Learning the new math

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We are going to have to totally rethink how marketing and sales promotion programs are developed and implemented. The reason? New accounting requirements so fundamental they promise to change the way sales and marketing mangers use such promotional tools as off-invoice allowances, couponing, frequent purchaser programs and the like and to require a rewriting of most sales promotion texts.

The new requirements, issued by the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB), indicate when a marketing or sales expenditure is classified as an "expense" and when it is classified as a "reduction in revenue."

Known as EITF Issue 00-14 ("Accounting for Certain Sales Incentives") and EITF Issue 00-25 ("Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products"), the requirements must be applied in financial statements for all publicly traded companies for annual or interim periods beginning after Dec. 15.

Put simply, these new standards require that many of the traditional promotional incentives used by marketing organizations (off-invoice allowances, coupons, slotting fees and so on) no longer be considered "expenses" or "costs of doing business" and deducted from gross margins on sales. Instead, they will have to be taken as reductions in revenue.

For example, consider an organization with $10 million in gross sales. To generate that volume, it has spent $1 million in cooperative marketing funds. It now may be required to report gross sales as $9 million, not $10 million, unless the marketing funds are applied to programs that are separable from the vendor relationship and have a benefit for which fair value can be objectively determined.

Co-op advertising, for example, is seen as one form of promotional program that could continue to be classified as a marketing expense-if objective information about the value of the advertising (the cost of the media, etc.) is obtainable. Any cost charged by the receiving partner over the actual objective cost of the media or services must then be classified as a reduction of revenue by the offering party. Part of the cost of the program would then be classified as an expense and part as a reduction in revenue.

This means programs such as promotional allowances, coupons, buy downs and the like will reduce reported revenue-unless the result of the marketing effort generates sufficient additional volume to offset the reduction in revenue as required by the new EITF/FASB requirements. The "bottom line" will be the same under the new rules as under the old rules if additional sales are not generated. But this new requirement will undoubtedly create major havoc for sales, marketing and brand management accustomed to achieving sales targets through promotions and then managing margins.

Today, most sales and marketing groups focus primarily on volume and top line dollar sales. In many companies, sales and marketing "sell" everything at list price and then offer the trade and consumer promotions off that "list price" as expenses; the "inside guys" (i.e., accountants, financial reporting people, controllers and the like) are the ones who are supposed to worry about profit margins.

In some cases, senior sales managers in consumer product companies do not even know what the margins are on various product lines. They are given a volume objective and a promotional budget and are expected to "meet the numbers." Top line sales are not a problem since everything is billed out at list price (any case volume increase generates more top line dollars) and the promotional allowances are taken from the internal margins.

Under the new requirements, the promotional allowances are "taken off the top" as a reduction in revenue. Thus, the likely change for the sales force and marketing people will be a management mandate to effectively deliver top-line dollar sales, not just unit volume. That totally rewrites the sales promotion book.

What does all this mean for the sales promotion industry, the group that accounts for around 75% of all promotional investments by consumer goods marketers? For one thing, it likely will make measurement and evaluation of promotional investments a much more salient issue for top management. Knowing which promotions worked and which didn't will be critical.

Second, it likely says there will need to be more pre-testing of promotional programs. If the CEO is going to risk the top-line sales number on a promotional event, he or she is going to want much more assurance that the promotion will work as planned and deliver the required volume growth at an acceptable cost.

Third, the new requirements will cause promotion managers and promotion agencies to rethink the whole role of sales promotion. Today, sales promotion is considered by many to be a "short-term fix" for operations, distribution and the like when over-capacity occurs. More than likely, sales promotion in the future will have to be much more long term and strategic; that is, it must build not just short-term, off-price sales. It must also build brand value so the promotion builds long-term sales at full price to ongoing customers. That, in and of itself, will force many sales promotion managers to rewrite the book on sales promotion-not an altogether bad idea.

Mr. Schultz is professor of integrated marketing communications at Northwestern University's Medill School of Journalism, Evanston, Ill. Mr. Lunde's Chicago-based consultancy, Lunde Co., specializes in package goods and food retailer marketing. Assistance in preparation of this article came from Teresa Iannaconi, a partner in KPMG's department of professional practice in New York and a member of the Financial Accounting Standards Board's Emerging Issues Task Force.

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