Proving Marketing ROI in Ways the CFO Will Understand

 

Takeaway

  • Marketing strategy should show a benefit to shareholders
  • Customer and brand equity need concrete measurements, not assumptions of value
  • Marketing plans need to account for risk

Dr. Ramesh Rao believes marketing provides a solid return on investment, but don't ask him to acknowledge its value based on industry assumptions or gross sales figures. As a professor of finance, Rao demands proof that marketing boosts a company's financial performance — the kind of proof that will convince shareholders, boost market value, and provide direct guidance on levels of marketing investment. Absent that analysis, he claims, marketers are doomed to lose accountability and a place at the table when corporate strategy is being formed.

Rao's research on marketing accountability was featured in Exchange magazine in 2008. In the article Marketing ROI written by Sandie Taylor he says, “You have to go beyond brand equity and find tangible outcomes. Marketers don’t have a consensus definition of customer equity and brand equity. If they want to argue these concepts are important they must articulate a mechanism by which they can add value. Otherwise it’s all stories. For example, marketers claim that customer equity and brand equity create ‘marketing assets’ and lower the firm’s working capital, but they have provided virtually no justification for this claim. Marketing is more important than marketers say it is, but not for the reasons they give us.”

Learning that a second phase of his research on the topic was nearing completion, I asked for an update on his framework for measuring the value of marketing.

Q. Your original paper created a theoretical framework for showing the value of marketing, but it rejected some of the traditional marketing concepts for measurement. Why is it important to find some other basis for valuing marketing efforts?

A. We don’t reject brand equity and customer equity and so on. We just say you must define more carefully what those terms mean, and articulate them in a way that even people outside of marketing can understand. The problem, however, is that there is little consensus even among marketers as to what is meant by brand equity and customer equity. So when markets disagree among themselves as to what these terms mean, why should anyone else feel more comfortable with these concepts?

Right now the marketing field is doing a lot of soul searching. Articles are being written about marketers losing accountability and not thinking like businessmen and not making arguments that take into account cost and benefits to shareholders. Customer equity, brand equity, and other marketing-invented metrics have great appeal to marketing people, but other disciplines ask how do you measure those constructs? How do we really know they are good for the firm's owners?

I can give you one quick example with a widely used marketing metric: customer satisfaction. You can increase customer satisfaction if you sell things below cost. If Dell is willing to sell laptops at $5 apiece, I'll write a contract with Dell that I will buy them for the rest of my life as long as the quality is the same. But that's not good for the firm. There has to be a cost-benefit tradeoff to shareholders, and marketing has not addressed that.

Q. I've always been intrigued by your research because you're a finance guy first. Marketers have attempted to figure out measurements, but you're approaching it from a different angle.

A. Well, I'm a finance guy, yes, but I really believe marketing is what drives sales, and sales determine cash flows. So marketing does matter. But saying something is very important is different from saying I'm able to make recommendations for what's good for the company and what's bad for the company. Show me how marketing initiatives increase the benefits to shareholders, and then I can make an educated decision whether it's a good or bad.

Q. You’ve proposed some models for how marketers could begin to talk about return on investment. What are your basic points?

A. It's not so much about return. When you say return on investment, you're talking about percentages, 5 percent, or 7 percent, or 10 percent. What we're arguing is that ultimately marketers have to make decisions in the best interest of the firms' owners, and the owners are the shareholders. There has to be a link that you can articulate, at least in principle, between sales and how it will affect shareholders' wealth. The point I'm making is that no marketer can predict, with rare exceptions, exactly what sales are going to be.

You have to recognize uncertainty. In the business world uncertainty is a fact of life. How do you deal with the uncertainty associated with sales? Tell me the most likely scenario, the pessimistic scenario, the optimistic scenario, and so on. That gives you a measure of risk. Take that into account and then calculate the costs and benefits of a marketing initiative.

When you can calculate your risk you can determine what your firm's cash needs are going to be. Depending on your sales forecast, you can come up with how much working capital you need to hold and increase sales, and that changes the amount of capital you have to invest.

If a marketer is going to lower the firm's working capital, you're effectively lowering a total investment up front, and you'll boost returns. That's one effect. The other is that by changing the different sales realizations and predicting different possible outcomes you can also change the stock price. You benefit shareholders that way. This is something that marketers have acknowledged in the past, but there was no framework for putting it together.

Q. Your original paper came out about two years ago. Any new developments?

A. In our new paper we're writing an appendix on what are called prediction markets. Companies like Google and Apple are creating internal prediction markets. Imagine there's a market in which only people within that company can participate, and you have to predict outcomes. Based on your predictions you get a reward. There is evidence that prediction markets are working well. They are reasonably accurate, and there are prediction markets for all kinds of things.

There is evidence that when you have people risking their own money to make an educated guess somehow a different awareness or consciousness seems to operate, and the outcome seems to reflect some sort of a consensus or reality. We suggest that is one way for companies to actually come up with assessments of what will be potential sales outcomes.

Bottom line, marketing is ultimately going to be a behavioral science, looking at how behavioral attributes affect preferences of consumption, for example. Those kinds of things can affect sales and marketing. If they can get a handle on those behavioral attributes, I think marketing will be spectacularly successful.

Q. If you were talking to a president of an advertising agency or perhaps a corporate sales manager, where do they begin?

A. The first step is to foster an atmosphere where the culture changes. You can't tell me every marketing cost is good, the more I spend, the better off I am. Instead, tell me where it's good, and why it's good. You don’t have to predict exactly but there must be accountability. And then you’ve got to develop a better matrix to justify your revenue forecast, perhaps learning more about the competition and their strategic approach. Those kinds of strategic issues do matter.

And then you come up with a sensitivity analysis. How sensitive are your assumptions to shareholder wealth? What if I'm wrong by 5 percent? What if I'm wrong by 10 percent? That's how everybody makes decisions, right?

We recently met with the principals from Deloitte, the consulting firm. They told us there's massive demand for marketing accountability measures in their own companies, and they are getting inundated with requests for formalizing these things. Even the American Marketing Association is talking about marketing accountability. So it’s a question of better articulating the potential benefits and costs. Otherwise you don't have a framework for making decisions.

 

Faculty in this Article

Ramesh Rao

Professor, Finance

Ramesh Rao received his bachelor's degree in metallurgical engineering from the Indian Institute of Technology, and he received his MBA and...

About The Author

David Wenger

Director of Communications, McCombs School of Business

David Wenger is the director of communications at the McCombs School of Business. He writes primarily on topics of innovation, competition and human...

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