whyROI

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THE WHY OF ROIDr. Gary W. Williams

Professor, Agricultural EconomicsDirector, Texas Agribusiness Market

Research Center (TAMRC)Texas A&M UniversityCollege Station, Texas

Return on Investment: FAIR Reviews andEconomic Analyses as Strategic

Marketing/Management Tools

2004 Marketing Order Management ConferenceSan Antonio, Texas

September 29, 2004

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RATIONALE FORPROGRAM EVALUATION

An Obvious Motive:

because some type of evaluationof the effectiveness of yourpromotion/research investmentsis mandated by the 1996 Farm Bill(FAIR Act)

SOME OF YOU HAVE TO!

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Other Important Reasons:

1. Helps improve the efficiency and effectivenessof the program

Program evaluation can indicate howefficient fund allocation has been

How much bang for the buck hasbeen achieved?

What adjustments needed in futureallocations?

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2. Assists in the design and adjustment of theprograms long-run strategic plan

What are you trying to achieve and areyou doing it?

Doing things right and Doing the right things

Provides insight on whether promotionactivities are done efficiently but also whether

they are those that will maximum returns

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3. Serves the information needs of contributors,industry, and other stakeholders

Those who pay for such programs want to know whatthey are getting for the money they are investing

The of the program is immediately obvious tocontributors but the cannot be easily seen

The is a line item on contributors balance

sheets but the are included as part of therevenues earned.

COSTBENEFITS

COSTBENEFITS

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3. Serves the information needs of contributors,

industry, and other stakeholders (contd)

How much of revenues are result of the marketingorder and/or promotion investments and how muchis due to other factors (foreign demand, consumer

confidence, consumer health trends, food awayfrom home trends, changing demographics,marketing skills, etc.)?

Discontent in the ranks and even legal challenges ifcontributors do not understand the contribution of the

program to their bottom lines

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4. Provides the necessary economic ammunition torespond to legal challenges

Commodity promotion programs are under attack.Examples: mushrooms, beef, pork, dairy products,

grapes, cotton, orange juice, among many others

Cannot wait until a legal challenge is mounted becausegathering the needed data and conducting a credibleanalysis that will stand up in court as well as to peerreview takes time

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THE HOW OF ROIDr. Gary W. Williams

Professor, Agricultural EconomicsDirector, Texas Agribusiness Market

Research Center (TAMRC)Texas A&M UniversityCollege Station, Texas

Return on Investment: FAIR Reviews andEconomic Analyses as Strategic

Marketing/Management Tools

2004 Marketing Order Management ConferenceSan Antonio, Texas

September 29, 2004

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THE EVALUATION PROCESS

1. Identify the Program Objectives

2. Select the Appropriate EvaluationMethod

3. Collect the Necessary Data

4. Select the Evaluation Team

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STEP 1: IDENTIFY THE

PROGRAM OBJECTIVESGeneral objective is to enhance the profits

of those who contribute to the program

Common Intermediate Indicators of Success

1. Industry Sales

2. Industry Price

3. Industry Profits (Sales Revenue Costs)

4. Consumer Awareness

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STEP 2: SELECT METHODOF EVALUATION

Different Methods for DifferentStages of the Promotion Process

PROMOTION

CONSUMER AWARENESS

SALES/PRICE

CONTRIBUTOR PROFITS

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CONSUMER AWARENESS

Tracking Studies

Changes in consumer attitudes and beliefs

about product measured over time throughconsumer usage and attitudinal surveys

Assume that development of feelings about

product necessary to change behavior

Consumer surveys regarding recall (such asslogan, logo, message), awareness of productattributes, purchase behavior usually along

with advertising campaigns

Consumer Attitude/Belief Studies

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ProblemsIncreased awareness or changed

attitudesas indicated by surveys

CONSUMER AWARENESS

Attitudes and beliefs influenced by manyfactors so measured changes in attitudes

Results of tracking and consumer attitudestudies are

do notnecessarily translate into increased sales

may not be totally due to advertising

product/event specific and notgenerally applicable

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SALES IMPACT STUDIES

Statistical procedures to isolate and measurespecific effects of promotion

Anecdotal Evidence

Compare changes in sales with changes inpromotion expenditures

Statistical Modeling of Relationship

Analysis of Direct RelationshipBetween Promotion and Sales

Goal is to disentangle effects of promotionfrom those of other market forces

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Structural Modeling ApproachTwo Modeling Approaches

