms that buy many different kinds of products, purchasing and material management costs are can be substantial. Such costs are batch costs since the number of purchase orders placed rather than to the quantity or value of items purchased drive them. Similarly, the cost of many sales or customer relationship activities conducted by a sales team is driven by the number and type of customers in each customer class served by the sales team, rather than to the quantity or value of products sold. 3. Product/Service-level costs are the costs of sustaining individual products or services, regardless of the number of units or batches in which the product/service is produced and sold. In multi-product firms organized on a territory basis, sales management time may largely be driven by the complexity of the product mix sold within a territory. Mix complexity is largely a function of its breadth (number of lines) and depth (number of line items). Complexity as measured by number of lines multiplied times number of items in each line is the primary driver of the resources required by sales management for each territory. Allocating costs to product lines on the basis of line complexity is thus a cost that sustains activity at the product level. A similar allocation of sales management cost to territories is an allocation of cost that sustains activity at the territory level. 4. Facility-sustaining costs are those costs that cannot be traced to any of the above levels, but which support the firm or organization as a whole. In general there is a lack of identifiable cause and effect between these costs and a specific driver connecting them to products/services or other end segments. This lack of identifiable cause-and-effect leads some firms to exclude these costs from product costs, but to deduct them from operating income as fixed or administrative overhead costs. Other firms may allocate such costs to products on some basis they deem as suitable.

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Applying the three guidelines for refining a costing system results in a seven-step procedure for assigning cost to appropriate cost objects, which may be business units, market segments, channels, customers or customer classes, products, services, or territories. These steps are: 1. Identify the chosen cost objects; 2. Identify the direct cost of the objects; 3. Select the base activities for allocating indirect costs to the cost objects; 4. Identify the indirect cost associated with each cost allocation base; 5. Compute the per-unit rate for each allocation base used to allocate indirect cost to the cost objects; 6. Compute the indirect cost allocated to the cost object; and 7. Compute the total cost of the cost object by adding all direct and indirect cost assigned to the cost object. Typically, ABC systems focus on costs or expenses that traditional accounting systems treat as overhead or administrative costs because traditional systems find them difficult to assign to end products or other objects (e.g., customer classes, territories). The primary concern of ABC Systems is with allocating operating costs or expense items. Roztocki and Needy (1999) point out that while ABC systems can, and often do allocate depreciation expenses for capital items as part of capital costs, they normally exclude real or interest-imputed charges for invested capital. The present paper considers the terms invested capital; capital employed, and net assets to be interchangeable, following Hawawini and Viallet (2006). Roztocki and Needy (1999) advance the argument that while ABC systems can be instrumental in controlling cost, improving processes, and facilitating removal of non-value adding activities, such systems do not automatically lead to improved shareholder value, partly because of their deficiency in handling costs for invested capital. They consequently, propose a methodology for integrating ABC analysis with the economic value added (EVA) measure. They call the methodology activity-capital dependence analysis or ACD. Activity-Capital Dependence Analysis (ACD) ACD analysis calls for adding another step to implementing a traditional ABC system. This step requires calculating the capital charge for each activity that uses capital. The capital charges are then added to the

