BM401 Marketing

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BM401 Marketing

• Session 12
• Marketing Finance

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CLASS OBJECTIVE

• To provide an understanding of where and how
  financial analysis of the marketing function is
  essential to create shareholder wealth

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MARKETING/FINANCE INTERFACE

• Shareholder Value Criteria Drivers (Walters
  Halliday Fig 1.1)

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MARKETING/FINANCE INTERFACE

• Management Decision Areas
• Market penetration (increase production, may need
  increased capacity, lower price, loosen credit
  policies - marketing finance evaluate proposed
  strategy)
• Product development
• Market development
• Diversification (growth oriented - organic vs
  acquisition - capital decisions, risks
  associated)
• NB Cannot stress too much the importance of
  sales predictions

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MARKETING/FINANCE INTERFACE
Margin Mgt
Asset Productivity
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MARKETING/FINANCE INTERFACE

• Strategic Profit Model (WH Fig 1.3)
• Relates to management activity
• Principal objective - maximise return to
  s/holders
• Identifies growth profit paths (increase
  margins, increase gearing)
• Highlights key management areas - margin
  management, asset management, finance management

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MARKETING/FINANCE INTERFACE
No. 1 Mgt Objective
This model is helpful but far from perfect
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MARKETINGS POSITION

• In information age marketing professionals should
  be at top of the tree
• Need to understand adapt to changing world
• Marketing not production skills key to creating
  competitive advantage
• Marketing performance root source of shareholder
  value

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MARKETINGS POSITION

• But marketing appears to not have position of
  strength at board
• Must focus on customers markets not short term
  budgets, etc - do these create value?
• Marketing does not frame objectives in terms of
  shareholder value - objectives tend to be
  increase market share, awareness, etc
• Finance at fault as well - focus on historical
  costs, not understand account for value of
  intangible assets

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MARKET-BASED ASSETS

• Intangible assets (market-based assets) deep
  market consumer knowledge, brands, customer
  relationships, distribution relationships - these
  create long term shareholder value. Require
  investment in market research
• Marketing part of strategic debate by using
  shareholder value analysis

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SHAREHOLDER VALUE APPROACH

• Shareholder value (SV) principle is that business
  wants to maximise SV - when return on investment
  gt cost of capital
• Creating SV about building competitive advantage
  marketing provides the tools for creating this
• Effective marketing input allows SV analysis
  (SVA) to be dynamic growth oriented - key
  inputs are sales price

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SHAREHOLDER VALUE APPROACH

• Traditional accounting, by focusing on short term
  profits ignoring intangible assets,
  marginalises marketing
• But SVA offers marketing direct way to show how
  strategies create value
• Provides stronger theoretical base - closing link
  between customer loyalty, increasing market share
  to creating SV

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SHAREHOLDER VALUE APPROACH

• SVA promotes profitable marketing investments.
  Traditional accounting treats marketing
  expenditures as costs rather than investments in
  intangible assets.
• Long term profit streams from intangible assets
  are ignored - hence marketing is under funded
• SVA encourages long term effects of marketing
  expenditures to be explicitly estimated - brand
  building - value or cost?

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SHAREHOLDER VALUE APPROACH

• SVA can halt arbitrary cuts to marketing budgets
  - easiest to cut when short term profit increase
  needed
• Decreasing brand support raises profits not
  impact short term sales but can lead to longer
  term erosion of market share price premiums
• SVA gives marketing tool to demonstrate short
  term cuts destroy rather than create value

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NEW MARKETING DEFINITION

• Marketing is the management process that seeks to
  maximise returns to shareholders by developing
  relationships with valued customers creating a
  competitive advantage
• A marketing strategy makes sense if it increases
  the value of the business

Value-based marketing
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SHAREHOLDER VALUE

• Basic principle of SV is companys share price is
  sum of the future cash flows adjusted by the cost
  of capital

Made up of equity (from shareholders) debt
(from financiers Finance provides this figure
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SHAREHOLDER VALUE ANALYSIS

• Key Concepts
• Total value of firm is known as enterprise or
  corporate value
• Enterprise value debt SV
• Enterprise value calculated in 2 parts
• Forecast period value - present value (PV) of
  cash flows
• Continuing value (CV) - estimate of PV of cash
  flows after forecast period
• May be 3rd - investments (outside normal
  operations)

We compare shareholder value before after the
proposed strategy to determine whether value has
been created or destroyed
Vital aspect for Marketing
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SHAREHOLDER VALUE ANALYSIS

