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Walking the Path – A Framework for Marketing and Capital Spending

  • March 21 2003, 1:00am EST

A previous article ("Varying Marketing Spending,", December 2002), discussed the concept of adjusting marketing investment based on current and future customer or segment value. Since spending varies dramatically across a customer base, companies should adjust their marketing spending for each customer or segment commensurately. For example, the company probably should not invest $100 in communications and incentives to a customer who can only be forecasted to return $10 in their relationship with the company. The goal is to balance marketing investment with return from that customer’s increased relationship to yield a positive ROI. By adjusting spending across segments or customer proportionate to potential margin, marketing can improve program effectiveness and increase return per marketing dollar invested.

The relationship between marketing investment and customer return has far-reaching implications. Marketing investment has traditionally been treated differently from capital investments such as plants or equipment, since marketing is usually focused on creating a strong selling environment. The close relationship between sales and marketing leads advertising, promotion and trade spending to be lumped into a general category of "cost of sales" and thereby to be associated with the company income statement differently than capital investments, which are usually amortized over some time period. When sales are increasing steadily, marketing costs can grow proportionately to sales with little challenge. When the economy slows, marketing finds its spending reduced to maintain a consistent cost of sales. The truth is, both the growth and tightening approaches fail to consider the similarity between marketing investment and capital investments and the implications of that similarity on budget and financing decisions.

Let’s stand back and examine corporate investment decisions. During the course of a year, a host of business decisions determine the flow of capital across an organization. Different departments submit recommendations for plants, new offices, equipment and technology. Through a capital allocation process, those recommendations are evaluated and decisions reached. Usually, cash flow projections are required for a one to five year period, with benefits balancing the costs and yielding a return on investment that exceeds the company’s cost of capital or hurdle rate. The cost of capital is usually the cost of accessing additional debt or equity funding, and the hurdle rate often placed greater than capital costs to ensure positive returns. Following financing approval, a steering committee is usually formed, and the project begins with periodic milestones and checkpoints to ensure project approach, deliverable and returns are consistent with the original project proposal.

Now, let’s compare that process to marketing budget development. At a high level, marketing budgets are usually developed as a percentage of sales, since that spending is part of selling at some level. Once budgets are determined and drilled down to the category, brand or department level, that money is allocated across communication and incentive vehicles such as advertising, promotional marketing, trade spending, events, etc. Marketing and corporate management presentations outline potential return, especially from measured media such as promotions. With plan approval, execution begins. While the results from marketing spending were seldom tracked rigorously, today’s marketing evaluation is becoming more and more comprehensive.

The similarities between both capital and marketing spending processes are clear – both efforts include presentations of investment alternatives and estimates of forecasted results. The capital approval process may be more detailed, but resource allocation processes are similar for both capital and marketing expenditures.

Analyzing the difference between the two processes is even more illuminating and illustrates critical differences in the corporate mind-set regarding capital and marketing spending. At the outset, marketing spending is traditionally based on prior years' spending levels and a percentage of this year’s estimated revenue estimates. Capital spending, viewed as a high-order investment, is often based on company valuation and is reported to shareholders in financial reporting. The amount of capital investment is often seen as a sign of the company’s confidence in their strategy and in the marketplace as a whole.

When was the last time you saw marketing spending viewed that way?

In fact, marketing spending growth can sometimes be viewed as a negative by the markets – a way of using promotions to keep revenue up until the company can fix its strategy. The assumption is that marketing spending is hiding something, rather than a sign of confidence in strategy and the marketplace as a whole. While marketing expenses associated with a new product or strategy announcement can be an exception, clearly, marketing spending is not viewed the dame as capital spending.

The truth be told – marketing investments in customer relationships are capital investments, perhaps the most important capital investments a company may make. Why is marketing spending really capital spending?

  • Customers are the initial and primary source of capital for a company. Investment tools may supplement that capital, but if customers are mot supporting sufficient cash flow, investment options usually dry up as well. That cash flow is representative of margin or some bottom-line, profit- related result.
  • Investment in customer relationships, when done well, will yield a steady stream of incremental revenue, similar to plant productivity improvements.
  • Marketing spending really is the selection between different vehicles and approaches, just as capital spending involves a choice between different investment options, each seeking to select a portfolio of programs or investments that yield the highest possible returns.

I want to caveat this assessment by discussing the role of mass media, particularly advertising, in the resource allocation process. Advertising is critical to success in many B2C industries (and some B2B also). I do not mean to suggest that such communication should be curtailed or restricted due to difficulties in evaluation or measurement. Such communication is absolutely essential, particularly in industries that rely heavily on brand imagery and awareness generation/maintenance to sustain volume and revenue. My point here is that some marketing spending is very similar to capital investments and should be treated the same way, both internally and with the investment community. Other critical marketing investments (particularly brand building such as advertising) should be determined using more traditional approached such as share of voice, percent of spending and so on.

The implications of treating marketing spending as a capital spending is that customer or segment revenue forecasts would become part of the assessment of the company’s value. Companies with strong, clear customer management infrastructure and approaches would then be rewarded and companies lacking such initiatives would be penalized. Quarterly reporting would include segment level results and that metric would be heavily used as a proxy for the company’s strength and long-term prospects.

How would a company that treated some marketing spending as capital investment look? Three factors are beginning to distinguish companies that focus on customer metrics and marketing as core investments from those that do not:

  • Marketing spending may be ballparked as a percentage of sales, but the investment varies based on potential returns. The goal is to invest in a mix of short-term and longer-term projects that yield strong results and exceed a company’s cost of capital.
  • Customer segment metrics are presented consistently and measured throughout the company in the process if all decision making. Even traditional capital spending is considered in light of the potential impact on customer-level performance.
  • The processes of capital and marketing decision making are being brought together to unify all resource allocation decisions across the company. As with capital spending, marketing investments are given benchmarks and milestones, and rigorous reporting tracks actual results vs. the forecasted amount.

The question, in the end, is whether this discussion is merely an academic exercise, as sort of "how many angels can dance on the head of a pin" discussion or the start of a blueprint for corporate resource realignment that could potentially revolutionize marketing’s role in the organization.
If the latter is the case, what should marketers do today to help bring about that change?

  • Invest time and resources in customer analysis. Without rigorous, consistent measurement, marketing will always be considered a soft art and rely on proponents to support budgets rather utilizing a scientific approach as support.
  • Leveraging that customer or segment level analysis to provide assessments of marketing program results where possible. Begin to formulate marketing planning around segment-specific goals and objective.
  • "Market" the increased knowledge and accountability across the organization particularly to senior management. Relate marketing decisions to other company decision making, particularly in potential ROI relative to hurdle rates.

Many of these themes have been published by others and myself. However, the focus on capital spending permits marketing to place its activities in the context and language of other decisions made throughout the company, which can be key to driving buy-in and consistent decision making. As language across companies changes to a focus on shareholder value per dollar invested, customer value per dollar invested lies squarely on that path.

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