ENGINEERING, DESIGN, AND PROCESS DEVELOPMENT indicate a significant increase in the relative importance of small refiners (those processing under 20,000 barrels daily of crude), estimating that by 1955 they will increase their share of the total catalytic reforming capacity from 1.90 to 9.25% and that intermediate refiners (those processing between 20,000 and 50,000 barrels daily of crude) will increase their share of the catalytic reforming capacity from 0 to 13.28%. As a result of the acquisition of a larger share of total catalytic reforming capacity by the smaller and intermediate refiners, the percentage of capacity accounted for by the largest refiners will drop from 98.10 to 77.47% in catalytic reforming Of considerable significance, according to Deputy Petroleum Administrator Joseph A LaFortune, is the adoption by the smaller refiners of modern and more efficient processes a8 shown by the indicated increase in their catalytic reforming capacity. These modern and more efficient catalytic reforming processes were made available to the small and intermediate refiners (and, of course, the larger refiners as well) under licensing arrangements a t reasonable royalty rates. Certainly the smaller refiner with his limited resources would not have been able t o acquire this process technique and know-how by any means other than a reasonable licensing arrangement. A process of considerable interest today is that for producing polyethylene, developed by Imperial Chemical Industries of Great Britain. The licensing agreement offered by IC1 includes immunity from suit, technical know-how and design data for a plant, and instruction for operating personnel. The royalty rate has been set at a $500,000 lump sum payment plus 2% of the selling price of polyethylene produced in the next 15 years. The July 1954 market price was about 45 cents a pound. Construction cost of a 17,000,000-pound-a-year plant is estimated to be about $11,000,000. At least eight companies are expected to be in the polyethylene field by 1956, producing over 500,000,000 pounds a year. Until last year, two large companies, both with extensive research departments, were the only producers in this
country. The fact that these companies, both leaders in developing their own processes, licensed the process, is strong evidence that licensing is a t times the most economical way to acquire process know-how. I n conclusion, the acquisition of process know-how, necessary for profitable enterprise, requires the expenditure of large sums of money. I n the development of process know-how by individual operating companies, either on their own or through independent laboratories, there is the inherent risk that no financial return will be obtained because of failure to work out a satisfactory process or because another company anticipates the development. I n contrast, obtaining a process through licensing is relatively foolproof for the licensee, with the licensor assuming the risks. The licensee’s expenditures and probable financial returns can be closely estimated in advance, The licensee’s expenditure for the process know-how usually does not begin until after the process is in operation and he is deriving income from it. Dynamic advances have recently been made in the field of process industry technology. The search for improved processes proceeds a t an ever-increasing pace. The acquisition of process technique and know-how through licensing is often highly desirable for large Companies; for small and intermediate companies it is by far the most economical method of acquiring process know-how and very often constitutes the only practical means by which they may keep abreast in a highly competitive field.
References (1) U. S. Department of Labor, Washington 25, D. C., Bureau of Labor Statistics-in Cooperation with U. S. Department of
Defense, Bull. 1148, “Scientific Research and Development in American Industry-A Study of Manpower and Costs.” (2) Fortune, p. 115 (October 1950). (3) Oil Gas J.,51, 53 (Nov. 23, 1953). RECEIVED for review August 9, 1954.
ACCEPTED
February 10,1955.
Costs in Developing Marketing Know-How RALPH L. ERICSSON, Sumner Chemical Co., New York, N. Y.
LESTER
E.
JOHNSON, Mafhieson Chemical Corp., New York, N. Y.
Costs in developing marketing know-how vary widely among different chemica I companies. The large company with an established line of products will spend only a small fraction of its total sales expense in developing marketing know-how on a new product whereas a small company, fighting to establish itself with a line of newer chemicals, may have to spend the major part of its selling budget, especially in the initial stages, in learning how to market its products. This part of the symposium hypothecates the cost of developing (or maintaining) the three major aspects of marketing know-how-market research, market development, and selling itself.
