By Professor Malcolm McDonald
Introduction
This short paper is part of knowledge sharing linked to the Knowledge Development Committee, of which I am a member. It sets out some of my thoughts on the topic of BRAND, which will be the topic of the first event to be run by this Committee.
I am using the term “science” here somewhat loosely and am well aware of the longstanding debate by scholars about whether marketing is an art or a science. I personally lean toward the “art” school, although I recognise that great strides forward have been taken by, for example, the use of state-of-the-art statistical techniques and AI to test hypotheses about the impact of marketing strategies. These are scientific in the sense that they are proven and repeatable. I never forget, however, the words of William Bruce Cameron (frequently incorrectly attributed to Einstein):
“Not everything that can be counted counts. Not everything that counts can be counted”.
In this viewpoint, the word “science” refers to a probabilistic methodology for calculating how successful brands create shareholder value. My intention here is to offer some thoughts on the topic of the ‘science’ of powerful brands for the simple reason that brands and the way they are managed have a major impact on the creation of shareholder value added, (SVA) about which more later. They also have a major impact on an organisation’s reputation.
Next, I want to stress that I am not going to focus on logos. The world is awash with them and there are very few that the average person might recognise. I ask myself why do most CEOs, on taking up their new job, feel compelled to redesign their logo that no one in the world recognises or cares about? What they should be doing is working hard to ensure that their offers are distinctive and create advantage for their customers. Only then does the logo become valuable and important, as in the case of the likes of Coca Cola, Adidas, Shell and all the great brands that create SVA for their owners. Could you imagine anyone being allowed to mess with the Coca Cola or Shell logos?!
Deconstructing the Brand
At this point, I need to explain what brands are, logos being the very basic of definitions and worthless unless they create competitive advantage for their owner, such as 3M. According to David Haigh, CEO of Brand Finance plc, the next level is that bundle of associated intellectual property rights, such as product design rights, and a host of other assets such as the Guinness recipe and the Mercedes engineering processes. The third level spelled out by David is the holistic company or corporate brand. It is here that I focus this viewpoint. All corporate executives should be aware that everything from R and D through to after sales service manifests itself in the value propositions that are made to their customers, all of which have a strong association with the corporation and its operations. This is how the corporate brand evolves (or declines). A brand, of course, is also much more than the name of its products and services and includes other aspects of communication such as pack design and advertising. However, the name supporting the offer is the most important.
The reality, of course is that most so-called brands are "pimply little me too" products; according to McKinsey and my own research, fewer than 5% of companies have financially quantified value propositions, which means they get bought mainly on price as customers can buy something similar anywhere. So, in most cases, brand choice is merely a mild preference, often based on little more than convenience or availability and is certainly not an earth-shattering customer experience. This represents the most frequent daily interaction with ‘brands. What I refer to as “powerful brands” are those which offer distinctive and unique customer value and experiences. Such brands need to be protected, nourished and managed like the major profit-creating assets they are.
In this viewpoint, I do not plan to explore the well-established, quantitative methods for quantifying the value of brands and customer equity. For a detailed explanation of each valuation methodology, look at chapter 9 of my book on finance referred to below (chapter 9 is guest edited by David Haigh of Brand Finance) However, linked to such processes is a quantitative method, developed by me and my finance colleagues at the Cranfield School of Management, for evaluating whether a corporate strategy, represented of course by the corporate brand, creates or destroys shareholder value. I refer you to our book,’ Marketing and Finance-creating shareholder value, Wiley, 2013’ (sponsored by the CIMA)
The Central Role of Risk Assessment in Value Creation
Let’s first look at the concept of risk. For most companies, the current share price already reflects some expected future growth in profits. Thus, current investors and, even more particularly, potential future shareholders, are trying to assess whether the proposed business strategies of the company will produce sufficient growth in sales revenues and profits, both to support the current share price and existing dividend payments, and to drive the capital growth that they wish to see in the future. At the same time, such stakeholders also need a method of assessing the risks associated with these proposed strategies as, obviously, these will have a direct link to their required rate of return. This is where marketing plays a key role.
The new opportunity for CMOs from Shareholder Value Added (SVA - defined in the paragraph below)
In the best companies, senior managers carry out appropriate due diligence on declared future business strategies, taking into account the associated risks, the time value of money and the cost of capital.
Optimal business strategies seek to increase returns whilst reducing associated risk levels and it is these metrics that will create or diminish SVA. Remember, investors are interested in sustainable shareholder value as it is this which impacts the capital value of shares, not results in a single year manipulated by short termism on the part of managers.
Whether we like it or not, SVA will persist as the most logical method of measuring corporate performance since, unless it is created, all stakeholders will suffer. There are, of course, other measures of SVA. For instance, the privately-owned company Mars uses measures such as return on total assets to assess and create SVA. This metric provides an unprecedented opportunity for CMOs to show the true worth of their work, especially as today, according to Brand Finance, intangible assets, including relationships with customers) now account for about 65% of all corporate value in the UK
Set out below in summary form is a very clear methodology for calculating whether marketing strategies create or destroy shareholder value. It is this level of sophistication that will get the undivided attention of the boardroom.
Valuing market strategies. A tried and tested approach
- Identify your key products for markets.
- Based on your current experience and planning horizon that you are confident with, make a projection of future net free cash in-flows from your markets. It is normal to select a period such as 3 or 5 years.
- These calculations will consist of three parts:
o Revenue forecasts for each year
o Cost forecasts for each year
o Net free cash flow for each product for market for each year.
- Identify the key factors that are likely to either increase or decrease these future cash flows. These factors are likely to be assessed according to the following risk profiles:
o The riskiness of the product/market, e.g. is the market new, growing or mature?
o The riskiness of the marketing strategies to achieve the revenue and market share.
o The riskiness of the forecast profitability (e.g. the cost forecast accuracy).
(For further guidance on the quantitative methodologies for assessing risk in each of these three categories, please see my book referred to above).
- Now recalculate the revenues, costs and net free cash flows for each year, having adjusted the figures using the risks (probabilities) from the above.
- Ask your accountant to provide you with the overall corporate cost of capital and capital used in each strategic business unit (SBU). This should not consist only of tangible assets. Thus, £1,000.000 capital at a required shareholder rate of return of 10% would give £100,000 as the minimum return necessary.
- Deduct the proportional cost of capital from the free cash flow for each product for market for each year.
- An aggregate positive net present value indicates that you are creating shareholder value i.e. achieving overall returns greater than the weighted average cost of capital, having considered the risk associated with future cash flows.
Three actions for CMOs
There are only three things a CMO can do to influence SVA. The first is to invest in brands, markets and customers that earn more than the cost of capital. The second is to reduce expenditure on brands, customers and markets that earn less than the cost of capital. The third is to reduce the risk inherent in their brand strategies.
Conclusion
The “science” referred to in the title of this paper relates to the calculation of the shareholder value added by the holistic or corporate brand. The same methodology can, of course, be applied to individual products or service brands. More than anything else, this will capture the attention of the board of directors and guarantee their support for your branding initiatives. I understand perfectly well that probabilistic estimates of future risk and their impact on net free cash flows are fraught with danger, but if the “science” of marketing is applied to it, it seems to work.
Science or art? I will leave you to decide for yourselves, but look out for the KC brand event mid-year.