How shareholder analysis re-defines marketing

Peter Doyle
Source: Market Leader, Issue 8, Spring 2000
Downloaded from WARC

Shareholder Value Analysis offers a great opportunity for marketing professionals. Traditional
accounting, by focusing on short term profits and ignoring intangible assets marginalises marketing. In
contrast SVA enables marketing to be brought centre stage.

In the past marketing has not been able to measure and communicate to other disciplines. Now SVA
offers marketing a direct method of showing how marketing strategies increase the value of the firm.

Traditionally, marketing has tended to see increasing customer loyalty and market share as ends in
themselves. To-day, top management requires marketing to view its ultimate purpose as contributing to
increasing shareholder value.

SVA encourages profitable marketing investment and penalises arbitrary cuts in marketing budgets.

Peter Doyle

There is a paradox in how top management view marketing. On the one hand, marketing has become accepted
as the central driver of shareholder value. Every world-class company now puts building long-term relationships
with customers, based on satisfying their needs, at the forefront of strategy. Yet while the central role of
marketing in achieving competitiveness and creating shareholder value is undisputed, the role of marketing
professionals appears increasingly questioned.

Throughout the 1990s management consultants reported studies describing marketing as being in crisis. Indeed,
a recent survey of major companies by the Marketing Society echoed this marginalisation of marketing
professionals. Only 12 out of 100 chief executives had previous experience in a marketing position and only
57% of the companies had a marketing director on the board.

The marketing professions response to these studies has not been convincing. One response has been to
exhort the government and senior executives to understand the importance of satisfying customers. But to quote
Dr Johnson, what is true about this argument is not new, and what is new is not true. The case for the necessity
of satisfying customers in competitive markets was made very familiar to us by Adam Smith over 200 years ago.
Some marketing professionals want to go further, suggesting the firm should maximise customer satisfaction, but
such a view is absurd. Lowering prices and increasing service levels can always increase customer satisfaction
further, but such a policy would be a quick route to bankruptcy.

Another tack, tried by some marketing managers to make their contributions more appreciated has been to
justify marketing investments by showing how they increase corporate earnings or return on capital employed.
But such an approach is invariably counterproductive. Cutting, rather than increasing, marketing expenditures
will almost always boost short-term profitability. Because of the lagged effects of most marketing investments,
encouraging these expenditures to be treated as accounting costs is a dead-end for marketers. So it is
necessary to go back to first principles.

Unclear objectives and unreliable measures

Marketing managers have come up with a variety of metrics to evaluate campaigns and justify their performance.
The most common criteria for measuring the effectiveness of marketing are increases in sales and market share.
Unfortunately, any first-year economics student can demonstrate that such growth may just as easily decrease,
as increase, profits. Sales growth increases profits only if the operating margin on the additional sales covers
the higher costs and investment incurred to achieve that growth. Chasing profitless growth has been one of the
most common causes of corporate failure.

Other criteria for justifying marketing strategies include brand awareness, consumer attitudes, repeat buying and
ratings of customer satisfaction. Unfortunately, many of these have weak relationships to sales and almost none
to profitability. Increasing advertising, for example, will generally raise brand awareness and in many situations
will increase sales, but whether these incremental sales will be profitable is very hard to say.

So the starting point for reasserting the role of the marketing management begins with properly defining its
objectives. Major businesses now almost universally accept that the primary task of management is to maximise
returns to shareholders. The rationale for this goal lies in the property rights of shareholders and in capital
market pressures to oust management who do not deliver competitive returns. The driving force for the adoption
of the shareholder value concept was the dissatisfaction of investors with the results of the growth strategies
pursued by so many companies in the 1960s and 70s. Many managers, driven by a quest for size, diversified
into markets where they had no competitive advantage, took on unprofitable customers and launched arrays of
products that did not create value. The result was that while many companies grew greatly in size, shareholders
saw the value of the holdings stagnate or decline. The reaction in the 1980s and 90s was a stricter code of
corporate governance that defined the central responsibility of managers to be one of creating value for
shareholders.