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operating cost for activities calculated by the ABC system (Roztocki and Needy, 1999). This step captures the cost of capital investment that the activities demand in addition to other operating costs that resources use incurs. ACD captures capital cost by identifying capital cost drivers and tracing capital costs to products or other business units of interest (customer classes, channels, territories and so forth). Capital includes total money invested or employed regardless of source (equity or debt), plus equity equivalents such as reserves for deferred expenses and LIFO inventory evaluation. Roztocki and Needy (1999) argue that because non-interest-bearing current liabilities and accrued expenses reduce or offset the need for capital, they save capital and are therefore deducted from total assets or are assigned a negative capital cost. Non-interest-bearing accounts payable and accrued expenses may reduce the need for interest bearing capital to the extent that they do not result in higher costs or higher prices in the form of foregone discounts. Arriving at economic value added, however, requires application of capital cost to all capital invested, including the net working capital requirement. (Hawawini and Viallet, 2006). The analysis does not vary conceptually if managerial accounting procedures in the firm treat some traditional income statement items such as marketing, R&D, or reorganization outlays as capital items for decision-making purposes. The current or amortized portion of such items is expensed and the residual balance is included in long-term assets. A traditional ABC system may give favor to a product or business unit because it consumes a smaller portion of operating expenses and produces higher levels of after-tax profit. Such a product may actually prove to be much less valuable if it demands high capital investment and incurs the associated capital costs. Integrating ABC with ACD enables managers to see which products (business units) add economic value to the firm so they can develop appropriate strategies for them (Roztocki and Needy, 1999). Activity-Based Revenue Analysis (ABR) Analyzing the performance of revenue drivers is critical to evaluating activities that have the purpose of generating revenue. Broadly speaking, all marketing activities have the purpose of generating revenue through creating value to customers in product and service markets. Revenue-generating activities influence total revenue (total sales volume) through three basic variables: net revenue received per unit

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(net price per unit), quantity of units sold, and the mix or proportions in which products with different prices are sold. Revenue drivers include all factors that affect the net price paid per unit and the quantity of units sold. Net price per unit is driven by a host of variables, including the firms initial strategy to establish a list price at, above, or below usual market price. Net price may be adjusted downward by polices and practices adopted toward matters, such as one-price or variable-pricing; any number of discounts; allowances; rebates; financing arrangements; geographic price differentials; terms of sale; practices related to bundling or unbundling products and services; other special tactics for fine tuning price; and policies related to responding to competitive price changes. On the upward side, net price per unit depends on firm policy on many of these same variables including various up-charges, such as handling charges; expediting charges; any number of service charges; minimum charges or usage; rate adjustments; hidden or otherwise, two-part pricing; charges for extended or normal warranty; and penalty charges for canceling purchases or returning products, and the like. Lamb, Hair, and McDaniel (2006) discuss examples of these pricing tactics. Managers must take care to ensure lower cost or increased unit volume compensates for downward adjustments and that other increases in value offset upward price adjustments. Quantity of Units Sold: Generally, almost all marketing efforts drive unit volume. Most firms however, can distinguish between activities that have the primary purpose of generating unit volume rather than per unit revenue. Examples include those activities or programs designed to increase the number of product users, or converting light users to heavy users by increasing the number of use occasions or by increasing the quantity used per occasion. Many firms create reward programs for frequent users designed to motivate customers to use more, more often. Discount card programs and reward programs for frequent or loyal buyers are common examples. Some use multi-unit pricing such as two-for, or buy-one get-one, or multi-unit packaging or bundle pricing to encourage customers to increase units purchased. Still others use family or companion programs to encourage primary customers to bring others into the fold. Mix of Units Sold: Besides unit price and unit volume, the mix or proportions of unit sales with different unit prices, clearly affects revenue. That is, higher proportions of higher priced products increases total revenue. Further, to the extent that unit contribution differs for different products, changes in the mix of units sold impacts total contribution and

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operating income. Firms employ a variety of techniques to sell a more profitable mix of products, both to trade customers and to final consumer. Many rely on sales promotion techniques or personal selling programs that use special incentives to trade customers up to higher margin products. Using tactics that alter the sales mix combined with those that increase unit volume or per unit revenue can have a significant effect on the firms total contribution margin and operating income. Activity-Based Contribution Analysis Researchers in marketing have long recognized the key role that contribution margin plays in management decisions concerning deployment of marketing resources. A successful marketing operation obtains the highest contribution margin for a given investment over the long run. The objective is profit contribution, not maximization of sales alone or minimization of costs alone. That is why the contribution approach to the analysis of marketing performance is superior to full-costing approaches which fail to distinguish vital influences of various cost behavior patterns (Horngren, 1967, p. 366). The present focus on customer equity approaches to managing customer relationships and creating value stress customer lifetime value (CLV) as a key metric of the future financial value of the customers purchases with an organization. CLV takes into account how much the customer spends on each purchase with the firm, how often the customer buys, how likely the customer is remain or to become a customer of the firm, how much it costs to serve the customer, and the firms discount rate for evaluating the net present value of the customers future purchases. CLV is . . . the future profit flows from the customer to the firm, adjusted for the customers future probability of purchasing from the firm and appropriately discounted to the present (Rust, Lemon, and Narayandas, 2004, p. 23). The concept of CLV points out the necessity of managing activities contributing to both the revenue side and the cost side of the stream of contribution margin. Managing both require management systems that integrate activity-based revenue analysis with activity-based cost analysis into activity-based contribution analysis (ABCA). ABCA can be implemented at a number of levels from the corporate or division level down to the individual product or territory levels. A business unit is an elemental management unit that engages in resource-using activities to generate a flow of revenues and that incur an accompanying flow of costs. ABCA requires managers to identify and

