A New Era In Marketing Accountability

A New Era in Marketing Accountability

Aligning the CMO and CFO

Hunter Hastings Managing Director EMM Group, Inc.

July 2005

Offshore competition. Increasing channel control. Declining pricing power. There are a myriad of external challenges to growth in today’s competitive environment. However, research shows that, in many companies, the largest constraint on potential growth comes from the inside the corporation itself. In a majority of organizations, the primary engine of growth in cash flow and shareholder value is misunderstood, mismanaged, and misaligned with other corporate power centers. The engine of growth is marketing – defined in its fullest sense as the identification and fulfillment of customer needs through innovation, communications, and a superbly designed and executed customer experience. It is severely misunderstood by corporate power centers including corporate strategy, financial management, and most importantly the CFO. This misalignment between the Chief Marketing Officer and the Chief Financial Officer – the differences in their interests, priorities, and focus – can undermine the growth potential of the enterprise. To be successful in driving sustainable top-line growth, organizations must align CMO and the CFO.

To be successful in driving sustainable top-line growth, organizations must unify the interests of the marketing function and the financial management of the company – they must align the CMO and the CFO. This alignment can only come through systemization, measurement, and accountability – joining the interests of the two roles at the very highest level of purpose.

CEOs’ Perception of Marketing Marketing has a singularly important role to play in the 21st century corporation. According to a CEO survey conducted in September 2004 by the Marketing Society, a UK-based marketing organization, Chief Executive Officers place Marketing capability at the very pinnacle of corporate processes – the process of driving shareholder value. In the eyes of CEOs, nothing is more important. They feel that Marketing should lead the company and be the key driving force of business success.

Marketing Matters “Effective marketing is the key driver of future cash and shareholder value.” – CEO, Fast Moving Consumer Goods Company

“Marketing leads, operations works out how, and finance assesses.” – CEO, Financial Services Company Source:

Marketing Society, CEO Survey, September 2004

Yet, the very same survey revealed that CEOs have decidedly negative perceptions of the Marketing department. Even though the importance of the capability is so fundamental, CEOs largely view the Marketing department in a negative light. In the Marketing Society survey, CEOs found the Marketing department to be “undisciplined,” “not value-oriented,” “inconsistent,” “self-important,” “uncommercial,” “not accountable,” and “expensive.” In addition, the survey showed that CEOs are perturbed by the lack of accountability shown by the Marketing department – in fact, some CEOs are frustrated by getting the Marketing department to even accept accountability at all. The survey showed that CEOs felt that Marketing is:

f A Departmental Function – In the past, Marketing has not presented itself as an enterprise capability. Marketers have sought to be individual stars or struggled to be perceived as heroic groups practicing a secret art and devising creative ideas that produce extraordinary results.

f A Cost Center – By focusing on budgets, media costs, and advertising expenditures, Marketing has pigeon-holed itself as a July 2005

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cost center in the eyes of the CEO and CFO. Unfortunately, cost centers are made to be trimmed.

f Communications – Marketing has allowed itself to be viewed primarily as communications – advertising, public relations, Web sites, packaging, and trade shows. While Marketing produces flashy and persuasive ads, CEOs feel that communications is something ephemeral, inessential, and dispensable in the short term or when times are tough.

f Sales Support Rather

Marketing Frustrations “Marketing is the only place left where the department heads just expect to be given a budget without any real justification. That just can’t happen any more.” – CEO, Fast Moving Consumer Goods Company

“More akin to a recalcitrant child than an adult.” – CEO, Fast Moving Consumer Goods Company Source:

Marketing Society CEO Survey,

September 2004 Than Primary Demand Generation – In many businesses, Marketing has drifted towards a role as sales support. Salespeople control revenue and hence have greater control over where and how marketing resources are focused. In these cases, Marketing has lost its primary role and acts as a service for another function that has more influence on demand management.

f Assessed by Marginal Utility Measures Such As Return on Marketing Investment – While the current trend is to make Marketing, as a cost center, more accountable, Return on Marketing Investment (ROMI) is as insubstantial as the role it is trying to defend. ROMI is analysis applied at the margin to justify one cost over another. Because it has a monthly, quarterly, or annual horizon, rather than trying to truly analyze the entire Marketing investment, ROMI is hurting the positioning of Marketing, not enhancing it. So what is the CFO to think of a departmental cost center devoted to communications that is rapidly becoming the lackey of another department and that measures itself, when it measures at all, by spending control accounting methods? Marketing is the critical process that defines the modern corporation.