W
I T H the exception of this article, this symposium is concerned entirely with costs in developing technical know-how. It is useful, however, that a discussion on the costs of developing marketing know-how be included since marketing costs are a significant portion of the structure bridging the gap between raw material and consumer item. I n an article in the Journal of Marketing for January 1953, entitled “Increasing Distribution Efficiency by Better Organized Research,,’ Charles W. Smith points out “that the manufacturer receives on the average only about 50 cents of every consumer dollar-the balance being absorbed by distribution costa-has now been so well established by
992
economists that the importance of increasing our national distribution efficiency is generally recognized by the business community.’, This observation concerns industry as a whole and not the chemical industry specifically and the whole distributive coat rather than just the cost of sales, yet the cost of sales as a part of the distributive effort is well recognized by our industry and is the subject of continuous effort toward reduction. The title assigned to this paper is a broad title and the term ‘[know-how” is a very broad term. Know-how includes information of markets and the technique of applying this information. It could conceivably comprise the individual training of
INDUSTRIAL AND ENGINEERING CHEMISTRY
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KNOW-HOW ECONOMICS the whole sales force and the men in market research and market development. It could include the important but intangible contribution of experience of the individual engaged in the effort. It could lead to the problem of differentiating between the actual costs of men’s selling efforts and that effort consumed in training. It could include the esprit de corps of the organization, the cooperation that welds individuals into a functioning machine. Know-how could include the whole internal and external effectiveness of people working together The difficulties of costing such concepts are readily apparent. Because of the obvious difficulties of assigning a value to these broad and often intangible concepts and the resulting probable extension of this paper beyond a practical scope, marketing knowhow has in this discussion been limited to three principal categories :
tions of the marketing research and market or sales development for three hypothetical companies, one in each size category. This estimated budget for marketing research is shown in Table I. Company-size categories of small, medium, and large have been set up by assigning annual sales of $10,000,000, $75,000,000, and $200,000,000 per year. The number of technical and clerical personnel assigned to each size category has been based on the number observed t o be so employed in chemical companies of each category. Assignment of facilities and their costs and other expenses has been based on the number of individuals to be serviced. The assignment of an annual sales volume to each category has, of necessity, been arbitrary, but it is believed that companies with annual sales of $10,000,000, $75,000,000, and $200,000,000 per annum can logically be described as smdl, medium, and large chemical enterprises.
1. Marketing research-the costs of determining where markets are and what is their extent 2. Market development-the costs of developing markets for new products and the extension of old products into new uses 3. Direct sales-the cost of maintaining present markets and extending their volume
Table 1.
Having defined and limited the components of marketing know-how, it should be possible to proceed with the development of the cost of each individual component. The ease of such determination is, however, vastly complicated by several circumstances. The first is the nearly complete absence in the chemical industry literature of actual costs or even estimated costs of marketing operations. A substantial literature is developing on the techniques, procedures, and methods of marketing research and marketing development. Plans for a market research or market development organization are stipulated, and the location of each of these functions within the total corporate organization is suggested. But the literature is completely silent on the cost of each of these operations and what amounts or what proportion of gross sales typical companies in our industry spend for such operations. In the absence of a literature on the subject of marketing costs, one turns to friends and acquaintances in the field. We asked them to indicate what their companies spend for marketing research, market development, and sales. Here, too, barriers present themselves. Perhaps the most common is the consolidation of the functions of market research and market development, such that no accounting