Shareholder Value as Strategic Marketing Evaluation Framework - Essay Example

Shareholder Value as Strategic Marketing Evaluation Framework Every business exists to make a profit while selling a product or service to s willing to pay the right price. As the business remains profitable, it survives, and if its owners are ambitious and motivated, it grows, selling more products or services in its markets, hiring more employees, or using the profits to reward its owners or buy more assets. The owners of the business are called shareholders because they hold shares of ownership and "share" in the business' profits. Shareholders hire managers who run the business and who, as part of their jobs, make strategic and tactical marketing decisions. Some strategic decisions (entering new markets, increasing sales capacity, etc.) need shareholder approval as these may require capital investments that affect profits, while most tactical marketing decisions (like advertisements, promotional campaigns, etc.) do not. Since shareholders are after increasing the value of their investment (Shareholder Value or SHV), they want higher profits. Since profits result from how much the business sells and spends to generate those sales, it seems logical that SHV is a good framework for evaluating marketing decisions. This paper in effect analyzes the reasoning that making good and correct marketing decisions would increase profits and SHV. Drucker (1955, p. 36) was among the first to argue that the purpose of a business is to create value for its owners by creating and keeping customers, and that marketing encompasses the entire business and must permeate all areas of the enterprise because it is what will create and keep customers. Since then, academics and practitioners from Levitt (1960) to the American Marketing Association (AMA) have linked the marketing function with the concept of value - both to the business owners and to its customers. AMA (2004) defined marketing as "an organizational function and a set of processes for creating, communicating, and delivering value to customers and for managing customer relationships (customer value) in ways that benefit the organization and its stakeholders (shareholder value)." Marketing therefore links two areas where value is created: customer value that leads to shareholder value. Marketing is a complex activity that aims to satisfy people outside (customers) in order to satisfy the people inside (shareholders, managers, and employees) the business, and not the other way around. Since customers are satisfied if the business makes the right strategic and tactical marketing decisions, the customers buy what the business sells, and enough profits will come to keep everyone happy, at least in theory. Marketing decisions used to be simple and easy to make: find out what customers need, what price they are willing to pay for it, make the product, and sell it to them. Friedman (2004) argued that the age of mass production after the War was more about selling than marketing, but as the world became affluent and globalized, customer needs and wants became more sophisticated, business competition intensified, and meeting market needs became more scientific and complex and considered not only what customers want now but also what they would want in the future (Achrol, 1991). Thus, marketing decisions came to be classified as long-term (or strategic) and short-term (or tactical) depending on their impact on the business. Strategic marketing decisions took into account making an accurate (or close to it) prediction of what products would be demanded by customers in the future, and how much they are willing to pay for them, so that the business would not only decrease their profits and the rate at which profits are growing, but continue to compete and grow. Strategic marketing includes long-term decisions, aside from knowing what the present market would need and want in the future, about discovering new customers for present products, deciding on which new markets to enter, how much profits each market could generate and how much of that profit the business wants to gain, and the share the business wants in each of the markets where it competes (Webster, 1992). Tactical marketing includes many short-term decisions to support the strategic marketing decisions. Included are decisions related to the marketing mix, the set of controllable variables that need to be managed to satisfy the target market and achieve business objectives. These variables are traditionally classified according to four major areas known as the 4Ps of marketing: product, price, promotion, and place (distribution channels) (Balmer, 2001). There are thousands of strategic and tactical marketing decisions that a business needs to make just to stay in the market, and as the tragic stories of hundreds of formerly successful businesses would attest, mistakes are made and fortunes can be won or lost. Recent business history is rich with examples of businesses that closed down or are on the ropes because of poor strategic marketing decisions: (1) Detroit's Big 3 failed to develop hybrid and fuel efficient cars, (2) Computer giants like Compaq and IBM's PC business unit have been absorbed by competitors, and (3) Airline companies went bankrupt because customers they imagined would fly did not. In these cases, the business made the wrong marketing decision, like failing to develop the right products customers want, and paid dearly for it. They bet a large chunk of shareholder value and lost it as products and services were left unsold. In the aftermath of every business disaster is the forensic search for the underlying culprit(s), which have ranged from management incompetence to downright greed. Rarely has it been acknowledged that faulty marketing decision-making, both strategic and tactical, could be the underlying cause which led to the annihilation of shareholder value (SHV). Take, for example, the notorious bankruptcy cases of Enron and WorldCom, where billions of dollars of SHV were wiped out. It turned out these cases were linked to wrong marketing decisions where products and customers were created out of thin air and investments made to satisfy needs that never existed, and Wall Street believed it. Enron successfully pioneered in marketing electric power, but when they attempted to apply the same innovative concept to bandwidth and drinking