Marketing Spending Models - Innovation and Marketing in the Pharmaceutical Industry - page 565

19.3.4 Return on Investment of Spending Categories

Managers are usually highly interested in models that enable them to quantify the
return of a marketing investment (marketing ROI). The ROI concept is simple and
recommendations can be derived in an intuitive manner. If the ROI of an activity is
negative, then managers should no longer spend money on this activity. The oppo-
site is true for positive returns. In addition, we know that the optimum level of an
instrument is achieved if the ROI is zero provided that there are no budget con-
straints. 2 Consider the following basic profit equation where ∏ denotes profit, Q ( p ,
X ) represents the market response function of unit sales with respect to price p and
the level of expenditures for a marketing instrument X , and c denotes the marginal
cost of producing one unit:

(

)

(

) −

P =− pcQpXX , (19.6)

The short-term ROI in percent may be obtained as follows (see also Narayanan
et al. 2004 ):

pc Q
X

) ¶

[ ] =-

(

[ ]

ROIin%

¶ -´

1 100 (19.7)

The exact expression depends on the specification of the response model.
In addition, the calculation of ROI changes if interactions are considered and
dynamic effects are included culminating into a multi-period ROI.
Table 19.3 summarizes the ROI findings from several studies. Authors have used
different functional forms to model brand sales, among them double-log functions,
log-linear functions, and linear functions. The studies by Chintagunta and Desiraju
( 2005 ) and Narayanan et al. ( 2004 ) combine a mixed logit market share model with
a category sales model to derive ROI estimates for expenditures on detailing and
DTC advertising. Three studies are based on individual-level data (prescriptions
issued by a physician), whereas the rest of the studies use aggregate brand sales
data. Table 19.3 shows ROI figures in %, consistent with specification ( 19.3 ). For
example, if 100 additional dollars spent on detailing generate 130 dollars additional
profit contribution this is equivalent to an ROI of 30 % [(130 - 100)/100 × (100%)].
The studies in Table 19.3 show that detailing may provide substantial positive
returns on investment at observed investment levels. The values are greater for drugs
that generate higher baseline sales and that are in the early stages of their life (Neslin
2001 ; Wittink 2002 ). It seems that ROI figures obtained at the individual physician

2 I want to emphasize that I use the term ROI from a marginal analysis perspective. Here, the
objective is to find the profit maximizing spending level. The ROI measures the incremental profit
gain from an incremental increase in spending level divided by that increase in spending.
Practitioners sometimes refer to the ratio of total profit gain and total spending level. By definition,
this ratio is maximized if incremental ROI is zero.