How to Speak the Language of Finance Before The Corporate Boards?
“Today you have to run faster to stay in the same place.” -P. Kotler
[ I N T R O D U C T I O N ]
The recent global economic crises hav e forced businesses to change the ways they operate. Most corporate boards, CEOs and CFOs now believe that the only way to manage a business effectively is through intensive financial management and scrutiny. They expect their executives to provide more justification for the budgets they seek and demonstrate adequate returns on their spending. This new trend has created renewed pressure not only on Finance Executives to install extended systems and procedures for detailed evaluation of various expenditure but also on operating executives to train and groom their staff to develop the necessary financial acumen and capability to handle such requests.
During the last decade, since the recession after the 9/11 and the dotcom burst, businesses in general have accomplished significant gains in productivity and operational improvement. Intense business competition and continuous focus on cost reduction has forced manufacturing, supply chain and support functions to reach to the new level of efficiency and operational excellence. Marketing, however in most organizations as a function has generally escaped such intense cost pressures on the belief that cutting down marketing costs could be too risky for the future of the company. The typical long term payback nature and lack of transparency in cause and effect relationship between marketing costs and financial consequences did not let the corporate executives venture with unknown risks and Marketing as a function escaped the cost pressures. As a result, marketing expenses as percentage of sales now show a significant increase for many companies in the last few years.
After the recent economic turmoil of 2008-09 however, companies have become more proactive and spending money in any area of businesses, including marketing, now gets lot more financial justification and scrutiny. This has created pressure on marketing executives to provide more financial and ROI type analysis on their marketing expenditure. They are now forced to quickly establish necessary analytical tools and capabilities within the marketing function to handle this urgent requirement.
Generally, in companies there are detailed procedures and widely accepted practices to thoroughly evaluate even a $10,000 expenditure on an item of fixed assets before it is spent. However, when it comes to financial evaluation of multi-million dollar spending on marketing campaigns and programs, practices widely differ and any detailed financial evaluations are almost non-existent. It has long been accepted that most marketing expenditure particularly on advertising and brand development do not require any detailed advance financial evaluation and the confidence of the marketing executives and the belief of the corporate executives that some value would be realized in the long term is considered sufficient.
Additionally, despite the uncertainty about the returns on marketing spending, there is a general belief that spending on marketing is essential for the success of a company. The famous quote from a company head that “I am certain that half the money I am spending on advertising is wasted. The problem is, I do not know which half” is still true for many companies.
The question is not whether the companies should spend money on marketing, but when and how much. The return on marketing campaigns and programs must be evaluated before the budgets are approved and systematically measured throughout the campaign to ensure efficiency and effectiveness of the spending as well as to correct the course if the results are not coming through as projected and planned.
In the recent past with the advancement in ERP, CRM and other online automated systems, there is extensive data available to companies on customers, consumer demographics, products and buying patterns that can be effectively utilized to create useful marketing metrics. Corporate boards, CEOs and CFOs are getting impatient with the lack of marketing metrics that can help them understand the linkages between marketing spending and the corporate financial goals. It is the time for marketing executives to initiate a more robust quantification process of their marketing programs and ensure that these are clearly linked and fully aligned with the corporate financial goals.
One logical question from many marketing executives however is where to start. The software market is crowded with expensive solutions in the form of complex CRM systems and sophisticated marketing dashboards and scorecards with unnecessary bells and whistles. For a mid market company however the best place
to start in an effective and economical way is to establish a system of marketing metrics through creating their own measures on a template based on an Excel spreadsheet.
Microsoft Excel is probably the simplest but most powerful software that provides sufficient flexibility to experiment and test a metrics model before it stabilizes and proves its worth within the specific culture of a company. Once it reaches to a level of stability it can easily be migrated to an advanced CRM or ERP platform. Implementing a new system of metrics is about performance measurement and performance measurement is a sensitive subject that involves people and culture of the organization. No two companies, even in the same industry with same product portfolio, are the same. The new metrics have to be carefully evaluated and experimented to match the company requirement and evolve within the company culture. It takes at least 6 to 12 months to see if the metrics are properly established and accepted within the organization.
In the recent past, marketing experts have suggested metrics to measure the aspects of marketing that were earlier considered difficult if not impossible to quantify. Among these metrics, the most popular ones are Customer Profitability, Customer Lifecycle Value (CLTV), Return on Marketing Investment (ROMI), and Brand Equity. These metrics have been built on a common concept however there are variations in approaches and formulation as suggested by different authors and experts.
