Running the Numbers

Running the Numbers

2009|By Chris Lynn

Do you know how to tie your marketing investments to shareholder value?  It might help you to get your CFO to see marketing as a business driver instead of a cost center.

This is the Age of Accountability. Investors have demanded it, Congress has mandated it. The SEC is enforcing it. And some high-profile captains of industry are doing the perp walk pour encourager les autres. Of course, by itself, all that is old news. What economists are calling “the agency problem”—aligning the interests of managers with owners—has been around since Machiavelli gave advice to the Medicis.

But one thing is new. The Sarbanes-Oxley Act has made public companies document their controls and procedures, asking them to assess the risks associated with those procedures. This call for compliance is forcing many to look—anew and in-depth—into how they operate. And Sarbox is just one factor driving businesses to do that. Global competition, commoditization and market fragmentation are persuading companies to do the same rigorous analysis. As a result, no marketing leader today is willing to admit that he doesn’t know which 50 percent of the advertising budget is wasted. And nobody is getting away with the sort of let’s-just-add-6-percent-to-last-year’s-media-spend style of incremental budgeting. On the contrary, “zero-based” budgeting—where every line item is cost-justified or assumed to be unnecessary—is becoming a standard discipline.

But many marketing groups still experience a curious disconnect between their spending decisions and a commitment to increase shareholder value. That’s in part because they have little interest in financial analysis (a weakness that accounts for marketing’s low status in many companies). It’s also because accounting standards persist in treating money spent on marketing as a cost, to be expensed in the current financial year, rather than an investment like R&D that pays back over several years.

Given that you are unlikely to overturn GAAP—the Generally Accepted Accounting Principles—in the next year, what can you do to ensure that marketing is seen as an investment rather than a cost center? Start by recognizing that, ultimately, it all comes down to cash and measurement.

The numbers part of it can be a little daunting, but remember that increasing shareholder value simply means making the stock price go up or increasing dividends. Dividends come from cash flow, and the stock price reflects the stock market’s expectations for the company’s ability to generate cash flows in the future. Basically speaking, the value of the company is the discounted net present value (NPV) of the stream of cash flows that are expected to be generated into the infinite future. See? It’s simple (kind of).

Here’s all you really need to remember as a marketing manager. It is your job to:

      Raise cash flows in volume and number

      Accelerate cash flows so that they start as early as possible

      Prolong cash flows so that they last as long as possible

      Minimize the risk to cash flows so that surprises are avoided

Your ability to make the connection between marketing and shareholder value will reinforce your position that the money spent on marketing is a strategic investment and not merely cost without clear justification and accountability.

Tools of the Trade

Companies recognize that a loyal and profitable customer is the best kind to have, and that identifying and communicating with these customers is critical. Brands create loyalty and product longevity, extending the duration of the cash flows. In fact, studies show that leading computer brands can get customers to adopt their next generation of products three to six months earlier than weaker brands, and they can also get faster access to distribution channels—both factors that accelerate cash flows.

Brand loyalty also reduces risk to cash flows—and not so incidentally, this lower risk can lead to lower cost of capital for the corporation. Other benefits of a strong brand are higher volumes (more sales and therefore cash) leading to economies of scale—reducing product costs and amortizing fixed cost over more units. All that means that each investment in building a brand should be cost-justified in terms of its implications for the growth and volatility of future cash flows and not in terms of revenue growth, market share or, worst of all, brand awareness. That might be a good conversation to initiate with your CFO. Of course, you’ll want to be able to show how the ability of a branded good to command a price premium can lead to increased cash flows. The trick is to be able to measure the investments in brand development and the resulting cash flows on an individual basis.

Many corporations have found that customer lifetime value (CLV) is a useful tool to provide focus to their marketing efforts. This is the NPV of a customer—that is, the discounted value of the net cash the customer brings to the company over the lifetime of their relationship.

CLV starts off negative, as acquisition costs are incurred in today’s dollars. Then it is eventually offset over time by the net contribution of the customer’s purchases, plus the value of loyalty effects such as word-of-mouth recommendations, PR and so on. Quantifying acquisition costs and CLV is not straightforward; marketers must allocate costs and benefits to specific brands and to specific campaigns, using tools such as activity-based costing. But even if some heroic assumptions are used for the allocations, the results are likely to be more meaningful than, for example, simply dividing total sales by sales and marketing expenses to get acquisition cost.

Special Sauce

Integrative Logic is a company that represents the new breed of statistical marketers. According to CEO John Gardner, “CMO accountability will destroy the traditional ad agency.” Gardner hesitates to call his company an agency, though it does some creative work. But neither is it a direct marketing shop since it creates, manages and analyzes entire campaigns for its mostly retail and pharmaceutical clients. These campaigns may include e-mail and direct mail components, coupons, newspaper and online ads, and loyalty cards. Integrative Logic’s “special sauce” is its ability to close the loop on the cycle of tailored communication/response/transaction/next tailored communication. His company’s analyses show clients precisely what they are getting for their marketing investment. The key measures provided include incremental sales, gross marginal contribution, contribution net of incentives and CLV. This data-driven approach ensures that segmentation and messaging are optimized to create profitable long-term relationships for clients.

Another data analysis boutique, SRI Analytics, recently helped a major telecommunications company reduce the customer churn that was costing it $5 million per month. It created a “propensity to defect” model that used demographics, payment history, feature usage and service records to identify valuable at-risk accounts. This allowed the company to target these consumers with special promotions, reducing the churn rate, and to identify up-sell and cross-sell opportunities that increased revenue.

Marketing analytics, of course, are not new. Catalog marketers have been using RFM (recency, frequency, monetary value) scoring to segment their customers for years. But the Age of Accountability is giving analytics new attention. The previously low-status statisticians from the direct marketing department are being brought up, blinking, into the light of the boardroom to explain ANOVA, significance testing and Bayesian estimators. The tools they use—the statistical software, the data warehouses with terabytes of transactional, demographic and psychographic data—are available at increasingly affordable prices. Marketers’ ability to capture data has increased exponentially over the past few years: point-of-purchase data, bar-coded coupons and e-mails, online registrations, reverse telephone and e-mail appends—these all feed the data farms and provide grist for the statisticians’ mill.

Companies such as Integrative Logic and SRI Analytics are likely to thrive in the Age of Accountability because they help CMOs explain how their investments directly drive shareholder value. This explanation is no longer optional.

“In God we trust…. Everyone else bring data” has been attributed to quality guru W. Edwards Deming, but it should be the motto of the skeptical CMO. Why? Because shotgun marketing no longer works; because we can’t be relied on to watch just three TV channels any more; because we are an over-communicating society. And because we’re in the Age of Accountability. The CEO won’t sign off on that $10 million ad campaign without knowing in advance what it will do to sales, profitability, CLV, market share and ultimately, shareholder value.