If you’re just joining us, we’re having a fascinating discussion about the future of marketing in light of significant changes in the business environment. We’re discussing Victor Cook’s new book, Competing for Customers and Capital. If you want to get up to speed, hop over to the Book Discussion page to get started.
Okay, let’s move on to the second bullet point in this discussion. I’d like to propose some questions for Vic (and Jonathan, I hope you don’t mind being brought in on this one).
First, I think some of those who have read your posts and reviewed Vic’s narrated power point are a little bewildered. On the one hand Vic says in the power point presentation that intangibles are like "clouds in the sky," which makes them difficult to measure, at best. On the other hand you both reported in your last posts the percentage of market value accounted for by intangibles. How did you move from the clouds in the sky to percent of intangible value? Can anyone apply your methods? Please give us some examples of where you got the data and how you used it to come up with these results.
Second, you both provide a list of the types of intangible value. Vic, on page 16 of your book you say intangibles are created from the following list of "assets," and point out they don’t actually appear on the company balance sheet:
technology-based
customer-based
market-based
talent-based organizational related
contract/statutory based
In his post yesterday Jonathan said they are:
technology-related
contracts
artistic content
customer knowledge
marketing-related
Looks to me like you guys agree on the framework to describe these "assets." This is a good start. Now, can you give us some idea how to measure the costs of those "assets"? And maybe say something about why they don’t show up on the balance sheet?
THE PRICE OF VALUE
Capital markets are a wonderful thing … if you like transparency. I have a close friend who hates transparency. He prefers to deal in thin/opaque markets. Those where he can leverage uncertainty. It’s a very risky way to invest. For those of us who have to live in the real world, the transparency provided by (more or less) efficient stock markets is a good thing. Because they’re jam-packed with information mere mortals can understand.
“Financial price data provide a viewing window into the firm through the market’s evaluation of the securities issued by the firm and the changes in these values over time. Accounting data, on the other hand, provide information on the resources used by the firms. Thus, comparing accounting data and financial valuation data offers the opportunity to examine performance, the difference between inputs, on the one hand, and output, on the other (Eric B. Lindenberg and Stephen A. Ross, “Tobin’s “q” Ratio and Industrial Organization,” The Journal of Business, Vol. 54, No. 1, (Jan 1981, pp 1-32).”
Accounting data also are jam-packed with information. But there are some things these data can’t tell you. To continue with the metaphor I introduced in my narrated power point presentation on Chapter 1, accounting data can’t tell you the value of “clouds in the sky” because there’s no way to hold legal title to them. And “assets” are things to which you hold legal title, so and can buy or sell them.
To find out the market value of tangible assets traded in a “thick” market, like gold, all you need to do is look up its price online. You also can look up the market value of a public company online. That’s the closing price of its common stock times the number of common shares outstanding. Calculating the market value of a public company is the first step in estimating its intangible market value.
The other two general categories of assets (plant & equipment and inventories) are less liquid, but they do have an accounting value: depreciated book value and replacement cost. The depreciated book value of technologically outdated assets may be a poor measure of their replacement cost. Estimating the replacement cost of such an asset is very tricky because of the need to impute the value of improved technology. If you want to dig into the details of how to do this, check out the Lindenberg and Ross paper I cited above.
For relatively new assets, like digital images, it’s reasonable to assume depreciated book value is a fair estimate of their market value. This also is true for old assets with a very long shelf life, like oil refineries. In either of these cases, the second step in estimating the market value of intangibles is to look up the net book value of tangible and intangible assets.
Which brings me back around to the OIL v. IMAGES story I posted yesterday. For those of you just joining in, that story was about Getty Oil and Getty Images.
The biggest deal in US history up to July 11, 1984 closed when the Federal Trade Commission approved by a vote of 4-to-1 the purchase of Getty Oil by Texaco for $10.1 billion. On December 31, 1983 the closing price of a single share of Getty Oil common stock (ticker GET.1) was $98.125. The number of shares outstanding on that date was 79,135. This made the total market value of the company $7,765.1 million. In its final SEC filing Getty Oil declared the book value of intangibles was $0.00.