Of course, the reality of Marketing is 100 percent removed from these perceptions. In truth, Marketing is the critical process that defines the modern corporation. When properly designed, managed, and implemented, the Marketing process drives cash flow, profitability, and shareholder value. It is the raison d’etre of most businesses, and marketers should be proud in asserting their fundamental role in driving growth.

Demand Creation Vs. Cost Cutting: Relative Value of Growth In assessing the value of Marketing, it is instructive to compare Marketing, the “demand side” of the business, to Manufacturing, the “supply side” of the business. On the supply side, there has been an incredible productivity revolution in the last quarter century. With the application of process, measurement, and technology, a host of what were previously viewed as “costs” have been transformed into the hero of the enterprise, the “supply July 2005

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chain.” The supply side of the enterprise is now the exemplar of management science – CEOs talk with pride about lean global supply chains, advances in logistics, inventory reduction, and increases in percentage of ontime order fulfillment. But just how valuable are these achievements? Are these supply side cost reductions as valuable as margin enhancements provided by Marketing? Calculation of the Relative Value of Growth provides the answers to these questions. To be sure, reducing costs is advantageous to a company. Given a constant product price, reducing costs means increasing margin and boosting profits for a company. The real measure of a company is not only the profits it generates, but the value the market places on that stream of profits – the shareholder value of the company.

However, the real measure of a company is not only the profits it generates, but the value the market places on that stream of profits – the shareholder value of the company. Of course, it is reasonable to assume that increasing profits will cause the market to place a higher value on that stream of profits and to increase the value of the company for shareholders. The same is true for demand growth: increasing demand will generate more profits for a company, causing the market to place a higher value on that stream of profits and to increase the value of the company for shareholders.

Relative Value of Growth

To assess whether supply side cost reductions are as valuable as margin Relative Value of Growth equals the enhancements provided by change in shareholder value caused Marketing, one must compare the increase in shareholder value by an increase in growth divided by caused by an increase in growth to the change in shareholder value the increase in shareholder value caused by an increase in margin. caused by a like increase in margin. This, in a nutshell, is the Relative 1 Value of Growth (RVG). RVG is calculated by dividing the change in shareholder value caused by a one percent increase in growth by the change in shareholder value caused by a one percent increase in margin. For an illustration, consider Procter & Gamble, a well respected consumer products company. Procter & Gamble’s RVG is 7.2. This means that if Procter & Gamble were to wring out another point of margin by further improving supply chain efficiencies, the market would assign an additional $7 billion in market value. However, if P&G could demonstrate to the market that the company can deliver an extra point of top line revenue growth, the market would add more than $50 billion in market capitalization. In other words, P&G would have to eke out 7.2 points of additional operating margin to deliver the shareholder value of just one additional point of growth. The value of growth from increased demand generation is many times that of growth from increased margin.

1

Thus, in terms of shareholder value, the value of growth from increased demand generation is many times the value of growth from increased margin – the shareholder value generated by increased demand is far greater than that gained from cost reductions in the supply chain. Realizing this fact is the first step in aligning the interests of the CMO, CFO, and all the C-suite officers.

Mass, Nathaniel J., “The Relative Value of Growth,” Harvard Business Review, April 2005.

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Marketing Builds Brand Equity that Drives Revenue Growth Marketing affects growth by building strong brand – brands that drive superior cash flows and thereby create superior shareholder value.

