Competing for Customers and Capital

Intangible Value Drivers

In my last post on "Oil vs. Images" I speculated that the intangible market value of a company was driven by three forces: brand names, technology, and service. And design plays an important role in all three of these areas. In this entry I want to add some evidence to support the role of brand names, technology and service in creating intangible market value.

THE METHOD

Total market value (v) is equal to tangible market value (v1) and intangible market value (v2). To make this simple, let’s assume the depreciated book value of a company’s tangible assets is approximately equal to their market value. If that’s true we can estimate the intangible market value of the company by subtraction: v2 = v – v1.

In order to control for shifting market forces, I ran these numbers on the financial accounting statements of the fifty companies with the highest intangible market value in both 1966 and 2003. Twelve of these companies reported the data in both years. And all of them had an intangible market value greater than 50%.

BRAND DRIVEN INTANGIBLE VALUE

The intangible market value of five of these twelve companies appears to me to be brand driven. And their intangible value as a percent of total market value is relatively stable of the thirty-seven years. Coca-Cola (1966 v2 = 76%; 2003 v2 = 81%); Gillette (80%, 77%); Procter & Gamble (57%, 77%); Johnson & Johnson (68%, 76%); PepsiCo (52%, 75%).

TECHNOLOGY DRIVEN INTANGIBLE VALUE

The intangible value of seven of these companies appears to me to be technology driven: Pfizer (1966 v2 = 59%, 2003 v2 = 78%); 3M (77%, 78%); Eli Lilly (77%; 73%); Texas Instruments (65%, 71%); Merck (85%, 62%); Bristol-Meyers Squibb (85%, 62%); IBM (77%, 38%).

A COMBINATION OF THREE DRIVERS?

Fifteen companies of the top fifty companies in 2003 weren't even on the radar screen in 1966. These companies were (along with an estimate of their 2003 intangible market value): eBay (91%); Amazon (90%); Genentech (86%); Yahoo (86%); SAP (86%); Amgen (85%); Cisco Systems (81%); Qualcomm (80%); Sysco Corp (76%); Microsoft (74%); Clear Channel Communications (72%); Nokia (63%); Wal-Mart (58%); Home Depot (58%); and Nextel Communications (57%). I'll leave it to you to decide whether the intangible market value of these companies is driven by brands, technology, or service … or some combination of all three.

WHAT’S IT MEAN?

What do these results mean to managers and investors? In my view the market value of leading companies across a broad spectrum of industries is driven by the intangible forces of brand names, technology, and service. Just as clouds in the sky drive the weather. And accountants can't agree on how to (or even if) these can be reported in the balance sheet. So, we've got to figure out what inputs drive intangible value and how they affect total market value. More on this in future posts. 

~V

OIL vs. IMAGES

When I put together the audio slide show for "A Bridge to Tomorrow" I went looking for high resolution images to dramatize the concepts in Chapter 1 of my book. I couldn't find any good ones in the usual places. By accident I found Getty Images. Two things were immediately clear to me. First, this site wasn't designed for someone accustomed to paying five bucks for stock images on the Internet. Prices stared at $55 and went up quickly from there. Second, the selection and quality of images, both still and moving, was extraordinary. I ended up buying four of the $55 images for that presentation.

Then, while running the numbers on the ratio of a company's market value to its sales revenue (its "v/r ratio") to compare it with the company's intangible value I noticed that Getty Oil was an outlier in the early 1950s with a v/r ratio of 17.2 in 1956. In other words, the company created $17.20 in market value for every $1.00 in sales revenue. That was more than twelve standard deviations away from the average of all companies in that year. The 782 companies reported in Standard & Poor's COMPUSTAT files in 1956 had a combined market value of $207 million and combined revenues of $206 million, putting the market's v/r ratio at 0.99.

So I ran the numbers on Getty oil over three decades. In every year between 1950 and 1983 the company reported the value of intangibles on its balance sheet (item 33 in the annual COMPUSTAT data) was $0.00. In all but six of those thirty-four years, the depreciated value of its tangible assets was greater than its market value. This I thought was a company ripe for takeover. Sure enough the following story appeared in the New York Times on January 8, 1984:

"Texaco Inc. and the Getty Oil Company are tentatively prepared to close the largest merger in American history, but a judge is delaying the estimated $10 billion agreement so that heirs of the oilman J. Paul Getty can study it."

Then I wondered, is there any connection between Getty Oil (ticker symbol GET.1) and Getty Images? So I went to Yahoo Finance and looked up the company (ticker symbol GYI). Sure enough Getty Images was founded in 1993 by Getty's grandson Mark. It went public in 1995 and complete financial data became available in 1996.