Marketing can take a place at the centre of value-based management if managers embrace this modern
statement of beliefs, principles and processes. This acceptance in no way weakens the traditional contribution
of marketing, rather it enormously strengthens it by providing a sound intellectual base. The approach states
that the role of marketing is to contribute to increasing shareholder value, and it suggests a new definition of
marketing, as follows:

Marketing is the management process that seeks to maximise returns to shareholders by developing
relationships with valued customers and creating a competitive advantage.

This definition clearly defines the objective of marketing and how its performance should be evaluated. The
specific contribution of marketing in the business lies in the formulation of strategies to choose the right
customers, to build relationships of trust with them and to create a competitive advantage.

What are a companys marketing assets?

Marketing expenditure adds value when it creates assets that generate future cash flows with a positive net
present value. Marketing assets are what link marketing activities to value creation. Accountants define assets
as economic resources, owned by an entity, whose cost at the time of acquisition can be measured objectively.

Unfortunately, this definition generally leads accountants to include only tangible assets in their balance sheets.
Yet, in modern companies, such tangible assets account for only a small proportion of the market value of
companies. The market-to-book ratio in Britains largest companies averages three, which suggests that two-
thirds of the market value of these companies lies in intangible assets.

Four types of marketing asset

1. Marketing knowledge. Superior marketing knowledge provides a core competency consisting of skills,
systems and information that convey a competitive advantage to the firm, in terms of identifying market
opportunities and developing marketing strategies.

2. Brands. Successful brand names convey powerful images to customers that make them more desirable
than competitive products. Owners of strong brands possess assets that attract customers, often earn
premium prices and can be enduring generators of cash.

3. Customer loyalty. If a company has built a satisfied, loyal customer base it will be more profitable and
should grow faster than other companies. Many studies have shown that loyal customers buy more of the
companys products, are cheaper to serve, are less sensitive to price and bring in new customers.

4. Strategic relationships. A companys network of relationships with channel partners can provide
incremental sales, access to new markets and allow the firm to leverage its competencies in additional
areas.

Marketing assets are no different from the firms tangible assets in that their value lies in their contribution to
generating future cash flow. However, marketing assets are often more valuable to the firm for two reasons.

First, they are harder to acquire than tangible assets. Normally they take years of investment and are closely
integrated into the firms culture, which makes them difficult to buy or reproduce. Second, the worth of marketing
assets derives solely from the value customers attach to them. Since customers are the ultimate source of cash
flow, marketing assets can be considered the primary source of customer preference and competitive
advantage.

Marketing assets do not normally appear on the balance sheet because accountants believe that their value
cannot be measured with sufficient accuracy. Commentators have speculated whether this matters. While
accountants do not measure intangible assets, the discrepancy between market and book values shows that
investors do. Most accountants recognise that balance sheets no longer give meaningful information about
values, instead they record historical details of transactions.
It has been suggested, on the other hand, that because marketing assets are not recorded their values are
underestimated. Because they are treated as costs rather than investments that are depreciated, this then leads
to insufficient spending on developing brands, retaining customers and creating channel partnerships.

How marketing assets determine shareholder value

Fortunately, shareholder value analysis (SVA) avoids such possibilities of bias. It values strategies and
companies in the same way outside investors do. SVA is not based on accounting conventions but instead on
cash. While profits are subjective, cash is a fact. Investments and costs are treated identically as deductions
from cash flow at the time they are paid. Like investors, managers have to judge their strategies in terms of their
impact on future cash flow. Expenditures to develop marketing assets make sense if the sum of the discounted
cash flow they generate is positive.

Turning around failing companies has conventionally been seen as a financial problem, but the significance of
SVA is that it shows that value creation is much more to do with the firms effectiveness in developing marketing
assets. Investors assess strategies on their ability to create shareholder value so the companys share price
reflects investors evaluations of whether the current strategy of management will create value in the future.