Here’s the point: the total market value of a company (v) equals the value of its tangible assets (v1) plus the value of its intangible assets (v2). Now with a little arithmetic we can combine these accounting and financial market data to estimate what Getty Oil was worth just before the merger. Here’s the equation:
v = v1 + v2, or
$10,385.1 = $10,385.1 + $0.00.
Texaco paid $10,100 million for Getty. The purchaser discounted the book value of its tangible assets by $285.1 million. But shareholders got $127.63 per share because the last recorded price had these assets trading at a 25% discount.
As a final example, let’s turn to estimating the market value of intangibles for Getty Images (http://creative.gettyimages.com/source/home/home.aspx) founded in 1993. In case you missed the first story, Mark Getty is the founder and CEO. But while his grandfather’s oil company was very 19th century, Getty Images is sooooooo 21st century.
The common stock of Getty Images closed at $89.27 on December 31, 2005. With 62,295 common shares outstanding the market value of the company was $5,558.4 million. The balance sheet reported the book value of total assets as $1,663.1 million. The book value of intangibles was reported on the balance sheet as $885.1 million. Subtracting the one from the other we estimate the book value of tangible assets was $808.1 million.
Rearranging the terms and combining the accounting data with the financial market data we can estimate the intangible market value of Getty Images:
v2 = v – v1
$4,750.3 = $5,558.4 – $808.1
Notice, the book value of intangibles under-estimated the market value of those assets by 83%. That’s because accountants can’t agree how (or even if) these intangibles should be reported on the balance sheet.
So, now you know how to calculate the value of “clouds in the sky.” But remember my cautionary note about the assumption that the book value of tangible assets is a reasonable estimate of their replacement cost. When you apply this logic to your own company, ask accounting for their estimate of the replacement cost of tangible assets (they have one) and compare that with reported book value.
Why all this fuss with market and accounting data? Because if you don’t know how much intangible value your business is creating, you can’t possibly figure out how much of that value is due to enterprise marketing. And when you figure that out, someone in the board room will listen to your story.
THE CMO CHALLENGE
Chris, before we go on to the third week in this discussion, I want to answer your last question about intangibles “… can you give us some idea how to measure the costs of those “assets”? And maybe say something about why they don’t show up on the balance sheet?”
What do we know about how shareholder value is created? Most of the value creators in finance are based on tangible assets:
“Linda Tan, a recent M.B.A. graduate and a financial news reporter, was given an assignment to analyse the financial performance of various Asian and American companies. It was her job to present her findings in a front-page feature on “identifying value creators.” To assess which company created or destroyed value for investors, Linda would make use of several financial criteria (Ho, M., S. H. Chan, and K. Wang. 2002. “Identifying Value Creators.” Center for Asian Business Cases: The University of Hong Kong School of Business HKU185 (January): 1).”
Linda compared a number of public Asian and American companies on the basis of sixteen value creators including sales revenue, net income, earnings per share, return on capital, return on assets, market value of equity, share price, price earnings ratio, beta, and debt to equity ratio. Notice that the lion’s share of these value creators is found on a company’s balance sheet. Sales revenue was the only marketing metric included in the list. The conclusion you come to is that customers’ brand experiences and market share, for example, are not among the value creators.
So why should this matter to CMOs? Because this is where they get cut out of the action. What matters most to your CFO and his or her CEO is total return to shareholders. It’s based on two factors: price appreciation (or, God forbid, price depreciation) and dividends paid.
What’s the threshold return to shareholders? I have a good friend who serves on the boards of several billion dollar companies. Twenty-five years ago he told me this: “If you can consistently deliver a 20% return to your shareholders every year, you’re doing a good gob. If you deliver less than that your company is under-performing. More than that and you’re doing a great job.” I think these rules of thumb still apply. But there are upper bounds. If your company delivers an annual return to shareholders of 100% or more, year in and year out, either you’re riding a bubble or doing something illegal … or both.
Here’s the point: when a CMO circulates an internal report that shows an ROI of 150% on a multi-million dollar ad campaign, other senior managers just roll their eyes and throw it away. I’ve seen this happen hundreds of times. Then they try to find a new candidate for the CMOs position that knows what he or she is talking about. This is one of the reasons why the tenure of CMOs is notoriously short.