At the close of business on December 31, 2005 Getty Images had a market value of $5,558 million. The intangible market value of the company was $4,750 million, or 85% of total value. Its value/revenue ratio was 7.6. Or the company created $7.60 in shareholder value for every $1.00 in sales.

To me the comparison over five decades of an oil company with an image company in the same family captures beautifully the choices managers and investors must make in placing a value on tangible vs. intangible assets … oil vs. images. This in turn goes to the heart of the reasons I think drive these choices. I think they boil down to three forces: brands, technology, and services. And design plays an important role in all three of areas.

~V

The Greatest Asset

Take a look at this eye-opening video by Microsoft called "The Greatest Asset." This video is short and compelling. Quiet but passionate. Emotional too. Kind of a high-tech-take-off on Ebenezer Scrooge in the 21^st century.

What's this got to do with my book? It dramatizes two of the main messages in my chapter on Enterprise Marketing Expenses. First, people create a company's intangible market value. Second, if only implied by the characters the CEO talks with, the costs of people in a manufacturing business are reported in financial accounting documents as Selling, General and Administrative expenses.

The CMO Challenge

There are two kinds of market value – tangible value and intangible value. What do we know about how these values are created? Most of the value creators in finance are based on tangible assets.  The following story tells how business students today are taught about market value:

Linda Tan, a recent MBA graduate and financial news reporter, was given an assignment to analyze the financial performance of various Asian and American companies. It was her job to present her findings in a front-page feature on "identifying value creators." To assess which company created or destroyed value for investors, Linda would make use of several financial criteria.

In this case Linda compared a number of public Asian and American companies on the basis of sixteen value creators including sales revenue, net income, earnings per share, return on capital, return on assets, market value of equity, share price, price earnings ratio, beta, and debt to equity ratio.  Notice that the lion's share of these value creators is found on a company's balance sheet.  Sales revenue was the only marketing measure included in the list.  The only conclusion you can reach is that customers’ brand experiences and market share, for example, are not among the value creators.

OUT OF THE ACTION

So why should this matter to CMOs?  Because this is precisely where you get cut out of the action. You know what "ROI" matters the most to your CFO? It's total return to shareholders. This return is based on two factors: price appreciation (or, God forbid, depreciation) and dividends.

What's the threshold return to shareholders? As a rule of thumb it's about 20% per year. Less than that and your company is under-performing.  More than that and you're doing a great job. But there are well know upper bounds.  Beyond an ROI of 60% or 70% your CFO will think one of three things: you've made an error in your calculations; or you're doing something illegal; or you don't know what you're doing. The other possibility is you were working for a private equity firm in 2006! So, when a CMO circulates an internal report that shows an ROI of, say 300%, on a multi-million dollar ad campaign, other senior managers who read that report roll their eyeballs and throw it into the round file. Then they try to find a new candidate for the CMOs position that knows what he or she is talking about. This is one of the reasons why the tenure of CMOs is notoriously short.

THE $64 BILLION QUESTION

So what's a CMO to do? You have no control over dividend payouts.  That's the domain of the CFO and his or her boss. So the $64 billion question is this: how can you show the impact of marketing on the price of your company's common stock? This is the CMO challenge.

You might try to do this the Willy Lowman way by schmoozing your most important customer – the CFO.  I don't recommend this approach, unless you have something substantive to offer. And that something has got to be more than explaining the importance of customer loyalty, retention rate, and brand awareness on accounting profits.

MARKETING AND STOCK PRICE

You've got to go the next step and show the link between marketing and stock price. And to do that you must broaden your horizons. In two ways.  First, learn to speak the language of financial accounting and use these data to make your case on the impact of "marketing" on stock price. Second, embrace the concept of "enterprise marketing" and sell it to your peers and superiors. For a quick walk through new ideas that can empower all CMOs click on this link to my narrated Breeze presentation on "Enterprise Marketing Expenses." Sounds pretty dry I know, but it could help you double your compensation and it runs only 14 minutes.

COMPETITIVE ACCOUNTING DATA

The framework is simple in concept. I call it the "three parts of a dollar." The finance department in your company probably subscribes to one or more syndicated financial accounting database services. More than likely one of these is Capital IQ's Compustat.  The finance department may also subscribe to one of the competitors the EDGARonline Pro "I-Metrix suite.

These syndicated services provide flexible and friendly access to the filings submitted to the U.S. Securities and Exchange Commission by your company and its competitors, if they are publicly traded on North American stock exchanges.  All domestic and many foreign companies file these reports with the SEC. The two reports of most importance to you as the CMO are the Income Statement and the Balance Sheet.