Given that the value of growth is many times that of increased margin, Marketing should strive to affect growth. But, how can Marketing do this? Simply put, Marketing affects growth by building strong brands – brands that drive superior cash flows and thereby create superior shareholder value. The late Peter Doyle’s work at the University of Warwick has shown how this works. According to his research, marquee brands deliver excellent cash flows in four ways: higher, faster, longer and less volatile.

f Higher – Strong brands command higher prices f Faster – Powerful brands have faster consumer uptake and faster penetration through distribution channels

f Longer – Great brands last forever and deliver profits to the companies that own them for a longer period of time

f Less Volatile – Robust brands have fewer fluctuations in demand and provide steady revenue streams over time By building brands, Marketing can improve one or more of these cash flow dimensions, and when multiplied by a positive RVG, this brand building activity can quickly generate significant shareholder value. But how does brand building translate into strong cash flows? The answer lies in the following:

f Marketing builds brands that customers love f Customers are loyal to brands that they love f Loyalty is the primary driver of high quality, profitable cash flows By building brands that help customers climb the loyalty ladder, Marketing delivers high quality, profitable cash flows to the corporation.

The book “Up the Loyalty Ladder” by Murray Raphel and Neil Raphel provides a metaphor for customer The Loyalty Ladder behavior called the “loyalty 2 ladder.” According to the book, the goal of successful customer relationship management is to move a customer up the ladder × from simply being aware that the brand exists, to placing the brand in a set that it is acceptable to choose, × to adopting the brand as a favorite Accept in that set, to ultimately adoring the brand and the customer × experience it provides – and seeking Aware it out exclusively. The loyalty ladder is a representation of the fundamental marketing tenet that how customers feel drives what they do. It represents a customer’s vital emotional connection that creates loyalty, and this emotional connection is captured in the idea of brand equity – the perceptions and attitudes about a brand that a customer develops over time.

Adore Adopt

So, given this metaphor for customer loyalty, Marketing builds brands that help consumers move “up the loyalty ladder.” That is, Marketing builds brand equity, and brand equity drives top line revenue growth, cash flow, and shareholder value through the loyalty ladder effect. 2

Raphel, M. and Raphel, N., Up the Loyalty Ladder, Reed Business Information, Inc., 1995.

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Measuring Brand Equity Brand equity is driven by innovation, communications, and brand experience.

The question then becomes, “How can Marketing drive brand equity?” The answer lies in three simple factors:

f Innovation f Communications f Customer experience Determining the ratio of investment that optimizes among these three factors should be the essence of Marketing and Brand Management. The st brand manager or product manager of the 21 century will advise the corporation on the level of investment for each of these three drivers of brand equity, the measurement of the outcomes, and the consequent calculation of return on investment. As with any process, improvement requires measurement. So, too, with Marketing and brand equity. Measuring brand equity and the drivers of brand equity is the key to success.

f Innovation – Metrics must be customer focused. Is the customer getting enough innovation relative to their needs? Is the customer getting the quality of innovation they want? Does the customer see the brand as more differentiated and relevant in the area of innovation than the competition?

f Communications – In the past, Marketing has been guilty of measuring inputs. Marketing has routinely measured variables like reach, frequency, and awareness. None of these are leading indicators of brand strength. Rather, communications metrics must be performance-oriented. The leading indicator measurements that are tied to improvements in brand financial performance are differentiation, relevance, esteem, and brand knowledge. Do customers understand the differentiating attributes and principles that a brand stands for? Are these attributes presented in a manner that is relevant to the customer? Do customers grasp the brand’s essence and character?

f Brand Experience – The distinctiveness of brands today is not so much dependent on benefits, but on preferred, sustainable, consistent customer experiences. Does a brand only make promises it can keep? Does a brand keep the promises it makes? Every time a customer selects the brand, is the experience excellent? One can think of these factors as an equity account – one can make deposits, and those deposits will accumulate interest and make the asset stronger over time. However, one can also make withdrawals and weaken the equity. Brand equity increases when brand experiences are in line with customer expectations and decreases every time a brand lets the customer down.