Demand/Sales Equation(Single or Demand System)

DOJ = f(POJ, FDOC, BRAND, Other)

Other Factors:

- Prices of related products(substitutes and complements)- Income- Population- Others specific to the product

Demand Supply

NewDemand

Sales

Price

Effect of Advertising on Demand/Sales

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Time Series Modeling Approach

Focus is on the data and regularitiesin the data themselves

Two Modeling Approaches

Statistical relationship between demandor sales and current and past values ofmarket, macro, and other variables,including promotion expenditures, with noconcern for theoretical or structuralrelationships

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Estimated Elasticities

Percent change in demand/sales froma 1% change in promotion expenditures

Measures of Impact

Simulation Analysis

Calculate level of demand that would haveexisted over history of program without

promotion program and compare withactual level of demand over time

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Measures of Impact

Even if sales revenues increase

as a result of promotion, theimportant question is whetherthey increase enough to more

than pay for the cost ofpromotion

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Measures of Impact

Return on Investment (ROI) Analysis

Misnomer because most ROI studies

calculate a

BCR=Total Revenue Generated by Promotion

Total Promotion Expenditures

BENEFIT-COST RATIO (BCR):

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Beef 5.74 Orange Juice 6.1 (2.9)

Pork 4.79 Apples 12.00

Eggs 6.00 Catfish 0.17-0.57

Soybeans 5.00 Tomatoes 27.15

Cotton 1.57 - 3.59 Almonds 3.0 - 10.0

Milk 4.00 (various) Grapefruit Juice 10.44

Selected BCRs fromSelected Studies

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Measures of ImpactReturn on Investment (ROI) Analysis

BCR is AVERAGE return per dollarspent on promotion

Some studies calculate the

to promotion as:% Change in Revenues from a 1%Change Promotion Expenditures

MRR=

MARGINAL

RATE OF RETURN

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Limitations of BCR and MRR Measures

STATIC measures of promotion

effectiveness (when calculated fromdemand/sales models)

Often Not Believable

How High a BCR is High Enoughto Justify Continued Investment?

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CONTRIBUTOR BENEFIT STUDIES

If promotion does NOT increases sales,then NO benefit to those who pay for thepromotion

But even if promotion increases sales,the benefits MAY or MAY NOT translateinto increased profits of those who payfor the promotion:

1. Small sales impact

2. Free rider effects and benefit spillover

Small contributor benefit

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3. (linkages among countries)

2. (linkages amongmarkets for closely related goods)

1. (market linkages from retail

to processing to production)


Measuring benefits to contributors requiresmore complex market models than typicallyused for demand/sales impact studies

If promotion is at retail and contributors areat producer level, then the model mustaccount for:

HORIZONTAL LINKAGES

TRADE LINKAGES

VERTICAL LINKAGES

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capacity

Florida

PlantingsRemovals bytree ageTree Inventoryby tree ageProduction bytree age group

OrangeProductionAZ, CA, TX

BearingAcreage

Production

Production

Florida


OrangeProduction

Florida


OrangeProduction

TotalOrangeSupply

Fresh

OrangeSupply

Fresh

OrangePrice

FloridaFreshPrice

AZ,CA,TX

FreshPrice

FreshDomesticDemand

FreshExport

Demand

Demand

ProcessOrange

Price

ProcessOrange

PriceProcessFlorida

AZ,CA,TX

ProcessPrice

OJProd.

OJ

StocksEnding

OJ

DemandDomes.