To explore the implications for marketing we need to review how finance professionals estimate value and value
creation. Modern finance is based on four principles: the importance of cash flow, the time value of money, the
opportunity cost of capital and the concept of net present value. Cash is the basis of value it is what is left over
for shareholders after all the bills have been paid. Cash has a time value because a pound today is worth more
than a pound tomorrow. The opportunity cost of capital is the return investors could obtain if they invested
elsewhere in companies of similar risk. The net present value concept represents the value of an asset as the
sum of the net cash flows discounted by the opportunity cost of capital. By maximising the net present value of a
business, managers are pursuing those strategies most likely to maximise the returns to shareholders.

To illustrate the calculations, consider the Alpha Company (Table 1). Its current sales and net operating profit
after tax (NOPAT) are shown in the first column. Management has developed a new marketing strategy that it
believes will grow sales by 10% annually. To arrive at free cash flow we have to deduct the investment in
working capital and fixed assets that will be needed to support this growth. This is forecast to be 40% of
incremental sales. Shareholder value is obtained by discounting this cash flow by the opportunity cost of capital,
r, which is taken here to be 10%. The annual discount factor is 1/(1+r)i where i = 1,2, is the year.

TABLE 1: ALPHA COMPANY: SHAREHOLDER VALUE ANALYSIS (

MILLION)
 Year Base 1 2 3 4 5

Sales 100.0 110.0 121.0 133.1 146.4 161.1

Operating margin 10.0 11.0 12.1 13.3 14.6 16.1
Tax (30%) 3.0 3.3 3.6 4.0 4.4 4.8
NOPAT 7.0 7.7 8.5 9.3 10.2 11.3
Net investment 4.0 4.4 4.8 5.3 5.9
Cash flow 3.7 4.1 4.5 4.9 5.4
Discount factor (r=10%) 0.909 0.826 0.751 0.683 0.621
Present value of cash flow 3.4 3.4 3.4 3.4 3.4

Cumulative present value 16.8

Present value of residual 70.0
Other investments 7.0
Value of debt 25.0
Shareholder value 68.8
Initial shareholder value 52.0
Shareholder value added 16.8
Implied share price () 3.44
Initial share price () 2.60
The shareholder value calculation divides the estimation of the value created by a strategy into two components.
The first is the present value of cash flows during the planning period. Generally, managers feel it reasonable to
plan ahead in some detail for a period of around five years. Here they forecast a cumulative cash flow in the
planning period with a present value of 16.8 million. The second component is the continuing value, which is the
present value of cash flow after the end of the planning period. The residual value is calculated by the standard
perpetuity method, which is NOPAT/r.

This method effectively assumes that beyond the 5-year planning period, competition will drive down profits to a
level such that new investment just earns the companys cost of capital, so that there will be no additional
shareholder value created. When the residual value is multiplied by the discount factor we arrive at its present
value, 70 million. Adding any non-operating investments the firm owns, and deducting the market value of any
debt, leads to the shareholder value of 68.8 million.

If there were 20 million shares outstanding this would produce an expected share price of 3.44. If the current
share price is below this figure analysts would recommend the shares for purchase. If the company had not
introduced the new growth strategy and remained at its present level, the implied share price would have stayed
at 2.60 The significance of shareholder value analysis is that it provides an effective vehicle for demonstrating
the contribution of marketing to the companys financial performance. To explore this further we need to show in
more detail how marketing adds value.

The model illustrated in Table 1 shows that the amount of shareholder value created depends upon four factors:
the level of future cash flow; the timing of cash flow; the risk attached to the business; and the continuing value.
Marketing assets are the principal drivers of all four determinants of value by their effect on:

1. The level of future cash flow

2. Accelerating cash flow

 3. Business risk

4. Continuing value

1. Effect on the level of future cash flow

Table 1 shows that the level of cash flow is a function of sales growth, the after-tax operating profit margin and
the net investment required to fund the growth of sales, i.e.