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define the business units producing contributions they are responsible for managing. There are myriad bases for identifying and categorizing business units. At the corporate or division level business units are the firms corporate or division strategic business units (SBUs). Analysis at these levels is strategic business contribution analysis (BCA). Further refinements to the scheme leads to identifying units according to market segment or marketing channel. Segment level contribution analysis is (SCA). Channel level (or class-of-customer) contribution analysis is (CCA). Product lines involve line contribution analysis (LCA). For individual products or services, analysis becomes product contribution analysis (PCA). Refinements below the PCA level result in identifying contribution units according to the customer classes deemed important, for example, new versus existing customers, previous customers versus first time customer and so forth. Beyond the customer level, detailed refinement may lead to identifying analysis units at the territory or, salesperson level. Classifying contribution business units at the customer level in terms of new versus existing, or first time, versus previous customer status provides the link between managing activities that generate revenues and costs for new or first-time customers (customer acquisition activities) and managing activities that generate revenues and costs for existing or previous customers (customer retention activities). More detailed refinement to the territory or salesperson level permits activity-based management to this level of detail. The appropriate level of detail should be determined by concerns of managers with a view to avoiding subdivision beyond parsimonious levels. Activity Based Value Analysis (ABVA) Value and Value Drivers Providing value to customers is the raison detre for customer-focused organizations. Along with satisfaction, value has long been a core concept of marketing management and key to the marketing philosophy of customer-focused organizations. As pointed out by Woodruff (1997), in the pursuit of competitive advantage, there is no shortage of calls for organizations to orient themselves toward delivering superior value to customers. This orientation requires managers to align their value-delivery processes with what customers actually value. Cus-

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tomer focus and value delivery inevitably impact employee performance, morale, and the market value of the firm or organization. In keeping with the concept of value proposed by Rust, Lemon, and Narayandas (2005), customer value as conceived in this paper is a multi dimensional concept that results in the customers net objective assessment of the utility of a brand based upon perceptions of what the customer gives up for what the customer receives. This assessment includes four value types, product value, value in use, possession value, and overall value linked together in the customers evaluation process (Burns, 1993). The customer assesses these value types in terms of the customers means-end value hierarchy that begins with desired product attributes and attribute performances the customer believes will lead to desired consequence experiences, reflected in use and possession value, that will, in turn, lead to achieving the customers goals and purposes in use situations (Woodruff, 1997). A significant body of research investigating customer value and consumers perceptions of value dimensions has identified three important drivers that affect value; quality; price; and convenience. Quality includes both physical and non-physical dimensions of the product and service offering of the firm. Price is comprised of what the customer gives up as influenced by the firm. Convenience entails actions the firm can take to reduce the customers time-, and effort-related costs of doing business with it (Rust, Lemon, and Narayandas, 2005). Activity-based value analysis complements ABM and ABC systems and provides a procedure for aligning value delivery processes with what customers value. As in ABM and ABC, ABVA focuses on activities as fundamental drivers. ABVA identifies, quantifies and links events or units of work (activities) to customer value creation. What customers value varies across products and customers (Zeithaml, 1988), over time, and customers use situation (Woodruff, 1997). There are three prerequisites to implementing ABVA: (1) a framework for monitoring customer value; (2) a process and a system for monitoring the dynamics of what customers value and what the firm is doing to create it; and (3) a scheme for classifying marketing functions, modeling marketing processes and decomposing them into elemental activities that create value for the customer. Parasuraman (1997) offers a value-monitoring framework that has the purpose of revealing the dynamic structure and nature of customer value assessment as they move through various stages of relationships with firms they patronize.

