The Marketing Book 5th Edition

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Managing the marketing mix 297


marketing enables suppliers and customers to
link their supply chains to make these econo-
mies (e.g. Anderson and Narus, 1996).
If investment requirements are reduced by
5 per cent – from 50 to 47.5 per cent of
incremental sales – this would raise the share-
holder value added from £5.6 million to £6.1
million. The effects on value creation of these 5
per cent changes can be summarized as
follows:


Shareholder
Value Added
(£ million)
5 per cent sales increase 5.6–34· 4
5 per cent price increase 32.7
5 per cent cost reduction 31.5
5 per cent cut in investment
requirements


6.1

Accelerating cash flows


The right marketing mix can accelerate cash
flows. This is important because money has a
time value: money today is worth more than
money tomorrow. If the cost of capital is 10 per
cent, £1 million in 5 years time is worth only
£621 000, and in 10 years, £1 million is only
worth £385 000. The faster acquisition of profit-
able market share and the consequent cash
flows are important means of adding share-
holder value.
Many marketing activities are geared to
accelerating cash flows, even though marketers
never conceptualize their strategies in these
financial terms. For example, there is sub-
stantial evidence that when consumers have
strong, positive attitudes to a brand they are
quicker to respond to new products appearing
under the brand umbrella. Again, marketers
have studied the product life cycle and the
characteristics of early adopters with the aim of
developing promotional strategies to accelerate
the launch and penetration of new products
(Robertson, 1993).
Table 11.1 can be used to explore the effect
of accelerating cash flow. For example, if year 3


sales were achieved in year 1, year 4 sales in
year 2, etc., shareholder value would increase
from £57.6 million to £58.4 million, even though
final year sales and profits are unchanged. This
extra £0.8 million is less than might be antici-
pated because, while profits are brought for-
ward increasing their present value, so is the
investment spending, increasing its real cost.
Nevertheless, this may underestimate the effect
of accelerated market penetration. Fast penetra-
tion can lead to first mover advantages. These
include higher prices, greater customer loyalty,
access to the best distribution channels and
network effects that enable the innovator to
become the specification standard. These feed
back into both higher sales and higher operat-
ing margins.

Reducing business risk


The third factor determining the value of the
business is the opportunity cost of capital used
to discount future cash flows. This discount
rate depends upon market interest rates plus
the special risks attached to the specific busi-
ness unit. The risk attached to a business is
determined by the volatility and vulnerability
of its cash flows compared to the market
average (Brearley and Myers, 1999). Investors
expect a higher return to justify investment in
risky businesses. Because investors discount
risky cash flows with a higher cost of capital,
their value is reduced.
Again, there is evidence that an important
function of marketing assets is to reduce the
risk attached to future cash flows. Strong
brands operate by building layers of value that
make them less vulnerable to competition. This
is a key reason why leading investors rate
companies with strong brand portfolios at a
premium in their industries (Buffet, 1994).
Reichheld (1996) and others have also demon-
strated the dramatic effects on the company’s
net present value of increasing customer loy-
alty. A major focus of marketing today is on
increasing loyalty; shareholder value analysis
provides a powerful mechanism for demon-
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