Cash flow = Sales growth x net operating margin net investment

Faster sales growth drives up returns to shareholders as long as the additional sales deliver economic profit.
While cost-cutting and downsizing can temporarily boost cash flow, only sales growth can deliver long-run
growth in cash flow. Growing sales is the main task of marketing. Growth is accelerated where the firm has
strong marketing assets: marketing knowledge, powerful brands, loyal customers and strategic partnerships with
channel members.

The second determinant of the level of cash flow is the after-tax operating margin. This is a function of the size
of the companys sales, its costs, and the average prices it is able to charge for its products and services.
Profitable sales growth should improve the operating margin by spreading fixed costs. Strong marketing assets
should also lead to higher prices and lower costs. This means the effect of growth could be greater than shown
in Table 2.

TABLE 2: ALPHA COMPANY: SIMULATION OF IMPACT OF

MARKETING ON SHAREHOLDER VALUE ( MILLION)
 Discounted Present ShareholderShareholderShareChange
cash flow value of value value added price in
residual () value
(%)

No sales 26.5 43.5 52.0 0.0 2.60 0

growth
Sales 16.8 70.0 68.8 16.8 3.44 32
growth
(+10% pa)
Sales 2.2 108.2 92.3 40.3 4.62 78
growth
(+20% pa)
Price 51.3 86.9 120.2 68.9 6.01 131
increase
(+10%)
Cut in 33.4 54.8 70.2 33.6 3.51 35
operating
costs (-
10%)
Cut in 30.2 43.5 55.6 3.6 2.78 7
investment
rate (-10%)
Accelerated 18.2 70.0 70.2 18.2 3.51 2*
cash flow
Cut in cost 27.2 45.5 54.7 2.7 2.74 5
of capital (-
10%)
Extending 20.5 70.0 72.5 20.5 3.63 5*
growth
period

* Compared to 10% sales growth base case

There is much evidence that strong brands are associated with price premiums. Studies have found that brand
leaders in the UK sell on average at prices 40% above regular brands. Strong brands also tend to possess
higher advertising and promotional elasticities, implying that the costs of acquiring additional sales will be lower.
There is also evidence that well-established brand names permit line and brand extensions that lower entry
costs.

Table 2 shows the enormous effect price premiums can have on shareholder value. A 10% price premium more
than doubles the projected share price and equity value of the company. It greatly boosts cash flow during the
planning period as well as leaving a significantly higher continuing figure for profits. Putting it another way, if
managers neglect to invest in marketing assets and suffer a loss of brand premium as a result, the share price
can be expected to drop dramatically as investors figure out the implications for future cash flow.
There is no more dramatic proof of the power of brands than simulating on a spreadsheet the effects of brand
premiums on shareholder value. Table 2 also looks at the impact of marketing assets in lowering operating or
fixed costs. If these costs amount to 50% of total costs, and they are reduced by 10% as a result of significant
marketing assets, then shareholder value is increased by 35%.

The third determinant of cash flow is investment. There has been a growing recognition of the importance of
customer partnerships to augment cash flow by reducing working capital and fixed investment. Stimulated by
new information technology, particularly the internet, suppliers are forging closer links with key customers to
eliminate the amount of stock and capital tied up in the supply chain. Customer partnerships are marketing
assets built through carefully listening to customers and meeting their needs. They generate a return in
enhanced cash flow through lowering investment requirements.

The effects of marketing assets on the level of cash flow have been looked at individually. The effects are, of
course, cumulative. If price premiums and growth are combined, the effects on the value of the company are
additive. Such cumulative effects account for the very high market-to-book value ratios earned by companies
such as Microsoft, Nokia, Coca-Cola and Vodafone. Similarly, the failure to achieve growth or price premiums
accounts for the poor returns to shareholders in such companies as ICI, Safeway and United Biscuits.

