by Professor Malcolm McDonald
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 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” (this is known as a chiasmus)
In this blog, the word “science” refers to a probabilistic methodology for calculating how successful brands create shareholder value.
My intention here is to record some notes on this topic and you will observe that I have added the word “science” to the title of this blog, for the simple reason that brands and the way they are managed have a major impact on the creation of shareholder value, (SVA) about which more later
Next, I want to stress that I am not going to talk about logos. The world is awash with them and there are very few of them that the average person might recognise. Why, I ask myself, 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 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 for example anyone being allowed to mess with the Coca Cola or Shell logos?! I am also going to confine my comments to the commercial sector and will exclude a discussion of logos such as the Christian cross, the Muslim crescent, the flags of nations and the likes of signs outside shops and pubs as a means of recognition.
At this point, I need to explain what brands are, logos being the very basic of definitions and pretty worthless unless they create competitive advantage for their owner. 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, packaging and a host of other assets such as the Guinness recipe and the Mercedes engineering processes. The third level spelled out by David, on which I intend to focus in this blog, is the holistic company or organisational brand. 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 the customer, all of which have a name on them and this name, of course, is the brand.
The reality, of course is that most so-called brands are "pimply little me too" products and this is simply because according to McKinsey and my own research, fewer than 5% of companies have financially quantified value propositions, which means they get bought on price in the main, as customers can buy something similar anywhere and they are all the same
In this blog I will not explain the well-established, quantitative methods for financially quantifying the value of brands and brand and customer equity. For a detailed explanation of each valuation methodology, look at chapter 9 of my book on finance referred to below (guest authored by David Haigh).
I will now proceed to explain the “scientific” aspect of branding by outlining a quantitative method developed by me and my Finance Professor colleagues at Cranfield and captured in a book sponsored by the Chartered Institute of Management Accountants ("Marketing and Finance - creating shareholder value". Wiley 2013) for evaluating whether a corporate strategy, represented of course by the brand, creates or destroys shareholder value
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, these 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 want to see in the future. At the same time, they 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 proper 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 that will create 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, for unless it is created, all stakeholders will suffer. There are, of course, many other measures and there are many privately owned companies such as Mars that use measures such as return on total assets, but these and other successful private companies still create SVA This provides an unprecedented opportunity for CMOs to show the true worth of their work, especially as today intangible assets, (which of course include relationships with customers) now account for about 65% of all corporate value in the UK.
I set out below in summary form 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:
- Revenue forecasts for each year
- Cost forecasts for each year
- 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 factors:
- The riskiness of the product/market, e.g. is the market new, growing or mature?
- The riskiness of the marketing strategies to achieve the revenue and market share;
- The riskiness of the forecast profitability (e.g. the cost forecast accuracy).
(I have 127 scholarly references which spell out quantitative methodologies for assessing risk in each of the above three categories)
- 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 SBU cost of capital and capital used in the SBU. This will 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 taken into account the risk associated with future cash flows.
THREE ACTIONS FOR CMOS
There are only three things a CMO can do to influence SVA.
1: The first is to invest in brands, markets and customers that earn more than the cost of capital.
2: The second is to reduce expenditure on brands, customers and markets that earn less than the cost of capital.
3: The third is to reduce the risk inherent in their strategies.
The “science” referred to in the title of this blog relates to the calculation of the shareholder value added by the holistic or organizational brand. The same methodology can, of course, be applied to individual 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!
About the Author
Emeritus Professor Malcolm H.B. McDonald MA(Oxon) MSc PhD DLitt DSc
Until 2003, Malcolm was Professor of Marketing and Deputy Director of Cranfield University School of Management, with special responsibility for E-Business. He is a graduate in English Language and Literature from Oxford University, in Business Studies from Bradford University Management Centre, and has a PhD from Cranfield University. He also has a Doctorate from Bradford University and from the Plekhanov University of Economics in Moscow. He has extensive industrial experience, including a number of years as Marketing and Sales Director of Canada Dry. Until the end of 2012, he spent seven years as Chairman of Brand Finance plc.
He spends much of his time working with the operating boards of the world’s biggest multinational companies, such as IBM, Xerox, BP and the like, in most countries in the world, including Japan, USA, Europe, South America, ASEAN and Australasia.
He has written forty six books, including the best seller "Marketing Plans; how to prepare them; how to use them", which has sold over half a million copies worldwide. Hundreds of his papers have been published.
Apart from market segmentation, his current interests centre around the measurement of the financial impact of marketing expenditure and global best practice key account management. He is an Emeritus Professor at Cranfield and a Visiting Professor at Henley, Warwick, Aston and Bradford Business Schools.