Basic Marketing: A Global Managerial Approach

Perreault−McCarthy: Basic
Marketing: A
Global−Managerial
Approach, 14/e

20. Managing Marketing’s
    Link with Other Functional
    Areas

Text © The McGraw−Hill

Companies, 2002

Managing Marketing’s Link with Other Functional Areas 583

Rather than sell stock, some firms prefer debt financing—borrowing money based

on a promise to repay the loan, usually within a fixed time period and with a spe-

cific interest charge. This might involve a loan from a commercial bank or the use

of corporate bonds. People or institutions that loan the money typically do not get

an ownership share in the company, and they are usually even less willing to take

a risk than are investors who buy stock.

Most commercial banks are conservative. They usually won’t loan money to a

firm that doesn’t have some valuable asset to put up as a guarantee that the lender

will get its money. Investors who buy a firm’s bonds are also very concerned about

security—but they often don’t have a legal right to some specific assets if the firm

can’t repay the borrowed money when it’s due. In general, the greater the risk that

the lender takes on to provide the loan, the greater the interest rate charge will be.

The cost of borrowing money can be a real financial burden. Just as a firm’s sell-

ing price must cover all of the marketing expenses and the other costs of doing

business before profits begin to accumulate, it must also cover the interest charge

on borrowed money. The impact of interest charges on prices can be significant. For

example, the spread between the prices charged by fast-growing, efficient super-

market chains and individual grocery stores would be even greater if the chains

weren’t paying big interest charges on loans to fund new facilities.

While the cost of borrowing money can be high, it may still make sense if the

money is used to implement a marketing plan that earns an even greater return. In

that way, the firm leverages the borrowed money to make a profit. Even so, there

are often advantages if a firm can pay for its plans with internally generated capital.^2

A company with a successful marketing strategy

has its own internal source of funds—profits that

become cash in the bank!

For example, the building-supply company,

Home Depot, reported a profit of just over $600

million from running its businesses in 1994. The

company only paid out about 11 percent of that

money as dividends to its stockholders. The stock-

holders liked it that way because Home Depot used

the remaining half a billion dollars to open 126

new stores. And by financing stores in this fashion

its profits grew to about $940 million by the begin-

ning of 1997.^3

Reinvesting cash generated from operations is usually less expensive than bor-

rowing money because no interest expense is involved. So internal financing often

helps a firm earn more profit than a competitor that is operating on borrowed

money—even if the internally financed company is selling at a lower price.

Firms that can’t get a loan or that don’t want the expense of borrowed money often

start with a less costly strategy and a plan to expand it as quickly as is allowed by

earnings. Consider the case of Sorrell Ridge, a small company that wanted to com-

pete with the jams and jellies of big competitors like Welch’s and Smucker’s. Sorrell

Ridge started small with a strategy that focused on a better product—“spreadable fruit”

with no sugar added—that was targeted at health-conscious consumers. After paying

to update its production facilities, Sorrell Ridge didn’t have much working capital to

pay for promotion and other marketing expenses. So it turned to health-food whole-

salers and retailers to give the product a promotion push in the channel. As profits

from the health-food channel started to grow, Sorrell Ridge used some of the money

for local TV and print ads in big cities in the Northeast. The ads increased consumer

demand for Sorrell Ridge’s spreads and helped get shelf space from supermarkets in

Debt financing involves

an interest cost

Interest expense may

impact prices

Winning strategies

generate capital

Expanding profits may

support expanded plan