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Justifying Marketing System Investments

  • June 01 2007, 1:00am EDT
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Marketers often find it difficult to justify investment in new technologies. This is partly because many new marketing systems are intended to improve how the company interacts with its customers. Because how customers will respond is rarely known in advance, any financial analysis is inherently uncertain.

But there's another reason that marketers' value estimates are so often questioned. Quite simply, many managers outside of marketing view those estimates as unreliable. Over the years, marketers have often justified their activities using measures such as brand awareness, customer satisfaction or response rates. While these make sense to marketers, other managers find it hard to relate them to traditional financial measures: profit, cash flow and return on investment. This confusion may have earned marketers some freedom from supervision, but at the cost of the trust of their peers.

The fundamental uncertainty of marketing investments is unavoidable. But marketers can at least present their estimates in conventional financial terms. This will remove some of the mystery surrounding their work and help other managers see the value of their activities.

Natural marketing measures are connected to standard financial metrics through lifetime value. That is, marketers can estimate the impact on lifetime value of changes in marketing measures and then convert lifetime value into standard financial terms. But just adding an estimated change in lifetime value will not make a marketing projection any more credible: if anything, it will seem like an even more arbitrary number that was cooked to justify whatever marketing wanted.

The way to make lifetime value credible is to break it into meaningful components. Fortunately, this is not hard.

Start with the customer lifecycle. Although customer management methodologies use different terms to describe them, most identify three basic life stages: acquisition, retention and growth. Acquisition refers to getting the first order from a customer or, more simply, to adding new customers. Retention refers to gaining repeat orders, or keeping existing customers. Growth is expanding the customer relationship by selling additional products. This is often referred to as cross-selling.

Almost any accounting system can associate a date and product with revenue-generating transactions. In systems that can also tie those transactions to individual customers, it's fairly easy to classify revenues as belonging to initial purchases, repeat purchases and cross-sales. Where purchases cannot be directly linked to customers, it's often still possible to estimate how revenues are divided among these categories through research.

A proper financial analysis includes not just revenues but also costs. These can be divided into marketing and fulfillment expenses. Marketing costs are discretionary: they include activities that promote purchases. Fulfillment costs are everything else: they include products, customer service and overheads. Some firms might further distinguish variable fulfillment costs (directly related to specific purchases) from fixed costs (incurred whether or not a particular transaction occurred).

The precise allocation of costs is a topic of endless fascination among financial experts. This is good news for marketers, because getting finance involved with the definitions used for lifetime value analysis builds credibility for the final results. Once corporate finance has helped determine the appropriate cost definitions, they also provide expertise to extract the values from the company financial systems. Knowing that the lifetime value figures are tied into the official accounting system - even if nobody outside of finance understands precisely how - is immensely reassuring to senior managers who might otherwise question the value's validity.

The three purchase types (initial, repeat and cross-sale) with their three cash streams (revenue, marketing cost and fulfillment cost) lend themselves to a tidy 3x3 matrix of lifetime value (LTV) components. These are much easier to understand than a single consolidated figure. Moreover, because most marketing investments affect only some LTV components, listing these separately clarifies how a proposed investment is expected to achieve its goals and lets managers assess whether the assumed changes are reasonable. Finally, the LTV component matrix is by definition comprehensive, so when you've considered the impact of a project on each component, you've captured its impact on the entire business. This sort of thoroughness is important for any investment proposal, but is especially useful in helping marketers gain credibility. As a side benefit, the component-by-component review often finds incremental benefits beyond the original investment purpose.

This still leaves the challenge of estimating the component changes themselves. For this, marketers must still rely on whatever research, experience and intuition they have available. The lifetime value model used to generate the component figures can also help with this process, although it cannot remove the inherent uncertainty surrounding future marketing results. What the lifetime value approach can do is help ensure other managers understand where the estimates came from and what the estimates mean. 

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