OJImports

OJPrice

Brazil &World

OJExports

weather

yields

technologyalternativecrop prices

costsproduction

weather

yields

technologyalternativecrop prices

costsproduction

disposable

population

other fruitprices

inflation

income

exchange

foreign

foreign

inflation

rates

population

GDPand

processing market

of supplyavailability

power

efficiencyextraction

disposable

population

other fruitjuice prices

inflation

income

exchange

foreign

foreign

inflation

rates

population

GDPand

Notes:

= flow relationship

= lagged flow relationship

= exogenous variables

= endogenous variables = endogenous identity variables

brandedand genericadvertising

marketing,

coststransport

marketing,

coststransport

Structural Representation of Orangeand Orange Juice Markets

Forecasting And Business Analytics, LLC

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OJMOD Structural Specification1


tbg)tpl)

U.S. Orange Production by StateFlorida Production

(1) Plantings: PLt = PL(yft * POft, Wft,

(2-5) Bearing Tree Inventory by age group (g): Bgt = Bg(yft * POt, =

gm

gni

PLt-i, Wft,

where ng = age of youngest tree in group

mg = age of oldest tree in group g

(6-9) Removal of Trees by age group (g): Rgt = =

gm

gni

PLt-i -Bgt

(10) Florida Orange Production: Oft = gtj

1ggt By *

=

where j = 4 (young, middle 1, middle 2, old)

Arizona, California, and Texas Production

(11-13) Bearing Acreage: Ast = As(yst * POt, Wst,

where s = Arizona (a), California (c), Texas (t)

(14-16) Orange Production: Ost = yst * Ast

(17-20) State-to-National On-TreeOrange Price Linkages: POft = POf(POt,

POst = POs(POt,

(21) National Average On-Tree Orange

Price Linkage to National On-Tree

Processing and Fresh Oranges Prices: POt= PO(PPt, PFt,

ts)

tf)to)

tpo)

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OJMOD Structural Specification(contd)


National Orange Supply and Demand

National Orange Production and Processing Orange Market

(22) National Orange Production: OTt= Oft + =

3

1s

Ast

(23) Processing Demand: DPt= DP(MOt(24) Processing Margin: MOt= t*POJt- PPt(25) Processing Orange to OJ Price Link: PPt= PP(POJt,

National Fresh Orange Market

(26) Supply of Fresh Oranges: SFt= OTt - DPt(27) Demand for Fresh Oranges: DFt= DF(PFRt,

(28) Export Demand for Fresh Oranges: XFt= XF(PFXt,

(29) Fresh Market Clearing Condition: SFt= DFt+ XFt(30) Farm-to-Retail Fresh Price Linkage: PFt= PF(PFRt,

(31) International Fresh Price Linkage: PFt= PX(PFXt,

tdp)

tpp)

tdf)txf)

tpf)tpx)

/t

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OJMOD Structural Specification1(contd)

National and World Orange Juice Supply and Demand

National Orange Juice Market

(32) Production of Orange Juice: SOJt = * DPt

(33) Demand for Orange Juice: DOJt = DOJ(POJt, GFDOC, GBRAND

(34) Ending Inventory Demand for OJ: IOJt = IOJ(POJt, SOJt(35) Market Clearing Condition: MOJt = DOJt + IOJt - SOJt -IOJt-1

(36) U.S. Import to Retail OJ Price Linkage: POJt = POJ(PMOJt

World Orange Juice Market

(37) Brazilian OJ Export Supply: XBOJt = XBOJ(PBOJt

(38) ROW2 OJ Net Import Demand: MROJt = MROJ(PBOJt

(39) World OJ Market Clearing Condition: MOJt = XBOJt - MROJt

(40) U.S.-Brazil OJ Price Linkage: PMOJt = PMOJ(PBOJt

1 Nominal values in all behavioral equations except price linkages deflated with appropriate price deflator prior to estimation. For

simulation purposes, the model was re-normalized to insure that each endogenous variable shows up on the left-hand side of only one

equation.

2 ROW = Rest-of-the-World.

t , tdoj)

, tioj)

, tpoj)

, tboj), troj)

, tmoj)

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MEASURING THE BENEFITS

Simulation (Counterfactual) Analysis

1. Use model to simulate effects on price, sales,production, production costs, trade, etc. withand withoutpromotion expenditures

2. Use simulation results to calculate change in

contributor profits (price x production - costs)

3. Calculate Contributor Profit BCR

(Total increase in profits Total promotion dollars)

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Internal Rate of Return (IRR) Analysis

Steps 1 and 2 the same as for the BCR calculation.