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Of course, the goal is to continually make deposits and avoid withdrawals. Deposits are brand experiences in line with customer expectations. Withdrawals are made every time a brand lets the customer down. The CMO should measure the deposit and withdrawal activity and – by monitoring the values of innovation, communications, and brand experience – continually monitor the value of the brand equity asset. Given that brand equity is an asset and Marketing drives appreciation or reduction in value of that asset, CMOs and CFOs can become more aligned by measuring the effectiveness of Marketing through a Marketing balance sheet. The Marketing balance sheet measures the brand as an asset, and, by reporting the value of innovations, communications, and brand experience, it represents the increasing or decreasing strength of the brand.

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Assessing the Intangible Value of the Marketing Of course, the brand asset depends on other intangible assets that Marketing creates internally – channel relationships, Marketing process quality, and the skills of the Marketing department. The CMO must take responsibility for building the brand asset as well as for building other intangible Marketing assets – the human, intellectual, relational, and structural capital of the Marketing department.

The CMO must take direct responsibility for building these assets as well. To measure progress in this task, the CMO must be aware that the value for an intangible asset – including the Marketing department – is calculated by multiplying together the values of the human, intellectual, relational, 3 and structural capital involved. These values are defined as follows:

f Human Capital – The

Value of Marketing Intangibles Value = HC * IC * RC * SC HC IC RC SC

= Human Capital = Intellectual Capital = Relational Capital = Structural Capital

value of the people in the enterprise who think, build, operate, and interact to drive brand equity

f Intellectual Capital – The value of the thoughts, ideas, innovations, and methods that come from the Marketing team

f Relational Capital – The value of the interactions that connect individuals inside and outside the enterprise, including channels, vendors and other partners

f Structural Capital – The value of the infrastructure to support and facilitate the people, their ideas, and their relationships To keep the CMO and the CFO aligned, the CMO should continually report to the CFO on the continued accumulation and strengthening of value for these intangible assets.

Calculating the Overall Value of Marketing: Revenue Growth The final piece of asset building happens when the brand asset and the value of internal Marketing assets are combined to create new sources of top line revenue growth. To illustrate the power of the combination of this brand asset and internal capital, consider an equation from the financial management world proffered by Richard Grinold and Ronald Kahn in the groundbreaking work, “Active 4 Portfolio Management.” They suggest that the information ratio equals the value of skill times the square root of breadth times the transfer coefficient:

f Information Ratio – The ability of an asset portfolio to grow faster than its 3 4

Value of a Financial Asset Portfolio

IR S B TC

= Information Ratio = Skill = Breadth = Transfer Coefficient

Greene, David Perry, IBM, Considerations of Intangible Value, July 2004. Grinold, Richard C. and Kahn, Ronald N., Active Portfolio Management, Irwin Library, 2000.

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benchmark in a risk-controlled manner. For example, an information ratio of two adds two points of growth for every one point increase in risk, where risk is defined as a variance around the expected norm.

f Skill – The ability of the asset manager to make good stock picks and accurately predict their appreciation. The asset manager’s skill is expressed in the forms of insights – signals he or she can identify and translate into competitively advantaged market activity, at least until the market arbitrages them away.

f Breadth – The breadth across which the insights can be applied. If the insights apply only to FTSE 100 stocks, then the breadth across which the insights apply – the scale of the economic impact – is quite small. If the insights apply to all stocks in all global stock markets, then the impact is larger. If the insights apply to all assets – stocks, bonds, currency, derivatives, etc. – then the breadth is maximized. The expression is presented as a square root because it takes four times the breadth to achieve twice the opportunities for growth.

f Transfer Co-Efficient – The ability to efficiently apply these insights in a portfolio. A portfolio manager has to execute trades efficiently, navigate constraints effectively, and move quickly before competitors see his insight and steal it or counter it. There are several important points about this equation:

f It represents a systematic and measurable way to look at an activity (stock picking) that in the past was regarded as magic, the particular inspiration of a special individual. Now, a pension fund sponsor does not have to depend on the unpredictable results of expertise that is lodged in one individual or team, rather it can build a system to execute that process.

f There are now metrics to monitor to assess the performance of the process. Are there enough insights? Is there one insight that is sufficiently powerful and sustainable? Are insights being applied across sufficient breadth to maximize their economic impact? Are ideas efficiently getting into the portfolio to allow monetization of the insights? Is the result an increase in return with an acceptable level of risk? Since Marketing should take responsibility for brand building and since brand building drives top line revenue growth, Marketing should adopt a variant of this equation to measure brand building – top line revenue growth equals the value of insights times the square root of breadth times the transfer coefficient: Marketing should be measured on its ability to drive revenue growth in excess of that of other companies in the industry.