The income statements reported in COMPUSTAT and EDGARonline standardize the line items into three parts. I use the following short hand to account for each part: r = o + s + a.  Where "r" is company revenue; "o" is cost of goods sold; "s" is selling, general and administrative expense; and "a" is earnings before interest, taxes, depreciation and amortization.  It's useful to give these three parts of the revenue dollar a functional name: the domains of executive action.

DOMAINS OF EXECUTIVE ACTION

Here's how these domains shake out. The cost of goods sold is the domain of operations management.  Selling, general and administrative expenses is the domain of enterprise marketing.  Earnings are the domain of corporate finance. Marketing is second in the line of command, but last in the heats and minds of board members. The CMO challenge is to change that by learning the principles of enterprise marketing.

The soul of enterprise marketing is a cross-functional perspective where “every member of your sales force, every customer service rep, every email, every invoice, every voice mail, every interaction with every customer at any time (Enterprise Marketing Management) is a part of the practice of enterprise marketing.  In manufacturing industries, selling, general and administrative (SG&A) expenses capture the costs of all these events and interactions.  These are the costs of enterprise marketing resources.   Looking at these expenses as a whole breaks down the silos and opens the analysis to how the company should operate if management's objective is to maximize long-run earnings.

COMPETITIVE STOCK VALUATION

Each of these expenses affects the way customers and investors feel, think, and act toward your company. Conceptually, the management of these resources is the domain of enterprise marketing. The job of a chief (enterprise) marketing officer is to lead all of the functional departments to maximize earnings after deducting the cost of these enterprise marketing resources. If you want to jump right into the future take a look at this narrated Breeze presentation on how the CMO can demonstrate the impact of enterprise marketing expenses on stock price. It summarizes the chapter on "Competitive Stock Valuation." This one runs just 14 minutes.

All this is a big challenge. It means partnering with the VPs of research and development, sales, human resources, and marketing as well as mastering the financial accounting data. Finally, armed with their support and this knowledge, you really can get the attention of your CFO and CEO.

About My Book

THE GENESIS

The genesis of this book dates to 1964 when I was a doctoral fellow at the Marketing Science Institute, then located in Philadelphia . At that time Wroe Alderson was a member of the marketing faculty at the Wharton School and MSI's offices were just across the street from the old Dietrich Hall. Alderson's contributions to marketing knowledge are summarized in this Brief History of the Wharton Marketing Department.

FOUNDATIONS

As a young doctoral student I was in awe of Professor Alderson. Physically he was a large man. Intellectually, he was bigger than life. I often overheard long conversations with his students in the cubical next door to mine on the second floor of MSI's offices. Those conversations motivated me to study his now classic book Marketing Behavior and Executive Action. In that book he developed the concept of "differential advantage." To me it was one of the most compelling concepts I had ever encountered. Before and after that experience there were many others that were influential in the development of this book. A brief review of these is available on my Listmania.

These accumulated experiences converged 1983 when I published a paper on "Marketing Strategy and Differential Advantage" in the Journal of Marketing. In this paper I operationalized Alderson's concept of differential advantage and defined the strategic marketing cost function. In their rebuttals, five marketing scholars attacked these ideas with unusual ferocity. The last time I read my response to these attacks published in the Journal of Marketing in my 1985 paper on "Understanding Marketing Strategy and Differential Advantage" was when I decided not to include it in the 1989 second edition of Readings in Marketing Strategy co-authored with Jean-Claude Larreche and Edward C. Strong. I excluded my response because it summarized a controversy I thought was settled. However, I should have cited it because this paper answers questions that you might ask about one of the key constructs in my book: the enterprise marketing cost function. If you're interested in reading a paper that was another foundation of my book, here is a link to "The Net Present Value of Market Share" also published in 1985 in the Journal of Marketing.

CONVERGENCE

Since these papers appeared I've spent a lot of time and effort applying the principles to the financial accounting data. I was motivated to do this by two things. First, if I tested my theories with audited financial accounting data they could not be dismissed so easily by those who simply didn't like them. Second, I believed the future of marketing strategy and corporate finance rested on their convergence.

My book is the culmination of these efforts. The data are available online to academics and students at over 150 universities world-wide through the Wharton Research Data Services (WRDS).  Alternatively, professionals can access the same data through Standard & Poor's Research Insight or use the EDGARonline Professional I-Metrix suite if their company subscribes to either of these interactive online services. All my applications (from Amazon to Toyota, from eBay to Whole Foods Markets) are based on the audited financial statements of public companies reported to the U.S. Securities and Exchange Commission. This means they all may be replicated.

A PAGE TURNER?

What's a one-line description of the book?  It would be something like "microeconomics applied to the financial accounting data of public companies to measure the quality of earnings and the riskiness of enterprise marketing opportunities."  One of my students at Tulane last semester called it a real page turner … compared with his other textbooks!