2. Effect on accelerating cash flow

Because cash has a time value, cash flows are discounted. Shareholder value is increased if cash flows can be
generated quicker. Table 2 shows the effect of accelerating the cash flow by one year. If the year 2 sales of
Table 1 were achieved in year 1, year 3 sales in year 2, etc., shareholder value would increase from 68.8 million
to 70.2 million, even though final year sales and profits are unchanged. Again, marketing assets are often
designed to achieve such acceleration.

In many cases Table 2 underestimates the effect of accelerated market penetration. Fast penetration can lead to
first mover advantages. These include higher prices, greater customer loyalty, access to the best distribution
channels, and network effects that enable the innovator to become the specification standard. These feed back
into both higher sales and higher operating margins. Many studies have shown that brands with strong images
can expect customers to adopt their next generation products significantly earlier than those with weaker
images. Companies now place emphasis on pre-marketing activities that focus on increasing awareness among
opinion leaders even before the product launch to speed up the product life cycle and therefore accelerate cash
flow.

Brands are not the only marketing assets that can accelerate cash flows. Strategic relationships and co-
marketing partnerships can also speed up market penetration. Alliances can enable the firm to open up
overseas markets faster. A firm with good marketing networks can use these assets to more quickly capitalise on
emerging market opportunities. Boots, for example, has an arrangement to place its pharmacies in Tesco
supermarkets, enabling it to penetrate this new growth area faster. By demonstrating how such investments
accelerate cash flow, marketers can quantify their efficacy in enhancing shareholder value.

3. Effect on business risk

The third factor determining the value of the business is the opportunity cost of capital used to discount future
cash flows. This discount rate depends upon market interest rates plus the special risks attached to the specific
business. The risk attached to a business is determined by the volatility and vulnerability of its cash flows
compared to the market average. Investors expect a higher return to justify investment in risky businesses.
Because investors discount risky cash flows with a higher cost of capital, their value is reduced.

Again there is evidence that an important function of marketing assets is to reduce the risk attached to future
cash flows. Strong brands operate by building layers of value that make them less vulnerable to competition.
This is a key reason why leading investors rate companies with strong brand portfolios at a premium in their
industries. Many studies have also demonstrated the dramatic effects on the companys net present value of
increasing customer loyalty. A major focus of marketing today is on increasing customer loyalty, and shareholder
value analysis provides a powerful mechanism for demonstrating the financial contribution of these activities.

Table 2 illustrates this by showing that if the opportunity cost of capital is reduced from 10% to 9%, as a result of
marketing activities which reduce the vulnerability of cash flows, then shareholder value is boosted by 2.7
million.

4. Effect on continuing value

Shareholder value is made up of two components: the present value of cash flows during the planning period
and the present value of the company at the end of the planning period. Not surprisingly, since a company
potentially has an infinite life, the continuing value normally greatly exceeds the value of the cash flows over the
planning period. In the example of Table 1, the residual value accounts for over 70% of the corporate value.
Figure 1 shows that this is a typical figure across industry; indeed, in high growth industries the continuing
value is an even higher proportion of total value.

The problem is in valuing the business at the end of the planning period. The most common approach is to use
the perpetuity method, as in Table 1. This assumes that at the end of the planning period the company earns a
return on net investment equivalent only to the cost of capital, so that shareholder value remains constant. An
alternative assumption is that the business can continue to earn returns that exceed the cost of capital.

Another more pessimistic assumption is that after the planning period the cash flow turns negative as
competition intensifies. The choice depends upon two factors: the sustainability of the firms competitive
advantage and the real options for growth it has created. Microsoft and Coca-Cola, for example, have very high
residual values because investors perceive them having very long-term brand strengths that can be leveraged to
future growth opportunities in new markets or product areas.