separation of the costs of each function is possible. Perhaps, too, one function might lie within one principal division of the company and the second function in a second division. Typical of such separation is the placement of market research in the research and development department of a corporation and market development in the sales department. Budgets for these two functions are often in such instances merged with the departmental budget and are, therefore, lost. The second, and perhaps more important barrier to accumulation of cost data for various marketing activities is that such costs are considered confidential information. Product costs are usually kept in confidential files that are not available to everyone within the company organization. Marketing costs appear to approach this status. The costs of marketing, like the costs of anything within the company, appear to be quite private affairs and individuals in these activities, when approached for cost data on their group function, often react as if asked t o display the contents of their wallet. These barriers are real and understandable. Careful separation of accounts may be necessary for the company’s own accountants t o know what the costs of the functions mentioned are, but the reticence in divulging costs is quite understandable. Although actual costs of each part of marketing may not be available to the inquirer, a useful estimate can be arrived at by preparing a stipulated budget for the group that performs each of the marketing operations and arriving a t an estimate of the cost of the operation in this fashion. This has been done for the funcMay 1955
Estimated Annual Cost of Maintaining a Market Research Department
Category Annual sales, millions Salaries Travel (20% of salaries) Office expense Other expense Total % of sales Cost per man-month Personnel Technical Secretarial and clerical
Small 10 $20,000 4,000 $
Medium $ 75 $40,000 8,000 4,000 4,000
2,000
2,000 $28,000 0.280 $ 1,167
$56,000 0.075 $
l,lG7
2
4
1
2
Large 200 $60,000 12,000 6,000 6,000
8
$84,000 0.042
I 1,167 6
3
Because of the arbitrariness of these annual sales figures, probably no valid conclusions can be drawn on the relationship of the market research costs as percentage of sales t o company size. It will be noted that cost of this operation as percentage of sales is materially reduced as company size increases, in spite of the fact that the number of people assigned to this function in each category are fairly representative of department sizes existing in the industry. It would, of course, be helpful to have chemical industry data against which to check the stipulated budgets. Although no study for this industry alone was uncovered in the literature, one item of interest for industry as a whole was noted. The American Management Association in 1953 reported a study entitled “Company Practices in Marketing Research.” As reported in Industrial Marketing foreOctober 1953, 180 companies responded to the AMA questionnaire of which 168 (93%) engaged in market research. As an indication of the size of these companies, 95.6y0 of the 168 companies reporting had a 1951 sales volume of more than $5,000,000. Sixty had a sales volume for the same year of more than $100,000,000,32 had a volume of $50,000,000t o $100,000,000, and 26 had avolumeof $25,000,000to $50,000,000. The type of companies reporting can be gaged by the fact that of the 180 replying to the questionnarie, 59 were producers of industrial products, 65 of consumer goods, 35 were producers of both industrial products and consumer goods, and 22 were in nonmanufacturing category. Eighty respondents in this study gave information on how much they spend on marketing research in terms of percentage of sales, and the average was 0.1 of 1%or 10 cents for each $100 of sale. Of those companies having an annual sales volume of less than $5,000,000, the average cost for marketing research was 30 cents for each $100 of sale or 0.3 of 1yo. The ratio of spending for marketing research to sales declined rapidly above sales volume of $100,000,000. In every aales group the range between the highest and lowest was notably wide. These findings indicate that although the stipulated budgets discussed are purely estimates, the resulting costs are in the right order of magnitude. This is further substantiated by a single estimate obtained confidentially from a privately owned chemical
INDUSTRIAL AND ENGINEERING CHEMISTRY
993
ENGINEERING, DESIGN, AND PROCESS DEVELOPMENT Table It.
Estimated Annual Cost of Maintaining a Market Development Department
Category Annual sales, millions
Small 8 10 $20,000
Salaries Travel (30% of salaries) Office expense Advertising, sampling Other expense
6,000
2,000 5,000 2,000
Total Yo of sales Cost per man-month
$35,000 0.350 $972 to $1,458
Technical Secretarial and clerical
Table 111.
