Two Perspectives on Revenue, Price and Quantity:

The Accounting Machine and The Marketing Machine

Ted Mitchell

Goal of Lecture

• Understanding the differences between • 1) an accountant’s perspective of controlling

costs to ensure profit• 2) a marketer’s perspective of choosing

optimal levels of marketing costs to maximize sales and profits

There are many perspectives

• On the nature of the price that sellers charge and buyers pay for things in the market place

• The economist’s perspective• The accountant’s perspective• Consumer behaviorist’s perspective• The marketing manager’s

Two Views on Nature of Business

• Marketing View • Spend money to make

profit• Revenues and profits

are the consequences of running a business

• Accounting View• To make profit, control

costs• Costs and profits are

the consequences of running a business

Two Views of the Business Machine

• Marketing View • Inputs: Price Tags and the

cost of the 3 P’s are Inputs to the machine

• Advertising, Sales force, building Product quality are costs inputted into the machine

• Outputs of the Machine are Demand (Quantity sold), Revenue, and Profit

• Accounting View• Inputs: Revenue and Price are

Inputs to the machine

• Advertising, Sales force, building Product quality are costs inputted into the machine

• Outputs of the Machine are Costs and Profits

• Advertising, Sales force, product quality are costs resulting from the machine’s operation

Two Views of the Business Machine

• Marketing View • The machine is a

conversion machine• Output (Revenue) is

converted from the cost of the Inputs

• Measure of Efficiency Profit returned on costs, ROME (aka ROMI)

• Accounting View• The machine is a

reduction machine• Input (Revenue) is

reduced to Costs and payments

• Measure of Efficiency Profit returned on sales revenue, ROS

Two Views of Revenue

• Marketing View • Revenue is an Output• Basic Two-Factor

Machine has a Direct Relationship between Revenue and Cost

• Revenue/Cost = r• Output = r x Input

Revenue = r x Cost

• Accounting View• Revenue is an Input

Basic Two-Factor Machine Has a Direct Relationship between Cost and Revenue

• Cost/Revenue = k• Output = k x Input

Cost = k x Revenue

Two Views of Unit Price and Cost

• Marketing View • Selling Price is the Price

Tag and the revenue generated by the sale of a single unit

• Direct Relationship• r = Price/Cost per unit

r = P/V• Sounds like unit revenue

returned on unit cost

• Accounting View• Selling Price is the

average revenue per unit sold

• Direct Relationship • k = Cost per unit/Price

k = V/P• Sounds like cost to

revenue ratio

Two Views of Returns and Efficiency

• Marketing View • Unit Revenue Returned

on Cost is P/V • P/V = Sales Return Rate• Profitability rate• Markup on Cost of

Goods SoldMv = (P-V)/V

• Accounting View• Average Unit Cost to

Price rate = V/P• V/P = Efficiency rate• Profitability rate • Markup on Price

Mp = 1-(V/P)Mp = (P-V)/P

Accounting Machine Produces Expenses

Accounting Cost Producing Machine

Marketing Revenue Producing Machine

Revenue R R

Cost of Goods Sold COGS COGS/R R/COGS sales return on inventory

Gross margin R – COGS = G G/R, gross return on sales

G/E, gross return on marketing expense

Marketing Expense E E/R, advertising to sales ratio

R/E, sales to advertising

Marketing Profit Z Z/R marketing return on sales

Z/E, ROMI or Rome

Overheads Expense H H/R

Shareholder Expense (Net Profit)

N N/R, return on sales

Marketing Machine Produces Revenues

Accounting: Cost Producing Machine

Marketing: Revenue Producing Machine

Revenue R R

Cost of Goods Sold COGS COGS/R R/COGS or P/V sales return on inventory

Gross margin R – COGS = G G/R, gross return on sales

G/E, gross return on marketing expense

Marketing Expense E E/R, advertising to sales ratio

R/E, sales to advertising

Marketing Profit R-E = Z Z/R marketing return on sales

Z/E, ROMI or ROME

Overheads Expense H H/R

Shareholder Expense (Net Profit)

