29 October 2017
The Times They Are A Changing
Marketing isn’t what it used to be. As a profession, it has changed enormously in recent times. When you study the definitions for marketing, and in particular how they have changed over the past decade, you notice something striking. Marketing has moved away from “only” identifying markets and commercial opportunities to also encompass internal processes and organizational functions. For example, World Marketing Association: “Marketing is the core business philosophy which directs processes of identifying and fulfilling the needs of individuals and organizations through exchanges which create superior value for all parties.” Marketing’s responsibility is to be a responsible advocate for the customer, to help the company create superior sustainable value for customers. What this signifies is a much tighter internal connection within the corporation because it touches on all processes that directly interact with the (end)customer. Marketing is focused on the inside as well as the outside of the company these days.
But something else in marketing has changed, too. Financial markets exert an ongoing pressure on corporations with regards to reporting demands and what kind of performance is expected. Every function needs to adapt to this new reality. For marketing this change has sometimes been traumatic: what used to be an elusive ‘art form’ appears to have transformed in to a ‘cold science.’ What happened? These days, marketers are expected to demonstrate how their activities translate into value creation for the customers and shareholders. And also provide quantitative evidence of those assertions. Some marketers fear this will take away the beauty of the profession. But in reality, creativity needs to be expressed in new and different ways. There is little place left for the ‘touchy feely’ artist. Nowadays, marketing actions need to be justified by numbers and business cases. They need to keep an eye out on acquisition and churn numbers, cross-sell, up-sell, customer LTV, and a raft of other numbers that are deemed important to evaluate ongoing success. At the core, this change embodies marketing’s accountability for budget appropriation.
Accounting rules are changing, which concurrently signals the need to change internal reporting of budget allocation, too. But this change wasn’t fundamentally triggered by accounting rules. For quite a while already, financial markets have valued companies on the basis of number of customers, cross-sell potential to existing customers, and attrition rates. Taken together, these numbers give insight in the long-term profit potential of a company.
But existing accounting rules do not allow customers as assets in the books. Nor do they allow marketing expenditure to be regarded as an investment. This is where the valuation model used by capital markets is fundamentally at odds with the “model” for financial reporting that accountants work with. The accounting model focuses on determining the liquidation value of property. But businesses aren’t run like property, nor with the goal to be sold (usually). Just to be clear: the valuation model used by capital markets is rapidly becoming the implicit view in boardrooms. Yet it is this implicit view that is at odds with the standard financial reporting they’ve been accustomed to from their controllers, and that they also need to abide by regulatory reporting purposes.
The contemporary view on marketing treats customers almost as tangible assets to the company. You invest in assets to achieve a better return. What is slightly different between investing in customers versus investing in capital projects is the ongoing nature of marketing expenses. You don’t “buy” a customer and amortize the cost. It is more like you “rent” a customer from the marketplace, and by continuing to provide superior value, you maintain the right to make offers. Along with this “new” view on the marketing function comes the accompanying scrutiny on the marketing budget: what’s the ROI?
The New Marketing Paradigm
But there are other reasons why marketing has changed. Whereas in the past the focus was on aggregate numbers like market share, last quarter sales, number of customers, nowadays these numbers will not suffice anymore. Customer Relationship Management (CRM) and new marketing trends have shifted focus from market- to customer share. From aggregate, “average” markets to atomic, fine-grained analysis of business performance. The time (longitudinal) component, relative within each customer’s lifecycle is a fundamentally new way of looking at “markets.”
Markets are now seen as composed of myriad micro-segments or even individuals, allowing for far greater insight and control. And with this new view on reality we seek and need new numbers, too. Not just market share, but customer share, as well. Not just “one-off” numbers, but numbers that indicate customer lifecycle development as well. For example, instead of reporting on cross-sell numbers per segment, we look at reports on cross-sell achieved 1-2-3 years after acquisition, and how those numbers evolve over time for subsequent cohorts. Data on customer acquisition, churn, and cross-sell are now considered essential in understanding the economic ‘well-being’ of a company.
How To Make The Marketing Function More Accountable?