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Woodruff (1997) proposes a customer value-oriented marketing information system (CVOMIS) that incorporates the dynamics of customer value. This approach advocates a process for customer value determination (CVD) that uses customer satisfaction measurement (CSM) survey methodology approaches for learning about higherorder customer values and collecting related data. Sheth and Sisodia (2002) also advocate a shift in thinking about information systems that should facilitate better delivery of superior value. Rather than using information and data-base technology primarily for better targeting of prospects, they argue that front line information systems (FIS) should provide cutting edge information technology to sales, customer service, and other front-line personnel who can use it to support relationship management, thereby dramatically impacting customer satisfaction. What customers value or want from the firm in terms of traditional marketing mix elements (i.e., product, placement, price and promotion) should provide the starting point for the firm to create customer value effectively and efficiently. Essentially, as pointed out by Hammer (1996) and affirmed by Slater (1997), firms must adopt a process perspective that begins with what customers want or value and work toward modeling marketing processes and identifying value creating activities that comprise them. Rather than minimizing cost of performing activities, ABVA may suggest that when a firm takes into account both benefits and costs of executing a marketing or business process, it may more effectively and efficiently deliver customer value by outsourcing selected processes and focusing on perfecting a few core processes that provide real long term value to important customer groups (Slater 1997). Integrating ABCA with CRM to Assess Marketing Productivity The third proposition of this paper is that an appropriate concept for managing marketing productivity, effectiveness and efficiency is the total dollar profit contribution generated relative to the marketing effort or budget required to generate it. This concept is referred to in this paper as the CONROME ratio. The numerator of the ratio is total dollar contribution generated in the relevant time period. The denominator is total marketing effort or expenditure in the same period. Therefore, CONROMR = (Total Revenue Total Variable Cost)/Marketing Effort.

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CONCLUSIONS AND IMPLICATIONS FOR FUTURE RESEARCH Applying activity-based management combined with activity-based accounting techniques holds much promise for managing marketing resources to improve their productivity effectiveness and efficiency in adding customer value and creating customer equity that lead to greater MVA and EVA. Doing so must begin with marketing managers developing a scheme or framework, such as that proposed by Parasuraman (1997) to monitor the dynamics of customer value and value drivers across customer groups and products. Managers must implement the framework by creating an information system oriented toward capturing customers value dynamics and value determination such as that presented by Woodruff (1997), using survey technology shown useful in satisfaction measurement. Mangers must facilitate value creation by ensuring that front-line sales and customer service personnel have and use the information for improving activities that add customer value and avoiding those that do not (Sheth and Sisodia, 2002). Research into several related areas will facilitate marketers implementing activity-based contribution analysis and associated value analysis. First, there is a need to identity product and industry-specific value drivers at all levels, from those related to attributes to those at the experience and credence levels, along with the development of an understanding about how these drivers change over time in the marketer-customer relationship. Second, marketing and accounting researchers need to collaborate in developing somewhat standard industry (or product) specific schemes for a hierarchical classification of marketing activities and tracing them to cost and revenue and customer value. There is a particular need for such a classification for multi-product firms. REFERENCES
Armitage, H.M. (1984). The use of management accounting techniques to improve productivity analysis in distribution operations. International Journal of Physical Distribution and Materials Management, 34 (2), 41-51. Blocher, E.J.; Chen, K.H.; Hopkins, G.; and Lin, T. (2005). Cost Management: A Strategic Emphasis. 3rd ed., New York: McGraw Hill Irwin. Burns, M.J. (1993). Value in Exchange: the Consumer Perspective. Knoxville: The University of Tennessee.

