FEBRUARY 1, 2005

By Christopher Kenton

Value Beyond the Balance Sheet

A business is worth more than its plant and equipment. Trouble is, how do you measure assets like reputation and customer loyalty?

Marketing as a profession today faces a huge crisis of credibility. However, the essence of it was summed up more than a century ago, in a famous quip by the retailer John Wanamaker, who said, "Half my advertising is wasted, I just don't know which half."

Despite all the advances in technology, metrics, and analytics, marketers have made little headway in easing concerns expressed by today's CEOs, not only about advertising, but every area of the marketing budget. Now, a changing economic environment is giving CFOs and COOs the opportunity to grab control over the destiny of marketing as a business function. And most marketers are blissfully unaware.

WHITE NOISE. . As I described in my last column, the fundamental driver shaping current trends in corporate strategy is a shift in how the value of a business is measured (see BW Online, 1/18/05, "Marketing's Bottom-Line Visibility"). Until the early 1980s, up to 75% of the market value of a business was defined by the tangible assets that appeared on the balance sheet. Today, that number is less than 25%.

It's fascinating fodder for armchair economists, I know, but the impact on businesses is very real. If you can't explain where three-quarters of your business' value originates, someone is going to come along pretty soon and eat your lunch.

So what happened to business valuations? Jonathan Knowles, managing director of Brand Finance USA, favors a theory that focuses on the growing value of intangible assets. It makes sense when you stop to consider all the white noise you have heard about moving from an industrial to a service economy, and about becoming a knowledge worker.

BEYOND DESKS AND PCs.  If you're generating more of your profit from service and knowledge, how do you account for that value? Is an influential consulting firm with a strong reputation and a lot of loyal customers really only worth the value of its computer equipment, office furniture, and cash?

Knowles is quick to point out that not only do service companies see the growing importance of intangibles, but so do traditional manufacturers. All of the focus on quality initiatives like total quality management and Six Sigma over the past two decades, along with improvements in technology and materials, have turned product quality into a commodity.

Knowles uses the car industry as an example, where, ever since the Yugo took its last dying gasp, product quality has improved to the point where J.D. Powers commented in 1998, "There are no bad cars out there." So what's the basis of competition?

MORE OF THE SAME.  All cars aren't the same of course. There are sports cars, sedans, and SUVs. There are Toyotas and BMWs. There are entry price points and cars that cost more than a house. But look at the total market. There is an astounding array of choices, and the most popular models look strikingly the same. Can most people tell the difference between a Lexus 300RX and a Toyota Highlander? Between the Honda Civic and Ford Focus? There is a difference, of course, but you would need to spend a lot of time at car-buying guide Edmunds.com to figure it out.

Knowles sums it up this way in one of his articles on brand valuation: "More goods, all of higher quality, chasing limited customer dollars creates an environment in which the sources of value creation have moved increasingly from tangible assets (such as plants and machinery) to intangible ones (such as brands, patents, customer databases, and skilled workforce)."

There are lots of intangibles that have the potential to create value, including intellectual property, business processes, specialized training, skilled employees, customer intimacy, corporate culture, brand equity, and many others that don't show up on most balance sheets. Businesses and investors have to figure out how to identify the intangibles that contribute to the creation of value; how to measure them to understand the nature of the value they create; and how to improve their value to measurably grow the bottom line.

The prevalent belief that the growing pressure on marketing performance is all about accountability is dangerous for marketers. Accountability is a major concern, but simply embracing financial terms like "customer lifetime value" and "marketing return on investment" won't cut it. Businesses are under pressure not only to improve efficiency, but to model, measure, and maximize the intangibles that create real market value.

EVALUATING INTANGIBLES.  CFOs, COOs, and CEOs are already approaching this challenge from multiple fronts, which is reflected in trends like business intelligence and the balanced scorecard -- initiatives that hinge on mapping business processes directly to corporate strategy. Unfortunately, few marketers are sitting at the strategy table to represent marketing's value, because, quite honestly, few really get it.

Too many still think they're being unfairly maligned by linear thinkers who can't understand the power of good creativity. They still resist the push for metrics because they think it's about performance evaluation, and not about learning which intangibles rock the bottom line. The result is that strategy moves ahead, while marketing stays tied to a tree on the front lawn.

It would help if marketers learned more about finance. But they really need to develop an aggressive approach to modeling marketing intangibles in the areas of strategy, execution, and management. Knowles has some interesting ideas on this front, so we'll check in with him again next time.