• Cash Flow From Operations
• Free cash flow (FCF) operating cash in out
• Inflows - sales operating profit margin
• Operating profit margin - pre-interest, pre-tax
  operating profit to sales
• Operating profit - sales less COGS, selling
  administration expenses less depreciation
• Outflows - cash taxes paid, additional working
  capital fixed capital incurred to achieve sales

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CONTINUING VALUE

• Estimating Value of Strategy in 2 Parts
• PV of cash flow (CF) over forecast period
• PV of CF after forecast period (continuing value
  or terminal value or residual value)
• Why like this?
• 5-7 years maximum sensible period for forecasting
• Maintaining competitive advantage longer than
  this unlikely
• CV usually gt value in forecast period

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CONTINUING VALUE

• CV important to marketing - spend big in early
  days on product development, brand building,
  opening new markets - may incur short term losses
  but creates long term value
• Perpetuity terminal value NOPAT/Cost of Capital
  (CoC)
• If NOPAT (after 7 years) 8M, CoC 10 then
  perpetuity CV is 80m with PV 41m

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MARKETING STRATEGY EVALUATION

• Fine Wines Ltd direct sales via quarterly
  catalogue
• Sales stagnated due to increased competition from
  retailers and other direct marketers
• Latest Net Operating Profit After Tax (NOPAT)
  5.3m
• Cost of capital 12
• Business value 44.17m (Perpetuity Method)
• Proposed new strategy start Internet operation
  called GourmetFoods.com

5.3m 12
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MARKETING STRATEGY EVALUATION
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MARKETING STRATEGY EVALUATION

• As new venture, management uses a 10 year
  forecast horizon. Other assumptions are
• Sales growth 30pa
• Normal operating margin of 15
• Heavy advertising investment in 1st 5 years -
  10m pa
• Net investment, working capital and fixed capital
  will be 40 of expected annual incremental sales
• CoC 15 due to perceived higher risk
• Raise capital via an IPO of 20 of shares placed
  on the market and 10m borrowing facility
• Initial implied share price 44.17m / 10m
  4.42

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MARKETING STRATEGY EVALUATION
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MARKETING STRATEGY EVALUATION
Sum of discounted cash flows in last column
(72.4 15) .247
99.04m - 44.17m
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MARKETING STRATEGY EVALUATION

• Before Board acceptance, assumptions should be
  tested using sensitivity analysis

GourmetFoods.com Sensitivity of SV (m)
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SVA APPLICATIONS

• This methodology can be applied to
• Launching new products
• Assessing worth of advertising or brand
• Developing pricing strategies
• Investigating new channels etc
• Key is to determine future cash flows from
  marketing strategies which requires in-depth
  knowledge of consumers, markets, competitors, etc

Marketing is an investment not an expense
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GROWTH IMPERATIVE

• Financial markets recognise long term growth
  potential
• Management should make growth top priority
• Growth central determinant of shareholder value
  due to its potential for increasing NPV of future
  cash flows

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FINANCIAL VALUE DRIVERS

• Operating Cash Flow
• Level
• Timing
• Sustainability
• Riskiness
• How marketing influences them

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FINANCIAL VALUE DRIVERS

• Level
• Sales growth - most obvious means
• NOPAT
• Higher prices - develop strong brands, create
  exit barriers, provide value to clients, segment
  by price sensitivities
• Cost decreases - effective supply chain
  management
• Volume growth - overheads not increase at same
  rate

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FINANCIAL VALUE DRIVERS

• Investment
• Invest in intangible assets such as brands,
  customer relationships, market research, sales
  training, etc
• Doyle Table 2.4 - firm returns 20 on new
  investment - invests 25 or 35 of profits
• Too little investment can limit value creation

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FINANCIAL VALUE DRIVERS

• Timing of Cash Flow
• Faster new product development
• Faster market penetration
• Network effects (VHS vs Betamax)
• Strategic alliances - new distribution
• Leveraging trusted brand

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FINANCIAL VALUE DRIVERS

• Sustainability of Cash Flow
• Real value offered to customers not easily
  copied or is it a fad?
• Risk of Cash Flow
• Higher customer satisfaction, lower acquisition
  costs, higher retention rates, build channel
  partnerships - reduce vulnerability

Continuous re-working of value propositions based
on market research
Product can be easily copied but not a BRAND
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SVA LIMITATIONS

• Forecasting cash flows
• Cost of capital
• Estimating terminal value
• The baseline - realistic?
• Stock market expectations - do they match the
  managers - communication crucial