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Cooper, R. and Kaplan, R.S. (1991). Profit priorities from activity-based costing. Harvard Business Review, 69 (May-June), 130-137. Gale, B.T. (1994). Managing Customer Value. New York: the Free Press. Hammer, M. (1996). Beyond Reengineering. New York: Harper-Business. Hawawini, G. and Viallet, C. (2006). Finance for Executives: Managing for Value Creation. 3rd ed., Mason, Ohio: Thompson-Southwestern. Horngren, C.T. (1967). Cost Accounting: A Managerial Approach. 2nd ed., Englewood Cliffs, New Jersey: Prentice-Hall Inc. Horngren, C.T., Datar, S.M., and Foster, G. (2003). Cost Accounting: A Managerial Emphasis. 11th ed., Upper Saddle River, New Jersey: Prentice Hall. Ioannou, G. and Sullivan, W.G. (1999). Use of activity-based costing and economic value analysis for the justification of capital investments in automated material handling systems. International Journal of Production Research, 37 (9), 2109-2134. Kearney, A.T. (1978). Measuring Productivity in Physical Distribution. National Council of Physical Distribution Management. Kennedy, T. and Affleck-Graves, J. (2001). The impact of activity-based costing techniques on firm performance. Journal of Management Accounting Research, 13, 19-45. Lamb C.W. Jr., Hair, J.H. Jr., and McDaniel, C. (2006). Marketing. 8th ed., Mason Ohio: Thompson-Southwestern. McConnell, C.R. and Brue, S.L.B. (1996). Economics. 13th ed., New York: McGrawHill Inc. Mills, R. and Print, C. (1995). Strategic value analysis. Management Accounting, 73 (2), 35-37. Nauman, E. (1995). Creating Customer Value: The Path to Competitive Advantage. Cincinnati OH: Thompson Executive Press. Parasuraman, A. (1997). Commentary: Reflections on gaining competitive advantage through customer value. Journal of the Academy of Marketing Science, 25 (2), 154-161. Rappaport, A. (1986). Creating Shareholder Value: The New Standard for Business Performance. New York: The Free Press. Roztocki, N. and Needy, K. (1999). Integrating activity-based costing and economic value in manufacturing. Engineering Management Journal, 11 (2), 17-22. Rust, R.T., Lemon, K.N., and Narayandas, D. (2005). Customer Equity Management. Upper Saddle River, NJ: Pearson-Prentice Hall. Rust, R.T., Lemon, K.N., and Zeithaml, V.A. (2004). Return on marketing: Using customer equity to focus marketing strategy. Journal of Marketing, 68 (January), 109-126. Seo, K.K. (1991). Managerial Economics: Text, Problems and Short Cases. 7th ed., Homewood, Illinois. Sevin, C.H. (1965). Marketing Productivity Analysis New York: McGraw-Hill. Sheth, J.N. and Sisodia, R.S. (2002). Marketing productivity: Issues and analysis. Journal of Business Research, 55 (5), 349-362. Slater, S.F. (1997). Commentary: Developing a customer value-based theory of the firm. Journal of the Academy of Marketing Science, 25 (2), 162-167.

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Stern, J.M. (1990). One way to build value in your firm a la executive compensation. Financial Executive, 6 (6), 51-54 Stevenson, W.J. (1999). Production and Operations Management. New York: Irwin McGraw-Hill. Stock, J.R. and Lambert, D.M. (2001). Strategic Logistics Management. 4th ed., New York: McGraw-Hill Irwin. Thomas M.J. (1984). The meaning of marketing productivity analysis. Marketing Intelligence & Planning, 2 (2), 13-29. Woodruff, R.B. (1997). Customer value: The next source of competitive advantage. Journal of the Academy of Marketing Science, 25 (2), 139-153. Zeithaml, V.A. (1988). Consumer perceptions of price, quality and value: A meansend model and synthesis of evidence. Journal of Marketing, 52 (3), 2-22.

doi:10.1300/J366v06n02_07

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