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2001-07-01 09:02:00

The 'MCO formula'

:  How does a small business owner, or for that matter, any size of a business owner know what to spend in advertising?

Charlie Traffas Question:  How does a small business owner, or for that matter, any size of a business owner know what to spend in advertising?Answer: That's a good question.  I will answer your question after giving you a little background.  I think it will make it more entertaining and ‘digestible’.When I got into the radio business in the early 70's, The Radio Advertising Bureau (RAB - a trade association for radio stations across America) put out a sheet of different industries and the percentages of gross sales each should spend in advertising.  How they came up with these numbers I do not know.  If I recall correctly some of them were: grocery stores should spend 2%; fast food should spend 5%; consumer electronics should spend 8%; furniture and carpet should spend 7%; etc.  It wasn't until I attended a seminar in Dallas in 1976 that I found what I believe to be the true answer to your question.At this seminar, a couple of men spoke whose writings and teachings have become very important to me and many others involved in marketing.  One was Jules Steinberg, President of The National Retail Merchants' Association (NRMA).  The other was Jack Trout, who along with his partner Al Ries, wrote several books on marketing… including two of my all-time favorites… 'Positioning - the Battle for your Mind' and 'Marketing Warfare'.  Jules, along with others, founded the NRMA in 1947  In 1976 he was probably in his mid-70's.  I was most impressed with him and his knowledge of business and retail.  After the seminar I told him how much I appreciated his remarks and asked if I could buy him breakfast the next morning to ask a few questions.  He accepted.  We met early the next morning in the hotel coffee shop.  We finished over three hours later.  I remember starting out telling him how much I enjoyed his and Jack Trout's segments.  He thanked me.   While I can't remember what I had for breakfast, I will never forget the rudiments of our discussion.  He told me that after World War II, there was a lot of business expansion that was taking place with basically a ‘by guess and by golly’ approach.  Some businesses were successful, but many others were "advertising themselves out of business", either through a lack of control on advertising content, or expenditures.  Business as a whole was in need of a place it could go to get good information about how to first survive, and secondly how to run more efficiently.  Thus the birth of the NRMA.  Jules had not only co-founded it, but also served as its first and only President ... a position he still held at the time we met.  He worked with all types of businesses,  from $50,000 to $500 million in annual sales.  One of the things owners, managers and operators all wanted to know was the answer to the same question you asked.  He said the first thing he had to do was to let business owners know that the word 'advertising' was the wrong word.  The word should be 'marketing'.  He said 'marketing' is the parent.  Advertising is one of the ‘children’.  Marketing is defined as… the process of conditioning people to need what you want to sell them.  He said 'marketing' has four 'children'.  Their names are advertising, promotion, merchandising and public relations.  Each one does something different.  •  Advertising is the process of changing, directing, aligning, re-directing or re-aligning the perception of a product, service or concept.  •  Promotion is the process of creating sampling in order to develop long-term users.  •  Merchandising is the process of giving a product, service or concept its greatest opportunity for sale.  •  Public Relations is the process of inducing the public to have good will towards a person, firm, institution, company, product, service or concept.It was 1976.  He told me that while advertising was how the majority of all marketing had been done since the turn of the century, he felt things were changing whereby the other 'children' of marketing would be used more and more in place of advertising.  How true his forecast was!  Today, over 3 times more dollars are spent in promotion alone than advertising.  Merchandising has become a more valuable approach to marketing than ever as has Public Relations.  He told me that once he got the vernacular down with those businesses he consulted, he proceeded to answer the question of “How much should I spend in marketing?”, which would include costs for all four 'children' of marketing.To answer the question, he built what he called the 'MCO Formula'.  Marketing + Compensation + Occupancy should never equal more or less than one-half of Gross Profit… where Marketing includes costs for all four 'children'; Compensation includes all costs for salaries and labor; Occupancy includes all Rent - Lease - Service payments on the building plus any Occupancy-Related Utilities; and Gross Profit is defined as Gross Sales minus Cost of Goods Sold.He went on to say everything needs to be allocated properly in the marketing budget.  Advertising would include the cost for such things as Yellow Pages, Radio, TV, Direct Mail, Print, etc.  Promotion would include the cost for such things as for people to demonstrate a product or service, the net cost of the product or service one is demonstrating or giving away, the amount of mark-downs, etc.  Merchandising would include the cost for displaying the product.  Public Relations would include costs for all sorts of things... from hosting a golf tournament for one’s customers, to the cost of press releases, to the cost of purchasing a 4-H steer at the Fat Stock Show.  Compensation includes all salaries and commissions but not payroll taxes or employee benefits.  Occupancy includes the rent, lease, or building loan payment, along with any forced Occupancy-related utilities such as Common Area Maintenance in a Mall.Gross Sales of course are just that… the total of all sales to a business over a certain period of time.Cost of Goods Sold (COGS) is the cost of the product or service the business purchased in order to add its labor to it and sell it.  COGS would be the cost of the vehicle to the car dealer - the cost of the raw aluminum extrusion to the machine shop - the cost of the ingredients of the pizza and packaging items to the pizza outlet - the cost of the wood, screws, hinges, nails and finish to the cabinet shop - the wholesale cost of the tires, batteries and accessories to the automotive supply outlet, etc. He then gave me an example of a pizza restaurant.   Gross sales for last quarter were $120,000.  Food costs for the quarter ran $33,600.  Labor costs were $26,200.  Rent is $3,500 per month.  Since the owner bases his next quarter's budget on last quarter's performance… how much should he spend in marketing costs, in accordance with the MCO Formula?  Being pretty good at math, I made a couple of scribbles and said $6,500.  He told me I was correct.  He went on to reinforce that this amount must be the total amount spent in all areas of marketing with all its 'children' for the quarter. He said if a business will follow this formula to the letter, they will not go broke.  They could even put all of their marketing in Russian to an English-speaking target and still not go broke!  In other words, a business can miss badly on their creative and selection of media and still survive.  It a business is right on the money with its creative, imagine how good it will work then?He said this formula will show a business whether or not it can afford to advertise.  If after figuring one-half of gross profit, and subtracting the two knowns… compensation and occupancy… you have nothing left… you can't afford to advertise.  “What do you do then?”I asked.  He said “Being good at spawning word-of-mouth advertising would help.  So too would things like paying yourself and your employees less; lowering your rent factor by moving; negotiating lower prices on the cost of your raw materials, etc.  But one thing is certain… if you spend money in marketing without it being there to spend… you won't be spending it long!” he said.                             We ended our breakfast with me thanking him for his time and again telling him how much I appreciated what he had to say.  He thanked me for listening.I had an old boss for many years that knew of my dislike of attending seminars.  He said that if I would go expecting to ‘glean’ just one thing from them that I could use, I would enjoy them more.  He was so right.  Between Mr. Steinberg’s MCO Formula, and Mr. Trout’s ‘Marketing Warfare’ (to be shared later in a follow-up article), I had much of what I needed for the rest of my career. Since that day, I have probably given 1,500 seminars... to all types of businesses across the country... trying to teach others what I have learned.  I have never failed yet to give all of the credit for these two ‘gems’ to Jules Steinberg and Jack Trout.