Marketing ROI

McCombs researchers from marketing and finance weigh in on whether marketing pays its way.

by Sandie Taylor

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Speaking Their Language

Even though many CEOs are already confident that marketing provides undefined benefits, Marketing Professor Leigh McAlister believes it’s incumbent on marketers to put their worth in financial terms the CFOs value. “Until we demonstrate the effect using their models, they won’t be convinced,” she says.
 
She and her McCombs colleagues, Associate Professor of Marketing Raji Srinivasan and Ph.D. student MinChung Kim, use methodology already accepted in the accounting and finance fields to link marketing expenditures to increased firm value.
 
In their paper, “Advertising, Research and Development, and Systematic Risk of the Firm,” which was published in the January 2007 issue of the Journal of Marketing and became a finalist for the journal’s prestigious H. Paul Root Award, the researchers examined how “intangibles” like brand equity help protect companies from systematic risk.
 
“Marketing insulates a firm from market downturns by building customer equity,” McAlister says. “But none
of the current variables used to predict systematic risk have anything to do with marketing.”
 
McAlister and her colleagues used all the standard accounting variables accepted by accounting researchers but added advertising and research and development (R&D) expenditures—the only marketing-related costs in publicly available financial reports—to the equation. After surveying the financial statements and stock returns of 644 firms from 1979 to 2001, the researchers discovered companies that spent more on marketing had lower systematic risk and, therefore, greater firm value.
 
“It seems as if the financial community ignores marketing,” McAlister says. “Accountants don’t include marketing in models of firm value. Analysts don’t pay attention to marketing when forecasting firm value. This despite the fact that capital markets do respond to marketing signals.”
 
If analysts would account for marketing, their earnings forecasts would improve, she adds. McAlister and Kim are continuing this line of research. In a new paper, they show that increased advertising effectiveness results in a higher firm value, yet analysts do not capture this marketing-driven change in firm value. They demonstrated this phenomenon by developing an accounting-based signal for advertising effectiveness (growth in sales minus growth in advertising) and include it along with other, similarly structured accounting signals to predict a firm’s stock price.
 
Ultimately, the paper proves that financial analysts under-react to the effectiveness of advertising in bolstering a firm’s stock price—despite its potential for creating intangibles like brand equity.
 
“Analysts know these intangible assets exist,” McAlister says. “In fact, it is often the case that a firm’s market value is higher than its book value. Analysts are just skeptical that marketing has anything to do with creating those intangible assets.”

An Outsider’s Perspective

Ramesh Rao, a professor in the McCombs Finance Department, and his co-author Neeraj Bharadwaj have a different way of looking at the situation. In their paper, “Marketing Initiatives, Expected Cash Flows, and Shareholders’ Wealth,” which was also published in the January 2008 issue of the Journal of Marketing, they create a theoretical framework for showing the value of marketing.
 
“You have to go beyond brand equity and find tangible outcomes,” Rao says. He explains that marketers don’t have a consensus definition of “customer equity” and “brand equity.” If they want to argue these concepts are important, he notes, they must articulate a mechanism by which they can add value.
 
“Otherwise it’s all stories,” he says. “For example, marketers claim that customer equity and brand equity create ‘marketing assets’ and lower the firm’s working capital, but they have provided virtually no justification for this claim. Marketing is more important than marketers say it is, but not for the reasons they give us.”
 
In the paper, he identifies two ways marketing can add value to shareholders—by affecting the stock price and by lowering the firm’s working capital needs.
 
Rao explains that by using marketing strategy, it is possible to affect the probability distribution of a firm’s sales revenues, which then affects the firm’s cash flows and, hence, shareholders’ wealth. In addition, he shows that marketing can lower the amount of working capital the firm will hold, which, he argues, can increase the firm’s productivity or operating efficiency.
 
“It’s not enough just to create value, you have to do it efficiently,” he says. “You have to be lean and mean in this hyper-competitive global environment. Marketing can actually increase the firm’s ability to survive.”
 
But spending more on marketing is not always the right answer, he cautions. Marketers gain credibility if they acknowledge there is a tradeoff—the benefits of marketing must exceed the cost of the marketing efforts, he says. Evaluating the nature of this tradeoff requires an analytical framework, which his paper provides.
 
All of these McCombs scholars are planning further research into the questions raised by their studies. Rao and McAlister are considering partnering on a study, and Rao and Bharadwaj have already begun follow-up research. Mahajan and Pravin are returning to the issue of the CMO’s influence and how this role has affected the decision- making process in top management over time.
 
As the search for answers carries on, McCombs researchers will continue to be at the forefront of these issues.
 
If you have a perspective to share on this topic, we invite your comments, some of which may be published in subsequent issues of Exchange magazine. Send them to Publications@mccombs.utexas.edu.

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