water, they spent millions to serve customers who never came. SHV went up in smoke and to cover losses, management did fictitious marketing and accounting engineering (Carroll, 2004). Given the straightforward logic between customer value and SHV, academics have proposed using SHV as a framework to evaluate marketing decisions. After all, they reason, the best way to determine if marketing decisions are correct is to see their effect on the bottom line: success = sales = profits = SHV. However, the issue is not as simple as that because there are theoretical (conceptual) and practical (computational) problems involved. There is more to value than profits and not all shareholders are concerned only with the bottom line. Day & Fahey (1990) were among the first to argue the usefulness of SHV analysis to evaluate marketing decisions, as in the case of a business looking at a portfolio of strategic marketing decisions and deciding which ones to carry out on the basis of how much SHV would be affected. However, they caution that since calculations are subject to accounting rules that, in turn, are subject to subjective manipulation, using the SHV framework would demand that the process be linked to rigorous strategy analysis to avoid problems with under- or overvaluations and the failure to consider all options. They also pointed out that the SHV analysis framework cannot compute the cost of sustaining the business' competitive advantage, as strategic marketing decisions take long to materialize, and their forecasted benefits in the form of cash flow projections may not be realistic. As a tool for conducting critical strategic thinking, SHV may help, but there are better options. Miller & Hoover (1999) refuted most of the conceptual problems identified by Day & Fahey (1990) as inconsistent with reality. Most shareholders are willing to make strategic decisions, top management may not be always objective (because of so-called agency theory where agents or managers conflict with the interests of owners or principals), and managers do not always act in the best interest of owners. Thus, they argued that SHV analysis may be a good tool, but instead of just providing a bottom line on which to base strategic marketing decisions, marketing managers must work the other way around: while they should not detach the development of marketing strategies with their impact on SHV, neither should they be limited by their mathematical assumptions. They cited an exercise where consultants did a marketing strategy that was perfect in terms of forecasting demand and production targets, but which ended up bringing down SHV because shareholders never liked the project and sold their shares, bringing down the price. In two articles, Doyle (2000 and 2001) argued that marketing and SHV analysis can complement each other in determining what is best for the business. His key point is that SHV analysis can help marketing to go beyond market share and sales growth and into the more important field of value creation for the business and its customers, for example in building brands as assets and managing those brands to generate sales, profits, and higher SHV. He warned against the perennial battle (present in every business) between finance and marketing, between those (finance) that manage, control, and allocate resources and those (marketing) that spend and generate it. This finance-marketing conflict was addressed by Srivastava et al. (1998) when they proposed that marketing people must consider the effects their strategies have on inventory levels, cash flows, and the stock price, all of which affect shareholder value. They suggested using SHV as a framework for evaluating marketing decisions by looking at marketing as an activity that would develop and manage market-based assets such as customer, channel, and partner relationships, all of which create streams of value. Others admit SHV analysis is a useful tool to bring marketing to the next level and improve the marketing-finance interface within the business firm, leading to greater cooperation instead of conflict between the two functions. Several academics, perhaps as a way to foster greater understanding between finance and marketing, proposed alternative frameworks. Luehrman (1998) and Amram et al. (1999) suggested incorporating options pricing theory into the evaluation of strategic marketing decisions, while Hopkinson et al. (2002) argued for the use of the capital asset pricing model (CAPM) to value customer relationships. These attempts while academically sound seem too complex to implement in practice, and rather than improve understanding may even lead to greater conflict because they reflect a tendency to use finance vocabulary (like CAPM, options, risk, value) to "quantify" the science of marketing evaluation by threatening to make its effects on the bottom line clearer. It would be better, perhaps, to heed the underlying argument used by Ryals (2002 and 2005) and Ryals & Knox (2007): to capture and keep the profitable customers by managing the relationship with them. Through the use of powerful concepts like the costs of customer capture, the long-term benefits the business can earn from each customer, the value of customer relationships, and prioritizing the acquisition and retention of profitable customers, they provide a customer-centered framework, in contrast with shareholder- or finance-centered frameworks, that seems more promising. In conclusion, the use of SHV analysis to evaluate marketing strategies is a good-intentioned way of showing the impact of customer behavior on profits and the value of the business. However, as the saying goes, the road to hell is paved with good intentions. Financial calculations such as those required by options pricing, capital asset pricing models, and accounting measures can be complex, difficult to understand, and open to mathematical manipulation and subjective interpretations. Besides, focusing too much on the bottom line may lead to an obsession with profits and over-relying on elegant accounting short cuts that look good on paper based on financial assumptions which may not have much grounding on reality. Profits come from profitable customers, so a better framework would be to calculate the profitability of each customer and craft marketing strategies that would attract and retain more of them. 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