Strong marketing assets, such as new product development expertise, brands, customer loyalty and strategic
partnerships should create competitive advantage and growth options that will often endure beyond the normal
period for which a company plans. Because such assets are difficult to copy and create, and offer lasting
advantages, they should enhance residual values and so have a marked effect on shareholder value. Table 2
illustrates this by showing the effect of extending the period over which the company earns positive net cash
flow by one year, from 5 to 6 years. This adds 3.7 million to shareholder value (from 68.8 million to 72.5 million).

Communicating the value of marketing strategies and justifying

advertising budgets
Shareholder value analysis allows marketing professionals to communicate the expected results of their
marketing strategies in terms that make sense for top management. In particular, it allows them to quantify how
investments in marketing assets may affect the share price. Measurements such as sales, market share or
consumer attitudes have little value as criteria for judging marketing strategies because they have no necessary
correlation with how investors value the business.

Valuing marketing strategies

Most marketers who work on developing strategy focus on marketing value drivers. For example, the strategy
might involve new creative ideas and above- and below-the-line initiatives aimed at increasing customer loyalty,
winning a bigger share of the customers spend and gaining new customers. These marketing drivers then need
to be translated into financial value drivers.

Two marketing strategies for Alpha

Suppose Alpha management has to choose between the strategy proposed in Table 1 and an alternative one
proposed by the new marketing director. This new strategy centres round a comprehensive relationship
marketing programme. The marketing department believes this would add an additional 2% to annual sales, and
to discount reductions amounting to 1% of sales (effectively this is the equivalent to 1% on the ex-factory price).
They also believe that higher customer retention will reduce the cost of sales by 1.5%. The additional cost of the
marketing programme will be an up-front investment of 5 million in the first year and an ongoing cost of 2 million
annually.

Table 3 evaluates the new strategy. While it reduces operating profits in the first year and reduces cash flow for
the first three years of the planning period, shareholder value is substantially increased. At 83.7 million, equity
value is 22% higher than in the original plan due to the higher long-term profits created, and these are reflected
in the higher continuing value of the business.

The example also illustrates the use of shareholder value in advocating aggressive marketing strategies. If
management wanted to maximise profits or earnings per share, they would reject the new marketing strategy.
But a proper analysis decisively demonstrates that such short-term orientation is in the interest of neither
shareholders nor the long-term competitiveness of the business.

TABLE 3: ALPHA COMPANY: VALUING A NEW MARKETING

STRATEGY
( MILLION)
 Year Base 1 2 3 4 5

Sales 100.0 113.3 127.1 142.7 160.1 179.6

Additional marketing 5.0 2.0 2.0 2.0 2.0
Operating margin 10.0 8.9 13.5 15.4 17.6 20.0
Tax (30%) 3.0 2.7 4.1 4.6 5.3 6.0
NOPAT 7.0 6.2 9.5 10.8 12.3 14.0
Net investment 5.3 5.5 6.2 7.0 7.8
Cash flow 0.9 4.0 4.6 5.3 6.2
Discount factor (r=10%) 0.909 0.826 0.751 0.683 0.621
Present value of cash flow 0.8 3.3 3.5 3.6 3.8

Cumulative present value 15.0

Present value of residual 86.8
Other investments 7.0
Value of debt 25.0
Shareholder value 83.7
Shareholder value added 31.7
Initial share price under new strategy () 4.19
Initial share price under old strategy() 3.44

Justifying advertising budgets

Many companies treat the advertising budget as a cushion, something that may be expanded in good times
ruthlessly cut back when profits are under threat. Top management appears to believe that advertising has no
demonstrable impact on shareholder value but proper analysis can show that this is a prime example of short-
term thinking. While cutting advertising will normally increase immediate earnings, it has a deleterious impact on
shareholder value. This is why cuts in advertising often lead to a fall in the share price even though short-term
profits increase.