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VALUE CREATION ALTERNATIVE

• Rationalisation
• Actions taken
• Cutting costs investments
• Divestments
• Market rarely rewards this strategy (NM/AXA)
• Why do it?
• Firm lacks market focus
• Management incentives based on EOY profits
• Works quickly to increase profits cash flow
• Relatively easy - internal reconfiguration
  whereas long term growth is more externally
  determined

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MARKETING VALUE DRIVER

• Value-based Marketing in 4 Steps
• Developing deep customer understanding - what is
  valued, how decisions made, how product is used,
  etc
• Formulating value propositions to
• Meet needs
• Create differential advantage
• Be superior to competitors

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MARKETING VALUE DRIVER

• From transactions to long term relationships
• Loyalty
• Trust
• More than a customer focus - requires
• Superior knowledge, skills, systems marketing
  assets
• Management needs to invest to obtain these
  elements

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CUSTOMER MANAGEMENT

• Customers are the building block of long term
  shareholder value growth
• Segment on value - different value propositions
  for each segment
• Continuously develop deep knowledge - database
  critical
• Target chosen segments
• Re-engineer processes to fulfill value
  proposition promise
• Launch campaigns monitor

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CRITICAL TO SUCCESS

• Segmentation - allows company to focus on
  preferred customers
• Stability of segment inclusion over time
• Database quality - collect relevant data,
  manipulate predictive capability
• Metrics - what is the measurement? Profit,
  contribution, revenue?

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SELECT CUSTOMERS

• Successful marketing is about focusing on key
  customers 8020 rule the 20225 rule
• Companies need to be able to select customers who
  will have a high lifetime value
• Four criteria are important the customers
  strategic importance, significance, and
  profitability, and the loyalty coefficient (their
  commitment to a long-term partnership)

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8020 RULE
This gives an incomplete possibly misleading
insight into who are the valuable clients. It
also does little to help devise marketing
strategies
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20225 RULE
Greater insights arise from this rule
highlights the disparity in customer value
can be used to shape marketing strategies for
each segment
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CUSTOMER MANAGEMENT SETTING THE SCENE

• Increased customer loyalty is the single most
  important driver of long-term financial
  performance
• Dave Illingworth, Lexus US

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CUSTOMER MANAGEMENT

• Customer lifetime value (CLV) focus reflects
  change from transaction to relationship from
  product to customer
• Current sales give an incomplete picture - more
  important is prospect of future sales
• Customers/segments must be evaluated according to
  projected lifetime value to the firm - ties in
  with Value Gap Analysis
• What is value - revenue, profit or contribution?

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CUSTOMER MANAGEMENT

• Customer lifetime value (CLV) is the NPV of
  customer
• For UK car insurance increase retention from 90
  to 95 customer NPV up by 84
• Customer life (n) 1/ (1- Customer retention
  CR)
• CR 1 - 1/n

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CUSTOMER MANAGEMENT

• Loyal customers are assets
• 1,000 in year 1, may have NPV of 50k over 10
  years
• Loyal customers are more profitable
• Buy more, less costly to serve, less sensitive to
  price, introduce customers
• Winning new customers is costly
• Costs 6 times to win vs retaining
• Increasing customer retention
• Large impact on lifetime value

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CUSTOMER MANAGEMENT

• Highly Satisfied Customers Repurchase
• 6 times more likely to repurchase than satisfied
  customers
• Dissatisfied Customers Tell Others
• Tell 14 on average
• Most Dissatisfied Customers Do Not Complain
• 4 bother to complain
• 1 customer complaint - 26 other customers have
  problems
• 1 complaint - 6 customers have serious problems

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CUSTOMER MANAGEMENT

• Satisfactory resolution of complaints increases
  loyalty
• More loyal than those who have never had a
  complaint
• Few customers defect due to poor product
  performance
• 14 due to product reason
• 2/3 due to service people

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PROFITABLE PRODUCTPARADIGM

• Seemingly reasonable approach has the following
  steps
• Measure profitability of all products
• Determine acceptable level of profitability
• Eliminate those not meeting the threshold
• Go back to step 1 repeat
• Financial metrics improve
• Process made easier by advances in IT database
  software

Rubbish
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PROFITABLE PRODUCTDEATH SPIRAL

• Key Insights
• Profitability from customers not products.
  Product decisions should be based on assortment
  of products bought by customers
• Keeping some unprofitable products may be
  necessary to keep some profitable customers

• Action Steps
• Set up information systems to track product
  assortments purchased by customers
• Use market research top track buying behaviour
  match with internal database

Make customer profitability key criterion for
product retention decisions