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Increase margin through targeted advertising

Anonymous A

Hey,

some questions regarding profitability analysis. Would be awesome to get some hints, confirmations:

1. In a situation, where we have three products, two of them have a profit margin of 30%, whereas the third has a profit margin of (-10%) i.e. we losing on this product. Instead of stop subsidizing this third produt, can we instead target customers for the other two products in order to increase the overall profit margin via targeted advertising? If this works, is it mathematically because the other two products with profit margin of 30% are weighted stronger through more units sold compared to the revenues of the third product (which should decrease through targeted advertising)?

2. In a situation where costs and revenue increase, the margin always (!) decreases (increases) if the costs increase proportionally stronger (weaker) than the revenues? However, we cannot say anything about absolute profit changes if the margin decreases - correct?

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Vlad replied on 08/27/2018
McKinsey / Accenture / Got all BIG3 offers / More than 300 real MBB cases / Harvard Business School

Hi,

1) You will still be losing money with the third product. So you can sweeten the situation but not solve the problem completely

2) If the revenues increase and the costs increase proportionally lower - your absolute profit increases as well. However, note that only variable costs might increase proportionally, while the fixed costs usually increase step by step.

Best

Francesco replied on 08/27/2018
#1 Expert for coaching sessions (1800+) | Ex BCG | 900+ reviews with 100% recommendation rate

Hi Anonymous,

for question 1: theoretically yes, however you have to double check that product 3 is not required for the sales of the other two products since it is complementary (eg - you sell razors at a loss to sell blades at a profit). If that's the case, decreasing the volume of product 3 may lead to a decrease in volume for the other products not compensated by the target advertising, thus to an overall decline in profits.

for question 2: correct, you may have situations where margin decreases and absolute profits increase. For example:

  • Revenues: 100
  • Cost: 50
  • Profit: 50
  • Margin: 50/100=50%

Let's assume:

  • Revenues increase: 10%
  • Cost increase: 15%

Then:

  • New revenues: 110
  • New costs: 57.5
  • New Profit: 52.5 (higher)
  • New Margin: 52.5/110=48% (lower)

Of course, you may also have situations where the magin decreases and absolute profits decreases, which is the case when cost only increases. For example:

  • Revenues: 100
  • Cost: 50
  • Profit: 50
  • Margin: 50/100=50%

Let's assume:

  • Revenues increase: 0%
  • Cost increase: 15%

Then:

  • New revenues: 100
  • New costs: 57.5
  • New Profit: 42.5 (lower)
  • New Margin: 42.5/100=42.5% (lower)

Best,

Francesco

Benjamin replied on 08/27/2018
ex-Manager - Natural and challenging teacher - Taylor case solving, no framework

Hi
1. You can indeed modify the global mix to improve global profit. If the thirs profit has negative margin, can you consider an opportunity to stop it or adjust its positionning ?
2. This is directly related to the ratio of the fixe vs. variable cost vs margin structure. Unless you are selling with negative margin, the absolute profitability will always increase.

I can answer more specifically if you provide numbers.
Best
Benjamin

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