The problems in justifying advertising budgets occur because sales are affected by many factors other than
advertising. Most studies of advertising agree that the effects of advertising on sales are small, certainly much
smaller than the effects of price or promotion. The maximum advertising elasticities reported are around 0.2,
meaning that a 10% increase in advertising increases sales by 2%. Another problem making the effects of
advertising even more difficult to calculate is its lagged effects. Sales today are not just affected by current
advertising but by the customers memories of past advertising. This means the short-run impact of advertising
may underestimate its total impact on sales.

Demonstrating the effect of advertising on shareholder value depends on understanding the function of
advertising. There are two main approaches to explaining how advertising works: the persuasive hierarchy
model and the low-involvement model. The former is sometimes called the aggressive theory of advertising,
which sees it as first informing consumers about the product and then persuading them to try it. The ultimate test
of whether such advertising has been effective is the resultant increase in sales. The shareholder value created
by such an advertising campaign can be gauged by first estimating the advertising effect, generally through
some form of econometric model, and then feeding the incremental sales attributed to advertising into the type of
financial model illustrated in Table 1.

A more difficult case is justifying advertising for established brands in mature markets. While the persuasive
hierarchy model of advertising might fit new products seeking to attract new customers, it hardly describes the
role of advertising for brands like Coca-Cola, Persil or Flora margarine. Virtually everyone buying these brands
has bought them before; they are familiar with them and have already been persuaded to buy. The low-
involvement model best describes the role of advertising here. This sees advertising as being essentially
defensive: the object is to maintain the brands market share and price premium through reinforcing current
buying behaviour. Advertising in these mature markets does not increase sales but it prevents them from
declining and preserves the brands as long-term generators of cash for the shareholders.

How shareholder value analysis can be used to justify advertising

Table 4 illustrates how shareholder analysis can be used to justify advertising, even though advertising does not
create incremental sales. Initially the brand has stable sales at 100 million and a 10% operating margin. In an
effort to increase profits and cash flow, management decided to eliminate the 5 million advertising spend. A
previous econometric analysis estimated the advertising elasticity at 0.1, implying that eliminating advertising
would only cut sales by 10%. Since two-thirds of costs are variable, management believed that profits were
bound to rise.

However, management ignored sales effects after the first year. In the second and subsequent years the brand
increasingly loses saliency to consumers without the benefit of advertising to reinforce and update the brands
associations. The model of Table 4 assumes diminishing advertising effects: in the first year the loss is 10%; in
the second year, 5%; and so on. In addition, management failed to take into account the loss of volume on the
brand premium.

Faced with declining sales and margin the major retailers demand bigger allowances. The effect was estimated
to take 1% off the ex-factory price each year. In the first year profits were indeed up as a result of the 5 million
saving on marketing. There was also a marked increase in cash flow in the first two years as lower sales
resulted in declining working capital requirements. However, after the second year, profits fell precipitously as
declining margins and the drag of fixed costs took their toll.

If advertising had been maintained, the shareholder value of the brand would have been worth 70 million.
Eliminating advertising produced a short-term jump in profits and cash flow, but a sharp decline in the long-term
value of the business. The value of the business to shareholders dropped by a third to 48 million.

TABLE 4: EFFECT OF ELIMINATING ADVERTISING ON SHAREHOLDER

VALUE
( MILLION)
 Base 1 2 3 4 5

Sales (units) 100.0 90.9 85.5 83.4 82.3 82.3

Price 1.00 0.99 0.98 0.97 0.96 0.95
Revenue 100.0 89.1 83.8 80.9 79.0 78.1
Variable costs 66.7 60.0 57.0 55.6 54.9 54.8
Fixed Costs 23.3 18.3 18.3 18.3 18.3 18.3
Operating profit 10.0 10.8 8.5 7.0 5.8 5.0
NOPAT 7.0 7.5 5.9 4.9 4.1 3.5
Net investment -4.0 -1.8 -0.9 -0.4 0.0
Cash flow 7.0 11.5 7.7 5.7 4.5 3.5
Present value of cash 7.0 10.5 6.4 4.3 3.1 2.2
flow

Cumulative present value 26.4

Present value of residual 21.6
Shareholder value 48.0
Original shareholder value 70.0

SVA places marketing at the centre of value creation

Shareholder value has become the new standard because of an increasing realisation of the defects of
conventional accounting. A focus on accounting profits encourages an excessively short-term view of business.
It leads to under-investment in information-based assets staff, brands, customer and supplier relationships. In
todays information age, the accounting focus on tangible assets makes little sense now that intangible assets
are the overwhelming source of value.