What’s a CMO to do? You have no control over dividend payouts. That’s the domain of the CFO. So the $64 million question is this: how can you show the impact of marketing on the price of your company’s common stock? That’s the CMO challenge.
You might try to do this the Willy Loman way — by schmoozing your most important (internal) customer – the CFO. I don’t recommend this approach, unless you have something to offer that the CFO wants. And that something has got to be more than explaining the importance of customer loyalty, retention rate, and brand awareness on segment accounting profits. You’ve got to go to the next level and show the link between marketing and stock price. And to do that you need to broaden your horizons.
First, learn to speak the language of financial accounting and use these data to make your case for the impact of enterprise marketing on share price. Second, embrace the concept of enterprise marketing and sell it to your peers.
The most I can do right now is outline a framework to measure the cost of enterprise marketing resources. This framework is simple in concept. I call it the “three parts of a dollar.”
The finance department in your company probably subscribes to one or more syndicated accounting data services. More than likely one of these is Standard & Poor’s COMPUSTAT and its user interface “Research Insight.” The finance department may also subscribe to one of the up-and-coming competitors like “Edgar ONLINE Pro” and its user interface “i-Metrix,” using XBRL-tagged financial statement data via Microsoft Excel.
These syndicated services provide flexible and friendly access to the filings submitted to the SEC by your company and its competitors (if they are publicly traded on North American stock exchanges). All domestic and many foreign companies file reports with the SEC. Two reports that are important to the CFO, and so to the CMO, are the Income Statement and the Balance Sheet.
The income statements reported by COMPUSTAT and Edgar ONLINE standardize the line items into the three parts of a revenue dollar. I use the following short hand to account for each part: r = o + s + a. Where “r” is company revenue; “o” is cost of goods sold; “s” is selling, general and administrative expense; and “a” is earnings before interest, taxes, depreciation and amortization. It’s useful to give these three parts of the revenue dollar a functional name: the domains of executive action.
Here’s how these domains shake out. The cost of goods sold is the domain of operations management. Selling, general and administrative expenses are the domain of enterprise marketing. (A friend told me that “Only a marketing professor would dare to claim that all SG&A expenses were the domain of marketing!”). Earnings, of course, are the domain of corporate finance.
What with six sigma standards, supply chain management, the theory of constraints, and just in time inventory control, it’s widely believed that ops management is doing a good job. And the finance department does the best it can with what’s left over — EBITDA. That leaves the management of SG&A expense as the odd man out. Some call it the “black hole of the income statement.” Whatever it’s called in your company, it represents a huge opportunity for enterprise marketing.
The soul of enterprise marketing is a cross-functional perspective where “every member of your sales force, every customer service rep, every email, every invoice, every voice mail, every interaction with every customer at any time (Sutton and Kline 2003, Enterprise Marketing Management, page 215)” is a part of the practice of enterprise marketing. Selling, general and administrative (SG&A) expenses capture the costs of all these events and interactions. These are the costs of enterprise marketing resources. Looking at each of the following expenses in the context of enterprise marketing opens up the silos:
The SG&A expense category includes the current costs of technology-based “assets” (R&D expenses), customer-based “assets” (sales operation expenses); market-based “assets” (advertising and promotion expenses); talent-based organizational “assets” (employee compensation); and contract-based statutory “assets” (legal expenses).
I assigned these expense categories based on the classes of intangible “assets” reported in “Getting a Grip on Intangible Assets,” Harvard Management Update, A Newsletter from Harvard Business School Publishing, 2001, Article Reprint No. U0102C, which in turn was based on a report to the Financial Standards Accounting Board.
Each of these expenses affects the way customers and investors feel, think, and act toward your company. The job of a chief enterprise marketing officer is to provide leadership for all of the functional areas listed above in searching for ways to maximize earnings after deducting the cost of enterprise marketing resources. In short to maximize EBITDA. It’s is very TALL order. It means partnering with the VPs of research & development, operations, sales, human resources, and strategy as well as mastering the financial accounting data.
Enterprise marketing resources contribute to (or diminish) shareholder value in ways we will explore in detail in the next chapters of my book. Hold onto your hat, you’re about to discover the enterprise marketing metrics you need to compete for customers and capital – and win!