Then calculate the total change in the future valueof estimated profits divided by the present valueof total promotional expenditures:

1$PromotionofPV

ProfitAddedofFVIRR

N

1

=

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FDOC Advertising Investments: Florida Orange Grower Benefit-Cost Analysis, 1967/68-1999/2000a


1967/68-1982/83

1983/84-1999/2000

1967/68-1999/2000

Added Orange Cash Receipts ($ million) 2,265.1 2,219.3 4,484.4

FDOC Advertising Expenditures ($ million) 155.7 331.0 486.7

Revenue Benefit-Cost Ratio (RBCR) 14.6 6.7 9.2

Average Cost of Orange Production ($/tree) 11.8 8.0 9.8

Cost of Added Orange Production ($ million) 502.1 513.2 1,015.3

Added Receipts Minus Added Costs ($ million) 1,763.0 1,706.1 3,469.1

Grower Profit Benefit-Cost Ratio (PBCR) 11.3 5.2 7.1

Grower Net Profit Benefit-Cost Ratio (NBCR) 10.3 4.2 6.1

Discounted Grower Profit BCR (DBCR)

b

7.0 3.2 2.9

Internal Rate of Returnc 26.4% 17.4% 14.4%

a Includes effects of only the Florida Department of Citrus generic orange juice advertising expenditures.

b The interest rate on the 30-day Treasury bill used as the discount rate.c Calculated with the Modified Internal Rate of Return procedure (Barry, et al.., 1995)

using the 30-day T-bill rate.

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Interpretation of the IRR:

The rate of return that contributors would

have had to earn on their funds in otherinvestments to have done at least as wellas investing those funds in promotion

The IRR Analysis Treats Promotion asan Alternative Investment

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SOME MEASUREMENT ISSUES

Relationship between promotion andmarket behavior is not straightforward

1. Minimum threshold level of expendituresfor promotion to begin to have effect

2. Life Cycle of Advertising:

- Delayed Effect stage- Carryover Effect stage

- Decay Effect stage

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SOME MEASUREMENT ISSUES

Researchers must account for LifeCycle Effects of advertising

1. Models must include some lag structure

for promotion expenditures

2. Models must adopt an appropriatefunctional form for demand relationshipto account for advertising decay

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STEP 3: COLLECT DATA

Data on large number of variables overlong periods of time required:

1. Promotion expenditures by type of activity,media type, geographic location, etc.

3. Other Key Market Variables (domestic and

foreign supply, demand, prices, trade,government policies, income, transportationcosts, macro variables such as interestrates, exchange rates, etc.)

2. Promotion expenditures on competingproducts

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Frequency of data is important

Weekly: Supermarket scanner data fromA.C. Nielsen or Information Resources, Inc.

Monthly or even quarterly: Ideal for demandanalysis

Annual: May be necessary if supply responseor foreign market behavior included such asin contributor benefit analyses

STEP 3: COLLECT DATA (contd)

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STEP 3: COLLECT DATA (contd)

Cannot Wait Until Analysis is Needed toBegin Collecting Data

Data collection takes a greats deal of time

Data collection, maintenance, and warehousing(database) system needed to facilitate analysisas required

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STEP 4: SELECT EVALUATION TEAM

Consumer Awareness Tracking Studies

- Advertising/Market Research Firms- Researchers in Marketing Departments of

Business Schools

Commodity Promotion Program Analysis

- Economists with expertise and experience inrelevant statistical analyses, market modeling,

scenario analysis, evaluation of commoditypromotion programs

- Selection of researcher(s) should emphasizeobjectivity and peer review to enhance

credibility and professional quality of the work

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WHAT TO EXPECT FROM ANALYSIS

Even if promotion is statistically significant, notlikely to have a large impact on sales or profits

Large BCRs not difficult to find

Dividing small impact on profits by evensmaller expenditures can result in large ratios

Contributors expect that the promotion will

make them individually better offPromotion does not necessarily raise price butcontributors often use price as measure ofprogram effectiveness

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WHAT TO EXPECT FROM ANALYSIS

Results of analysis may not provide entirelyreliable guidance for future allocations ofpromotion funds:

1. What may be true of a program as a wholemay not be true of individual promotionactivities

2. Such analyses are backward looking

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SUMMARY

Measuring Promotion Impacts is Possible

Statistically Complicated

Requires:

Proper and objective expertise to insurereliability, credibility, and usefulnessof results

A great deal of data over long time periods

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