There are serious problems when mixing forward and backward looking measures for marketing success. It’s an illusion to attempt to measure performance by one single number. Yet at the same time, we need to evaluate a marketer’s contribution in the past, and also take into account what (residual) expectations we may hold for the future, given the current state of affairs in the customer portfolio.
In general, marketing outcomes are hard to quantify. Number of customers, number of products sold, are straightforward. But how about short-term versus long term profits, etc.? In all cases, these are outcomes that result from investing in marketing budget, and therefore are (or should be) subject to the exact same scrutiny that any other investment decision gets: “what’s the ROI?” Sensible forward looking metrics that are sometimes used are DCF measures (Discounted Cash Flow), Increase in Net Present Value, Customer Lifetime Value (LTV), etcetera.
The problem with these forward looking measures is that they are estimates based on assumptions about the future. Therefore, they rest heavily on two fundamentally unknowable entities: estimates about future events, and assumptions about the state of the world from now on. To make matters worse, in annuity calculations like these, the long-term value can be grossly affected by relatively small changes to these assumptions. Forward looking measures like these make sense especially when comparing alternative future strategies, and how they perform in terms of ROI. You can then evaluate the ‘fit’ between alternative futures and wider strategic corporate goals.
When reviewing the performance of marketing executives, we need some yardstick to evaluate how strong past performance has been, and to what extent this should be attributed to voluntary marketing efforts (and not just favorable swings in the general economy). If you incorporate forward looking measures into this evaluation, you include assumptions about a future that is fundamentally unknowable. What’s worse is that assumptions will determine what is “considered success”, rather than achieved bottom-line results. And we all know what kind of dynamics such dependencies are likely to create. Therefore in evaluating past performance, it is safer to rely solely on backward looking customer profitability measures. Activity Based Costing schemes to determine an equitable measure of customer profitability are hard to establish, but that work is essential if you want to make past performance accountable.
To determine strategy, you need to know something about both short-term and long-term performance. But you also need to know how those compare to an external benchmark (“how is the industry doing?”), as well as an internal benchmark (“how are other departments doing?”). What could be expected from this company, given its market standing and access to resources. Not an easy task, but crucial in aligning performance management of the marketing function with new realities of reporting.
Marketing has transformed, there is no doubt about that. What is much less obvious, is how new accountabilities should be aligned with ongoing responsibility for marketing. Marketing is a creative profession, and should stay that way to foster entrepreneurial behavior and innovation that is dearly needed. We’ve entered an era of customer centricity and customer advocacy. Marketing’s new challenge is to both be an internal ambassador for the customer, yet at the same time provide adequate accounting of decision processes that impact the customer.
A rational and transparent budget allocation process optimizes organizational performance, and takes off the ‘political’ edge that often surrounds resource appropriation. To this end, corporate business partners need to agree on a “shared reality” that is in line both with internal controls and external financial reporting. There is little use in discussing alternative strategies if the way you evaluate future scenarios does not match. Finance and marketing need to ‘find each other’ here, and agree on metrics that represent the view one takes of the business and its customers. Traditional cost accounting is not much help to that end.
Last but not least, there are risk factors involved in various future strategies, that may or may not be factored in. All too often, they are not, at least not explicitly. But risks associated with alternative futures certainly deserve a place here. And that certainly not only holds for intrinsically risk bearing products like credit. Alternative future scenarios can be weighted in terms of relative risks and rewards, and corresponding break-even horizons.
Good marketing these days involves successful pan-company marketing. Modern day marketers face the challenge of aligning all functions throughout the company to create superior value for the customer. Insofar as they can align these challenges with new expectations about financial accountability, it has indeed become a totally new profession. Creativity is expressed in new ways, not in the least by showing new realities, painting a compelling picture of alternative future scenarios for growth, by explaining at the board level how investments in marketing should be understood. By explaining how marketing campaigns improve the customer portfolio. Even (or especially) when this can not be done through traditional cost accounting. The response to this new challenge will determine whether a fashionable trend to appoint Chief Marketing Officers at the board level will prove to have been another hype, or a change to the benefit of corporations.