Q: We were bothered about your views on COG (cost of goods) that we heard from a business associate to whom you gave an in-house seminar on accountable marketing. Apparently, you said that COG is also marketing’s responsibility. We asked for some practical explanation but the explanation we heard was not clear and too theoretical.
Ours is a practical concern. Doing something about this view of COG means changing our accounting procedure in a direction that we’re uncertain will be a change for the better.
We’re not against change. In fact, we welcome it provided there’s something really good to be gained from the change. The “gain” we heard was, frankly speaking, too theoretical. It may be good in theory but really not in practice. And we are practitioners. So we care more about good practice.
Please help us understand your COG views. We are avid readers of your column and have found your diagnosis and prescription sensible. Please give us a practical explanation.
A: There are two important but related sides to your request. The first is about the asserted role of marketing in COG. The second relates to the “practical” and not the “theoretical” basis for this assigned role.
We start with marketing’s responsibility for COG.
From a marketing standpoint, COG is the cost of the product you are offering to your target market. The start and end of that product came from marketing. It’s marketing who discovered or developed its concept as a product. Then manufacturing translated that concept into its physical and sensory form. After manufacturing, it’s again marketing who will bring it to its target market. That’s what is meant when we refer to COG not only as “cost of goods” manufactured” but also as “cost of goods” sold.
This latter distinction is also important in the marketing of consumer services. A restaurant, for example, is marketing not only its menu items but also the restaurant services surrounding each menu item.
In fact, the price of coffee at Starbucks or Chicken Joy at Jollibee relates less to the food cost of the coffee or the chicken but much more to the costs of the three components of a service. Those are the service staff, the service venue or what’s now more popularly known as the “servicescapes,” and the service processing. This means that it’s wrong to calibrate COG in a restaurant business as only its food costs. That’s only its “cost of goods manufactured” and not its “cost of goods sold.”
Look now at what COG does to profitability. In your P&L [profit and loss] statement, gross profit is defined as revenue minus COG. In almost all FMCGs [fast moving consumer products] gross profit rate now hovers between 20 percent and 30 percent. This means that COG is typically around 70 percent to 80 percent. That makes COG the largest expense item in your P&L [profit and loss]. But in most service companies like most restaurants which limit COG to just food cost, the gross profit rate looks artificially attractive at 60 percent or 70 percent. If any prospective entrepreneur would believe that this is the true first level picture of its profitability, this entrepreneur won’t look anywhere else for investing his money. However, we know this is not its true gross profit picture. Its true “cost of goods sold” does not only cover food cost but also its direct services costs.
Who says this is so? It’s the now accepted “theory” or “model” or “framework” of service that says so. According to this theory, from the standpoint of the marketer, a service is a “performance.” From the customer’s standpoint, a service is an “experience.” In a restaurant, that performance is not only about the menu food item being sold but also about what the service staff, the servicescapes, and the service processing do to that food item. It’s the experiencing of that totality that the customer is buying. And that’s why the costs of that totality are what make up its cost of goods sold.
This leads us to your belief about what may just be good in theory but may not be so in practice. Consider the COG concept that we’ve just explained especially as it relates to the restaurant service. Which restaurant do you think has the more likelihood of being profitable and in sustaining that profitability? The one who calibrates COG to cover only food costs versus the one whose COG covers both food costs and direct services costs? That’s meant as a rhetorical question. So why is it that the latter has the better likelihood? That’s because it has the better “theory,” the better “model,” the better “framework” as its basis.
The practicing behavioral scientist Dr. Kurt Lewin presented the truth of the idea when he said: “Nothing is more practical than a good theory. If it’s bad in practice, it came from a bad theory. If it’s good in practice, a good theory made it happen. A good theory is responsible for a good practice.” So align yourself with this good thinking practice. Disavow your mind in assuming that what may be good in theory may not be good in practice. Instead start accepting that “nothing is more practical than a good theory (a good model, a good framework).
Keep your questions coming. Send them to us at MarketingRx@pldtDSL.net or drnedmarketingrx@gmail.com. God bless!