Nov

9

In most companies, brand and marketing investment is a foreign concept; that is, branding programs—along with the marketing initiatives that support them—are viewed as discretionary expenditures that can be postponed or eliminated at the first sign of revenue slowdown. It is easy to blame marketers for this. After all, historically, they have shunned financial accountability and embraced an approach to marketing that can be best described as “trust me advertising.” However, simply making marketing executives more accountable—and we must—will not fix the problem. Rather, we must look at the flawed decision-making framework financial executives rely on when determining the quantity and timing of brand investments.

Parmenides’ Fallacy

Parmenides, the 5th century B.C. Greek philosopher, believed that change is an illusion and that conditions in the real world always remain constant. In other words, when making decisions about future outcomes one should assume that the current situation will remain unchanged, if left alone. However, quite the opposite is true. In the real world, the only constant is change, and over time normal circumstances deteriorate. This is Parmenides’ fallacy.

So, what does brand investment have to do with this fallacy? Executives tend to make investment decisions by comparing the status quo to a desired outcome, rather than with other possible outcomes. Let’s look at the financial industry, for instance. At a time when the industry is on the verge of collapse, chief financial officers (CFOs) at troubled banks see fit to decrease operating expenses by slashing branding and marketing budgets. They fail to realize, however, that consumers will not sit idle as their banks try to set their house in order. While budget cuts might lead to a decrease in operating expenses, profitability will spiral downwards at an increasing rate as customers—and revenue—head out the door.

Discounted Cash Flows

Discounted cash flow (DCF) analysis provides a good example of Parmenidian logic in action. DCF analysis is a valuation method used to estimate the attractiveness of an investment opportunity. In simple financial terms, a DCF model estimates the value, today, of an investment that will generate anticipated cash flows in future years. These cash flows are discounted to account for the time-value of money—since a dollar today is worth more than a dollar tomorrow.

There is a problem with overly relying on the DCF models when making investment decisions. From a CFO’s perspective, most brand investments provide two likely scenarios. If the investment is approved, the financial risk can never be greater than the amount invested. After the initial investment is made, incremental future cash flows are generally assumed to be greater than zero—but can never be less. If the investment is not approved, on the other hand, it will not be possible to generate incremental cash flows, but the financial risk is assumed to be zero.

Yet, we know that the financial risk of not making the right brand investment is not zero. Rather, a company’s financial risk increases and business performance declines when it fails to make appropriate and timely branding investments.

Accounting for Intangibles

Financial executives must understand that a company’s brand is an asset—an intangible asset—but an asset nonetheless. However, brand investments are typically expensed, and not capitalized, which makes no sense.

For example, upgrading personal computers for a company’s sales force is likely to have a non-material marginal effect on sales. Yet, this investment will be capitalized over three or four years. Brand and marketing investment, on the other hand, is expensed in the financial period incurred.

Let’s say that a CFO is given the choice to upgrade new computers for $10,000 or spend the same amount on a branding program. Under accrual accounting rules, he would only have to expense $2,500 during the first year if he buys new computers but the full $10,000 if he chooses the branding program. Obviously, buying computers makes for a more attractive investment. The true implications of these investments can be seen only from a cash perspective. When the IT upgrade and branding program are capitalized over the same period, the effect of both investments on cash is the same. The branding program, however, has a greater effect on revenue and shareholder value. Besides, the useful life of a brand is likely to outlive that of
a computer.

Capitalization accounting principles are the main reason why marketing budgets are the first to be slashed when corporations are looking to trim costs. Accrued earnings do not deliver shareholder value; cash does. It is wrong to make investment decisions solely based on short-term accrual accounting implications.

In most companies, marketing budgets are set as a percentage of projected sales or based on an arbitrary increase over the previous year’s budget. When sales decline, finance cuts the marketing budget; but, marketing spending drives sales—not the other way around. It, therefore, makes no sense to indiscriminately cut marketing budgets when sales are declining.

Building Value

Brand value equals customer value, equals shareholder value. Brands and customers, not products and services, generate the cash flows that create long-term shareholder value. Finance and marketing must work together to:

• Hold marketing, and their agencies, more accountable for business results
• Create investment decision tools that take into account all plausible outcomes
• Develop the models and infrastructure that link marketing programs to financial results
• Take a long-term approach towards brand and marketing investments
• Rely on measures of long-term growth—such as customer lifetime value—rather than short-term metrics such as monthly sales
• Create pro-forma statements that include the company’s brands as financial assets
• Set marketing budgets based on what the company wishes to accomplish in the future, and not based on what is happening today