Using Customer Franchise Value to Bridge Short- and Long-Term Investments in a Financial Context

 

 

Most CMOs have various elements of their marketing programs that are not intended to fully pay back in the near term, and they have to find some creative way to show their brethren in finance or accounting when the payback will occur and with what level of certainty. This is a particularly vexing problem. Most marketers understand and accept the conventional wisdom that money spent today generates some awareness and changes some attitudes, beliefs, and behavior — some of which falls into the 2007 revenue bucket, and some of which might fall into even longer-term revenue or profit generation. This concept is fundamental to a marketer’s understanding of the marketing discipline.

However, it is, unfortunately, not accepted or understood within the realms of finance and accounting. They follow “generally accepted accounting principles,” or GAAP reality, which not only clearly dictate but actually require that accountants take any money spent now and book it as an expense now. There is no such thing as a capitalized marketing expense — they’ve got to take it in the current period against the P&L.

 

So, it’s no wonder that they’ve got such a strong desire to understand what brand advertising is going to do to generate incremental revenue or incremental profitability in the near term. They just need to be able to figure out whether, from a cost-accounting perspective, this is a better expense than some other investment that the organization is seeking to make.

As a result, marketers need to start developing a more disciplined way of helping them understand the tangible, financial value being created over time — not just the strategic value. (See our Kevin Lane Keller interview for more background on measurement of brand investments.)

Let me go back to shareholder value as the bedrock of that. Marketers understand the concept that an enterprise has a total value based on what its market value might be. If you are a publicly held company, that’s easy to calculate. If you are a privately held company, the value is based on what someone might be willing to pay for the firm. The value of the organization is based in two different classes of assets. There are the tangible assets: the net working capital — in other words, the cash flow, the property, plant, and equipment — and intangible assets.

 

If you were to look, for example, at the S&P 500 in 2005, tangible assets represented only 22% of enterprise value across the entire group, which means that the other 78% of enterprise value was coming from intangible assets — contracts, channels, technologies, processes, management quality, reputation, brand, and customer relationships. And if you were to look at a 20-year trend line, it’s enormously upward-sloping in favor of intangible assets.

 

Intangible assets are exactly where marketing makes its largest contribution. They help drive networking capital in the tangible fashion in the shorter term; but in the longer term, they add to the intangible aspect of shareholder value by improving the reputation, brand, and customer relationships. But how can marketing be described in tangible dollars to help finance understand how to bridge the short- and long-term together?

One way is on the basis of “customer franchise value” (CFV). CFV is a snapshot — the net present value of your current customer base, looking at how many customers you have, what they are buying today, how long they are likely to continue to buy into the future, your churn rates, etc.

How do all those factors translate into net present value? For any given company, determining the customer franchise value is a relatively straightforward exercise you can do with your finance department, subject to making some assumptions about lifetime value and various segments of the customer base. It’s sort of like the home version of a game you can play at your kitchen table.

Breaking the customer franchise value formula down a little bit further, it’s really a function of the number of customers a company has times the lifetime value of those customers.

 

Again, it’s important to emphasize that, for the purpose of building a bridge between short- and long-term financial impact of marketing expenditures, CFV does not involve potential value, or products and services a company doesn’t yet offer that these customers might eventually buy. Rather, it refers to a very conservative present-value definition: What do customers buy currently and how long are they going to continue to buy it?

This customer franchise value breaks down even further into very simple components: the number of customers as a function of acquisition and as a function of retention. Retention is also a key factor in determining customer lifetime value, as are the dimensions, depth and breadth, of spend; or, put another way, the pricing leverage a company has in the marketplace.

So, interestingly, any marketing investment made that isn’t purely a brand development investment covered by the previous structure is likely to be targeted at achieving one or more outcomes amongst those three bubbles: some combination of acquisition, retention, change in spend pattern — everything done from a marketing perspective can be broken down into those bubbles. As a result, every marketing investment that might potentially be made can be looked at in the context of how it would be expected to change customer franchise value.

For instance, how much customer franchise value will a company create this quarter, next quarter, and three or four quarters down the road? This is the beginning of a foundation from a financial perspective for helping finance understand when and how marketing investments are going to pay back. But even more so, this provides a better framework for assessing what marketing effectiveness and efficiency are. Marketing effectiveness is a matter of saying how did customer franchise value actually change from one period to the next vs. how it was expected to change, and how did marketing’s actual results compare against its projection?

 

Marketing effectiveness measurement is all about forming clear specific expectations of what’s going to happen, assessing the extent to which that particular reality was brought about and understanding why it was or was not achieved. Customer franchise value really helps achieve that goal, especially with regard to looking out into the future to accurately understand the benefit of spending money today.

CFV also helps from an efficiency perspective; in particular, in the context of how much CFV change was achieved per dollar of marketing spent. That’s an efficiency metric that can be looked at across the board quarter in and quarter out, year in and year out, to gauge progress against expectation.

Generally, it’s not a slow, upwardly sloping line, because we all live in dynamic markets we’ve got to make adjustments for. But for marketers who understand the concept of an expectation of where we are going to be vs. where we actually are, marketing efficiency is really a question of how well a company’s expectation is achieved.

Finance and accounting managers are not as interested in long-term value as they are in short-term value, so marketers need to put long-term value in terms that parallel short-term value and that finance can understand. Customer franchise value helps accomplish that task. Providing the CFO with CFV facilitates buy in, top-down acceptance, and budget commitment, all designed to help marketers achieve the long-term goals that drive future value, competitive differentiation and solid growth.