N N/R, return on sales

Two Views of Unit Price and Revenue

• Marketing View • Direct Relationship between

Revenue, R, and Price Tag, P• q = Revenue /Price Tag• q = dollars of sales returned

on a $ of price tag• q = R/P• Revenue, R = q x P• Sounds like

Quantity x Price = Revenue, (But Not)

• Accounting View• Direct Relationship between

Revenue, R, and Quantity sold, Q

• Price, p = Revenue/Quantity

• p = R/Q• P = dollars of sales returned

on a unit sold• Revenue, R = p x Q• Sounds like

Price x Quantity = Revenue, (But Not)

Two Views of Unit Price and Quantity

Popular Marketing View Accounting View

Price Tag, P

Price, P

Quantity, Q

Quantity, Q

X X

Two Views Price, Quantity and Revenue

Popular Marketing View Accounting View

Price Tag, P

Price, P

Quantity, Q

Quantity, Q

Area is the RevenueRevenue, R = (Q) x P

Area is the RevenueRevenue, R = (P) x Q

X X

Two Correct Views of Marketing and Accounting

Marketing View Accounting View

Price Tag, P

Not Price, p = R/QIt is a conversion rate

Quantity, Q

Not Quantity, q = R/PIt is a conversion rate

Area is the RevenueRevenue, R = (R/P) x P

Area is the RevenueRevenue, R = (R/Q) x Q

Do Accounting and Marketing

• Have any perspectives in common?• Yes!

When managers are in Diagnostic Mode• Comparing Two Different Performances as if

they were different machines • Using ∆Price and ∆Quantity explain ∆Revenue

Diagnostic ModeComparing Two Machines

There is NO assumed relationship between the machines

Performance from machine 1

Performance from machine 2

Difference Can NOT say

Price, P P1 P2 ∆P = P2-P1

Quantity, Q Q1 Q2 ∆Q = Q2-Q1

Revenue, R =P x Q

R1 R2 ∆R = R2-R1 ∆P x ∆Q = ∆R

There is NO indication of a direct or an inverse relationship between price, P, and quantity sold, QThere is NO obvious conversion rate

Diagnostic ModeExplain the Difference in the Revenues

of the Two MachinesPerformance from machine 1

Performance from machine 2

Difference Impact of Changes

Price, P P1 P2 ∆P = P2-P1 I∆P = Impact of ∆P

Quantity, Q Q1 Q2 ∆Q = Q2-Q1 I∆Q = Impact of ∆Q

Revenue, R =P x Q

R1 R2 ∆R = R2-R1 I∆P + I∆Q = ∆R

Diagnostic ModeComparing Relative Performances

Relative to average competitive Position

Performance from machine 1

Performance from machine 2

Differences in Relative Performances

Relative Price, Pr = P/Pa

Pr1 Pr2 ∆Pr = Pr2-Pr1

Relative Volume, Qr = Q/Qa

Qr1 Qr2 ∆Qr = Qr2-Qr1

Relative Revenue, Rr = R/Ra

Rr1 Rr2 ∆Rr = Rr2-Rr1

Difference in the revenues, ∆R, has to be explained by the differences in the prices and quantities, I∆P and I∆Q

One Common View of the Variance (Impact) Analysis

• Marketing View • Relationship between

difference in relative price, quantity and revenue

• Q(∆Pr) + P(∆Qr) = ∆Rr

• Accounting View• Relationship between

actual and budgeted price, quantity and revenue

• Q(∆P) + P(∆Q) = ∆R

Goal of Lecture was to

• Ensure you understood the differences between

• 1) an accountant’s perspective of controlling costs to ensure profit

• 2) a marketer’s perspective of choosing optimal levels of marketing costs to maximize sales and profits

• 3) A common view on explaining differences between performances