Large 200 $70,000 21,000 7,000 14,000 7,000
$78,000 0.104 $1,300 t o $l,G25
$119,000 0,059 $1,239 t o $1,653
2-3 1
8
6-8 5
4-5 3
Estimated Annual Cost of Maintaining a Sales Department
Category Annual sales, millions Salaries Travel Office expense Advertising Other expense Total
o/o
Medium $ 75 $45,000 15,000 4,500 9,000 4,500
of sales
Personnel Salesmen and managers Market development Dlrnlin group FSecretarial and clerical
Small 10
s
$200 000
$
Q
8o:ooo
20,000
40,000
G O , 000
~400,000 4
Rlediuni 75 750,000 250,000 80,000 200,000 220,000
$
Large 200
$1,500,000 350,000 200,000 400,000 550,000
$ ~ , ~ O O , O O O~ 3 , 0 0 0 , 0 0 0 2 1.5
12-16
50-75
125-160
9-2 2-3 5-8
A-R 4-6 20-25
A -in 6-10 50-75
company believed to have a sales volume of $20,000,000 to $25,000,000 per year. Their cost of marketing research was about 0.2 of 1% of annual sales. Since cost data on the maintenance of a market or sales development organization were no more readily available than those for a marketing research organization, it was necessary again to resort to the method of a stipulated budget. Such a budget for the same company-size categories with the same stipulated annual sales in each category is shown in Table 11. Again, the assignment of the number of people is based on personal observation of the size of staffs in each company category within the industry. Comparison of Tables I and I1 reveals differences between the two types of organization. A higher proportion of clerical people has been included in the market development department. This is based on the fact that a maiket or sales development organization will necessarily engage in more external correspondence. rSverage salaries of both technical and clerical people have been maintained the same since observation indicates there is no significant difference in salaries at corresponding levels of people in market research or market development. A higher proportion of salaries has been taken as travel expense, based on the fact that additional travel will be required in actually introducing a new product to the market than in determining where the market is, largely because of repeated calls to the same point. Additional items of literature mailing and advertising and of sample distribution have been included in the estimated budget for market the increased travel, development. It is these items-namely, literature mailing and advertising, and sample distribution-that account for the increased cost of market development effort and the increased cost per man-month. For both a marketing research department and a market development department, a cost per man-month has been indicated. These costs are nearly the same for each company-size category.
END END 994
OF
OF
The cost per man-month has been indicated primarily as a means of estimating quickly and in general terms only the cost of a project, whether in market research or in market development, if the man-months of effort can be estimated. We now come to the most expensive of the three functions comprising this paper-the cost of selling itself. This function involves the fullest expansion of the markets indicated by the market research and development work that has preceded it, finding new markets that may not have been anticipated, and, above all, keeping the established accounts against the inevitable competition. While market research and development are largely matters of science plus imagination, the continued sales that are the lifeblood of any enterprise must employ the salesman’s “art.” Costing the development of this aspect sends us back again to the stipulated budget based on assumptions coming from experience. The hazards in these estimates are obvious but bear stating. I n the first place, few companies use exactly the same “chart of accounts.” Secondly, the only data the authors can be sure of is that of their own companies, and top management is reluctant to reveal quite all these intimate details to the public, so we have had to take liberties with our own data. Finally, no two companies have exactly the same sales philosophy and this makes for great variation in individual items in our figures, although we believe the totals are realistic. Table I11 s h o w a hypothetical sales expense for the same three size companies previously mentioned. As size increases, t h e percentage of total sales that must be expended in selling effort diminishes-one of the advantages of size. As staff increases, areas to be covered by individual salesmen are more restricted and hence travel expense per man is reduced. Growth is also accompanied by an increase in inside and clerical staff, and this is often greater in proportion to the “outside” salesmen. While advertising increases with growth, it usually is not in direct proportion to the growth itself. The “other expense” column is a catch-all to cover that 15 to 20y0of total selling expense some companies list under packaging expense, freight, light, heat, janitors, etc. The real meat of this article can only be obtained after thorough digestion of all the elements of cost that have been discussed thus far. I t is seldom that an organization must start from absolute scratch to develop marketing know-how. Even if the company has had no experience in a given field, it can usually purchase that know-how by hiring a staff of men with the necessary knowledge. The cost of such an acquisition therefore consists only of the salaries and expenses necessary t o create the staff. I n this case, the budget estimates included here can be considered to be the costs necessary to maintain and expand the present know-how of the staff, It is also not only possible but very often desirable to train the available staff rather than hire new people. Numerous companies have done just this, since they have found there are fewer disadvantages in retraining a staff already aware of company personalities and philosophies than in bringing in a group of “specialists” who may not mesh well in the established organization. Finally, the authors caution the reader to take the examples as examples only. Since we have apparently tackled a subject that has had scant public discussion or publication, yet is intimately the every-day concern of management, our examples may be a long way from the situation found in a given company. There are broad areas of agreement, however, and we believe our assumptions cannot be far from industry averages. RECEIVED for review .4ugust 9, 1954. ACCEPTED March 2, 1955.
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AND ENGINEERING, DESIGN, AND PROCESS DEVELOPMENT SECTION
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