A common challenge that remains is that most of these metrics are non financial and even for the ones that are financial it is difficult to relate to the corporate financial goals. For example, a higher customer retention rate may not always lead to increase in the profitability of the company unless customers are evaluated through CLTV and non profitable customers are removed from the customer base or converted into profitable ones through price increase or cross selling efforts.
The role of Marketing over period of time has shifted from functional and tactical to strategic in most organizations. Marketers must know and understand their companies by understanding their common financial measures. There is a deep and integral link between marketing and financial performance. Financial performance is driven by marketing objectives linked to customer, product, price, place and promotion. Marketers cannot do an effective job unless they deeply understand this link.
Marketing is about future and the future is uncertain. Marketing generally requires significant financial investment in future. Ultimate objective of marketing is to realize the corporate financial goal of creating shareholders’ value. With increasing pressure to demonstrate financial returns from their marketing investment, marketing executives have to take charge of managing the financial returns and risks from their marketing investments. It’s the time for CMOs to establish a deeper and long lasting partnership with their CFOs.
[ M E T R I C S F R A M E W O R K ]
A major issue in linking marketing spending with financial performance is the length of time it takes to realize benefits from such expenditure. The benefit out of other functional spending is generally short term and visible. Operating costs in manufacturing, supply chain, sales, IT, Finance etc. provide immediate benefit that is visible and tangible in most cases. Money spent on marketing programs, however may take multiple years before the benefit is fully achieved and realized.
A second challenge with marketing spending is the lack of cause and effect relationship between the marketing programs and the financial results. For example, the outcome from marketing programs aimed at developing brand loyalty or improving customer relationship is hard to measure directly in financial terms.
Thirdly, the nature of the marketing programs is risky. Marketing executives argue that their marketing programs are investment in the future of the company. Accounting rules, however, consider these spending as expenses for the period and require to be charged off on the P&L statement of the current period. Influenced by accounting principles, financial managers unfortunately in general have not enthusiastically pursued ways and means to measure the ROI on marketing spending.
In the table below, a framework has been presented to show the linkages between typical marketing activities and marketing objectives with the corporate and financial goals of a company. This framework is based on the balanced scorecard approach, as developed by Robert Kaplan and David Norton. This framework considers the marketing activities as input to reach marketing objectives which lead to realization of corporate and financial goals. Put differently, marketing activities and marketing objectives should be treated as ‘input’ and corporate and financial goals should be considered as ‘outcome’.
Typical marketing activities can be clustered into the following categories
1. Demand Generation: Mainly consisting of selling and demand generation activities including short term marketing campaigns and promotions aimed at increasing sales.
2. Customer Fulfillment: Customer support activities focused on optimizing and delivering on a compelling customer value proposition.
3. Customer Relationship: Comprised of marketing communication, loyalty programs, and customer retention activities.
4. Branding & Image: Public relations, brand promotion and brand/corporate advertisement.
5. Infrastructure & Capability: Mainly IT and HR related structure and support activities. These activities and costs are considered ‘enablers’ for all other marketing activities.
It should be noted that the expected impact of different market activities varies in timeframe depending upon the category involved. Demand generation and customer fulfillment activities are short term in nature and their impact is usually noticeable within a year. Customer relationship activities are somewhat mid-term in nature and the impact of such activities is more significant in 1 to 2 year timeframe. Branding and Image building activities are long term in nature and their impact usually results in 2 to 4 year time period.
In the remainder of this book, the metrics have been proposed for each category listed above. It is to be noted however that the metrics suggested under each category are not mutually exclusive. Different metrics serve multiple purposes and can be used to measure the progress of several marketing objectives. This book should serve as a reference guide for the marketing professionals interested in developing and implementing an initial framework of marketing metrics in their organizations with an objective to create linkage and visibility towards accomplishing financial goals.
It is important to reiterate that many marketing programs are long term in nature and it is not possible to see the results and outcome in the same year when the money is spent. Unfortunately, accounting rules require closing the accounting periods on a quarterly or at most yearly basis. This creates challenge for many business managers to understand the linkage between cost and benefit. According to accounting rules, all marketing spending is considered expenses and charged off in the same year when spent.
A system and framework of marketing metrics, when regularly maintained and updated, help provide a better, meaningful and more realistic picture of the marketing and financial performance of the company. It is highly risky to depend and use only the accounting information for managing strategic part of the business. Accounting information is prepared based on strict GAAP rules and has its uses and benefits for the external shareholder. Marketing executives must ensure that their marketing performance is not being interpreted through accounting information only.