Why shareholder value needs marketing

SVA is tautological without a creative marketing strategy. It provides a tool for calculating the value added from
any given growth, profit and investment projections.

However, what drives these projections is outside the financial model. SVA does not address how managers can
identify and develop the strategic value drivers that accelerate growth, increase profit margins and lever
investments. These tasks are the province of marketing. At the heart of SVA is the concept of competitive
advantage. In competitive markets, only by creating customer preference through lower costs or a superior offer
can a company earn profits above the cost of capital, i.e. create shareholder value. Marketing provides the tools
for creating such a competitive advantage.

Because many companies have lacked a market orientation in the past, SVA has been taken over by the finance
function. Lacking the concepts and experience to build value through strategies that develop competitive
advantage and growth, financial directors have relied upon what they can control. In a majority of companies,
shareholder value has become synonymous with rationalisation and downsizing. Such strategies rarely create
value because investors can usually see that while they produce a temporary fillip to profits and cash flow, they
do not offer sustained growth.

Why marketing needs shareholder value

SVA is a great opportunity for marketing professionals. Traditional accounting, by focusing on short-term profits
and ignoring intangible assets, marginalises marketing. In contrast, SVA enables marketing to be brought centre
stage in four important ways:

1. SVA roots marketing into a central role in the boardroom process of strategy formulation. The language of
the modern board is finance. Actions have to be justified in terms of their ability to increase the financial
value of the business. In the past marketing has not been able to measure and communicate to other
disciplines the financial value created by marketing activities. This has resulted in marketing professionals
being undervalued and sidelined. Now SVA offers marketing a direct method of showing how marketing
strategies increase the value of the firm. It provides the framework and language for integrating marketing
more effectively with the other functions in the business.

2. SVA provides marketing with a stronger theoretical base. Traditionally, marketing has tended to see
increasing customer loyalty and market share as ends in themselves. But today, top management requires
marketing to view its ultimate purpose as contributing to increasing shareholder value. This dilemma
suggests a reformulation of the marketing discipline as one that develops and manages intangible assets
marketing expertise, brands, and customer and channel relationships to maximise economic value.

3. SVA encourages profitable marketing investments. Conventional accounting has treated marketing
expenditure as a cost rather than an investment in intangible assets. Because the long-term profit streams
generated by such investments are ignored, marketing in many businesses is under-funded. SVA, however,
is future orientated: it encourages the long-term effects of marketing expenditures to be estimated explicitly.

4. Finally, SVA penalises arbitrary cuts in marketing budgets. Management has found marketing budgets an
easy target when it needs to improve short-term profits. For example, cutting brand support will normally
boost profitability without significantly affecting sales in the short run. The fact that such policies invariable
lead to longer term erosion in market share and price premiums has been ignored. Now SVA gives
marketing management the tool to demonstrate that these short-term cuts destroy rather than build value.

NOTES & EXHIBITS

Peter Doyle is Professor of Marketing and Strategic Management at the University of Warwick Business School, where he
directs the School�s MBA programme. He has worked with IBM, Coca-Cola, Nestl�, Unilever, Guinness, Marks &
Spencer and others in a consultancy role, and has published widely on marketing strategy, branding and international
competitiveness.

FIGURE 1: STRUCTURE OF CASH FLOWS BY INDUSTRY

 Source: Value Line, McKinsey

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