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f Top Line Revenue

Value of Brand Building

ΔR I B TC

= Change in top line revenue = Insights = Breadth = Transfer Coefficient

Growth – By meeting the functional and emotional needs of customers through brand building, Marketing generates customer loyalty, which drives cash flows that are higher, faster, longer, and less volatile. That is, Marketing effectively controls the process that delivers top line revenue growth. Of course, Marketing should be measured on its relative as

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well as its absolute performance. Just as a stock picker aims to beat a benchmark, the FTSE 100 index for example, Marketing should be measured in comparison to a benchmark as well. Marketing should aim to beat the index of industry peers – the average revenue growth of all competitors in a particular industry, for example.

f Insights – Marketing should deliver insights about customers’ needs to the enterprise, and insight is a function of how high on the customer’s hierarchy of needs the brand has ascended. Does the brand deliver on what sociologists call a “terminal value,” including “sense of accomplishment,” “sense of freedom,” or “feeling of harmony”? Brands like Nike, Starbucks, and IBM that can deliver these terminal values have fairly unlimited scale.

f Breadth – Breadth measures how broadly insights can be applied – across how many needs, how many customers, how much geography. What is the dollar size of the component categories? What are their growth rates and margins? To how many consumers is the brand relevant?

f Transfer Coefficient –

Case Study: Olay Olay’s beginnings were as Oil of Olay, a pink beauty fluid. Originally owned by a company that Procter & Gamble acquired, the brand was focused on a narrow segment of the population and had limited top line revenue growth. From its humble beginnings, P&G elevated the brand through insight about the need that the brand could meet. Through its insights, P&G provided a sense of confidence for women in their skin health and elevated its effect on their sense of femininity to a new and much higher level. In addition, with its global insights, P&G expanded the number of consumers that could realize the benefit, encompassing all age groups and countries. P&G also expanded the breadth of the business space in which Olay could participate. It grew the brand to include restorative creams, skin treatments, cleansing products, and even vitamins. By increasing insights and breadth, P&G grew the Olay brand to a global force in skin care, added to top line revenues, and increased shareholder value.

The transfer coefficient measures efficient and effective execution in the face of constraints. How much does the customer love a brand? How much loyalty does a customer exhibit? How much innovation does a brand deliver to the customer? What is the quality of that innovation? How fast does the innovation reach the market? What is the quality of the brand experience relative to the brand promise? A brand with highlevel insights and significant breadth can deliver a sense of self-realization across numerous product categories all over the globe.

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Given this equation for the value of brand building, it is obvious that a brand with high-level insights and significant breadth can deliver a sense of self-realization across numerous product categories all over the globe. Of course, not all brands have that scale, but when continually measured, all brands can certainly improve.

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Summary To continue to succeed, corporations need to align the interests of the CFO and CMO through the thread of accountability, and the most important measure of accountability is top line revenue growth. In most corporations, the relative value of growth is many times that of margin. So, investing in increasing growth will provide more benefit than investing in increasing cost savings. Growth in top line revenues results from moving customers up the loyalty ladder to a point of attitudinal and behavioral loyalty, and companies can accomplish this by brand building. Brand building is driven by innovation, communication, and the brand experience, and Marketing is the process owner each of these three drivers. This makes Marketing important to the CFO because Marketing is the key driver of the most important element of the enterprise – growth in both revenues and shareholder value. When Marketing provides insights, expands breadth, and delivers an efficient mechanism to turn those insights into products, get them to market quickly as innovations, accompany them by great communications, and provide a superb brand experience to customers, it will be important to the CFO because Marketing will be the key driver of the most important element of the enterprise – growth in both revenues and shareholder value.

