294 The Marketing Book
that is most likely to maximize the present
value of future cash flows available for
shareholders.
Justifying marketing budgets. When companies
are under pressure, marketing budgets are
usually the first to be cut (IPA, 2000; Doyle,
2001). Boards appear to believe that cuts in
marketing spend offer a ready means of
boosting short-term profits with limited
long-term risks. Marketing directors have
lacked the analytical tools for demonstrating
the dangers of such a view. Value-based analysis
allows marketing managers to demonstrate the
positive impact of marketing spending on the
company’s share price.
Valuing brands. The key difference between
today’s and yesterday’s businesses is that the
modern firm’s real value lies in its intangible
assets – its brands, the knowledge and skills of
its people, and its management – rather than
its tangible assets – the factories, buildings and
equipment that appear on the balance sheet. It
is these intangibles that provide the differential
advantage and which are difficult for
competitors to copy. In marketing, brands are
the central assets. Brand names like
Coca-Cola, Microsoft and IBM – cultivated by
consistent marketing investment – are the
foundations of strong share prices. Value-based
analysis provides the tools for valuing brands
and demonstrating marketing’s contribution.
Assessing acquisition opportunities. Acquisitions
have proved an appealing avenue for companies
seeking growth. They have certain advantages
over internal growth: they offer a faster way
into new markets; they can be cheaper than
costly battles for market share; some strategic
assets such as famous brand names and
patents simply cannot be achieved internally,
and an established business is typically less
risky than developing a new one from scratch.
Yet the evidence convincingly demonstrates
that most acquisitions fail to generate value for
the acquirer. They pay too much or fail to
achieve the cost and revenue synergies that
were anticipated. Again a value-based analysis
takes the guesswork out of acquisitions,
providing a clear framework for calculating
how much a prospect is worth and what needs
to be done to make the acquisition succeed.The marketing mix and shareholder value
Value-based management is of great impor-
tance to marketing because it clarifies the
central role of marketing in determining the
value of the business. The marketing mix is the
key driver of the share price. To understand this
we need to look at the determinants of share-
holder value. The value of the business and its
share price are determined by the discounted
sum of future cash flows (Equation 11.1).
Examining this equation, we see that there are
four ways of creating shareholder value.Increasing the level of cash flow
This is the most important way of creating
shareholder value. A business’ free cash flow is
cash in less cash out, or specifically in any year
i, cash flow is:CFi= Sales revenuei– Operating costsi- Taxi– Investmentsi (11.4)
This in turn means there are four ways of
increasing the level of cash flow.Increasing sales
Selling more will create shareholder value as
long as the increased sales are not offset by
disproportionate increases in costs, taxes or
investment. It can be shown (Rappaport, 1998,
pp. 51–55) that additional sales increase share-
holder value as long as the operating profit
margin exceeds a threshold margin:
Threshold margin =
Incremental investment×Cost of capital
(1 + Cost of capital) (1 – Tax rate)
(11.5)