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With such important responsibilities, the CMO is accountable not only for the outcome – revenue growth fostered by building a brand that moves customers up the loyalty ladder – but also for the internal and external capital that can leveraged in the form of a brand asset. The internal capital is the human, intellectual, structural, and relational capital that creates intangible value inside a company. The external capital is the opportunity to grow that is created when Marketing can apply a major insight across a large breadth of consumers, need states, and geographies. To improve, Marketing needs to be measured. A company can measure Marketing effectiveness by assessing revenue growth above a benchmark of industry peers. CMOs can ensure a positive result by providing insights, expanding breadth, and delivering an efficient mechanism to turn those insights into products, get them to market quickly as innovations, accompany them by great communications, and provide a superb brand experience to customers. If the CMO takes responsibility for all of these components of brand building from the top down, he will be accountable for all that matters in the enterprise. Tactical measures like ROMI will be of little interest since they st are small minded and incremental. The 21 century CMO sails for the horizon with large perspectives and a long time line. If the CMO puts the processes, measurements, and technologies in place to create powerful market-based assets for the balance sheet that generate high quality cash flows for the company and value growth for the shareholder, he will be perfectly aligned with the CFO and the corporation will have better expectations of success.

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About EMM Group, Inc. EMM Group helps its clients grow by creating world class marketing organizations that are expert at building brands. EMM Group helps clients increase share, boost margins, and rapidly introduce new products, all while instilling a marketing culture that increases clients’ marketing ROI. EMM Group is the creator of, and world leader in, enterprise marketing management, the marketing transformation that deploys marketing best practice intellectual property (IP) across the entire marketing value creation chain so that it is available to the right people in the right process at the right time. EMM Group makes this Best Practice IP available to clients 24 x 7 through a collaborative IT architecture on a global scale. The mission of EMM Group is to embed the discipline of enterprise marketing management at leading companies in every business sector around the world. EMM Group emerged from Emmperative, an enterprise marketing system funded by Procter & Gamble. EMM Group has reviewed marketing best practices from P&G and other leading companies, creating a best practice library of unparalleled breadth, sophistication, and proven practicality. EMM Group consultants all have decades of client experience in senior marketing positions. In addition, EMM Group has world class subject matter experts in consumer financial services, telecommunications, technology, retailing, entertainment, durables, and health care. EMM Group is the only company in the world that can:

f Offer a systematic benchmarking of current marketing best practices against the very best emerging enterprise marketing management standards

f Identify and leverage existing best practices and use global marketing best practices where gaps exist

f Create an integrated best practice marketing value creation stream aligned around metrics geared to measure marketing effectiveness and ROI

f Design and construct customized marketing knowledge centers for FORTUNE 500 companies

f Provide advanced technology design and systems integration to enable clients to integrate knowledge centers into their existing technology infrastructure

f Offer world-class training and change management capabilities specific to enterprise marketing management

About the Author Hunter Hastings, Managing Partner, EMM Group, Inc. Mr. Hastings has marketing, consulting and entrepreneurialism in his blood. With many years of brand management experience at Procter & Gamble and Stroh Brewery, he was a co-founder of the Ryan Partnership, heading the marketing strategy consulting unit and helping to build the company into a $100 million organization. His clients included MasterCard, Mercedes-Benz, Michelin, DEC, Kraft and PepisCo. Mr. Hastings is an expert at managing Marketing to improve effectiveness and efficiency across brands, business units, and geographies as well as to increase top line revenues. He has leveraged his experience to deliver results for clients ranging from Hewlett Packard and AT&T to Brown-Forman, Unilever, Kimberly-Clark, and Michelin. © Copyright 2005 EMM Group, Inc. All rights reserved. The EMM Group name and logo are trademarks of EMM Group, Inc. All other names are used for informational purposes only and may be trademarks or registered trademarks or their respective owners.

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