Competing for Customers and Capital

The Sundown Rule

The Wal-Mart website describes the story of a pharmacist who received a call on Sunday morning saying that one of his customers had dropped her insulin down the garbage disposal. He rushed to the store, opened the pharmacy, and filled the customer's prescription. The story says that this is just one of many ways a local Wal-Mart store might honor what is known as the Sundown Rule.

The website also says that this was Sam Walton’s translation of the proverb “never put off ‘til tomorrow what you can do today.” It's symbolic of the company’s dedication to customer service. Coupled with its policy of low prices, always, and its aggressive expansion from rural America to global operations, Wal-Mart became the darling of Wall Street and one of the most valuable companies in the world.

AMAZING VALUE
At the close of its 1st quarter in 2003 the price of Wal-Mart’s common stock was $56.32. With 4,380 million shares outstanding the company’s market value was $247.0 billion. This made it the second most valuable company traded on North American stock exchanges. GE was the leader with a market cap of $255 billion. By January 31, 2006 Wal*Mart's stock had fallen to $46.80 a share and its market cap was down 21% to $195 billion. Meanwhile, GE's market value jumped 44% to $367 billion. During these three years, two of Wal-Mart's competitors (K-Mart and Sears) merged.

MONEY DOWN THE DRAIN
You would think that one of the biggest, most valuable and efficient companies on the planet would come very close to maximizing earnings. You might think so, but you’d be wrong. Wal-Mart's actual earnings at the end of the second quarter of 2003 were $3.5 billion. Its theoretical maximum earnings were $4.8 billion. The shortfall in just this one quarter was $1.4 billion. Over the ten periods from the 4th quarter 2000 through the 2nd quarter 2003 the earnings shortfall totaled $10.7 billion. Money down the drain. Money that could have been used to pay dividends to shareholders. Maybe this is why the company's stock hasn't budged from that $46 price point while the Dow reached record heights. If you're curious about how to calculate maximum theoretical earnings from company financials, check out my narrated slide-show on The Rule of Maximum Earnings.

ACHILEES HEEL # 1
Wal-Mart has two Achilles heels. The first one everyone knows about: the company has been unable to adjust its merchandise mix to appeal to upscale shoppers. And it's not that the company didn't try. In fact they hired a high profile marketing wizard to do just that. Read Business Week's story of Julie Roehm's "Year at Wal-Mart." It's

a cautionary tale of what happens when a self-described change agent goes to work for a company that needs to reinvent itself but can't. In Wal-Mart's case, she says, the concept of "Everyday Low Prices" was so deeply embedded that the retailer's ambition of getting upscale shoppers to buy more was a nonstarter.

ACHILEES HEEL # 2
The second one is not well known. In fact it will come as a big surprise: Wal-Mart over spent on marketing! Not advertising and promotion, but Marketing with a big M. Read "Selling, General and Administrative" expenses. I call these enterprise marketing expenses because they include all the costs of employees. The people who influence what customers and investors think about a company.

SCALE EFFECTS IN MARKETING?
To put scale effects in perspective look at the sales revenues of these three direct competitors at the close of business in 2005. The sales revenues of Target and Costco were $52.6 and $52.9 billion respectively. Wal-Mart's sales were $313.3 billion, or almost six times greater. One of the things Wal-Mart is touted for is its scale efficiency. But Wal-Mart has no scale efficiencies in enterprise marketing.

LEVEL THE PLAYING FIELD
The best way to level the playing field is to calculate enterprise marketing expenses as a percent of gross profits -- over several years. Wal-Mart's cumulative gross profits from 2001 through 2005 were $316 billion. The company spent 72.7% or $230 billion of these profits on enterprise marketing. By comparison Target and Costco spent just 69.1% and 71.1% of their gross profits on enterprise marketing. Wal-Mart suffered from a 3.6 point competitive disadvantage compared with tiny Target and almost a 1.0 point disadvantage compared with Costco. This is particularly striking in the later case. Wal-Mart's gross profits as a percent of sales were almost double Costco's -- 24% vs. 13%!

IS THE SUN GOING DOWN?
Looks like the sun may be going down on Wal-Mart if management doesn't figure out a way to upgrade their merchandise mix. And at the same time, take their feet off the spending peddle! Want to know what costs are included in selling, general and administrative expenses? Check out my audio slide-show on Enterprise Marketing Expenses.

Thanks for visiting.

~V

Marketing Hell

TALK ABOUT A DEAL!

The predecessor of Coca-Cola Enterprises (ticker symbol CCE) made one of the greatest deals of all time. It happened in 1889 when two lawyers from Tennessee paid $1.00 for exclusive rights to bottle and market Coke. They then divided the country up into regions and sold the rights to other investors.

Over the years a vast network of independent bottlers developed. Two of the largest were the JTL company and the bottling division of the Beatrice Companies. In the fall of 1986 the Coca-Cola Company (ticker symbol KO) borrowed 2.4 billion to buy both bottlers. Then management immediately packaged their new assets for an IPO and sold a 51% interest to the public for 1.5 billion.

MARKETING HELL

For all its virtues the 1986 marriage of Coke and CEE was made in marketing hell. The battle between Pepsi and Coke for shelf space in supermarkets was punishing. And CEE was caught in the cross-fire.

Coke wants to be the best buy on the shelf because the lower its shelf price the more it sells. Of course, that means more syrup sales to its bottlers. CEE wants to maintain shelf price because that's the only way to keep its margins from shrinking. Who wins in this battle between shelf price and syrup volume?

TWO MARKETS

When marketing people talk about "the" market they're referring to the company's products. When finance people talk about "the" market they're talking about the company's common stock. This is a telling example of the fundamental disconnect between marketing and finance within the enterprise.

The markets for stocks and products are separate but equally important to the enterprise. And until marketing and financial managers begin to talk about how one market affects the other, they're missing half the information they need to make sound decisions. A close look at the cola wars will show you what I mean. Want to know the theory behind this analysls? Check out Y'all Buckle That Seat Belt. This Adobe Connect slide show runs 18 minutes.

COLA WARS

On the last trading day of 2005 CCE had a market capitalization of $9.1 billion. The company's sales revenues were $18.7 billion. On that same day in 2005 the Coca-Cola Company had a market cap of $95.5 billion. The company's sales were $23.1 billion. Pepsi (PEP) weighed into the fight with a market cap of $97.8 billion and sales of $32.6 billion. The market cap of all eight public companies engaged in the cola wars was 2005 was $207.6. The sales revenues of all eight companies added up to $79.8 billion.

SHARES IN TWO MARKETS

Now, we've got the data we need to take a first look at how the players in the cola wars are doing in both markets – we can easily calculate their share of market value and share of sales revenues. Comparing the results leads to surprising results.

CCE: 23% of sales and  4% of value --  a -19 point competitive disadvantage.

KO:   29% of sales and 46% of value -- a +17 point competitive advantage

PEP:  41% of sales and 47% of value -- a + 6 point competitive advantage.

A company's stock price is (approximately) based on investors' expectations about its long-run cash flow, discounted by its riskiness relative to the overall market and adjusted for competitive expectations. There's only one way CEE's market cap could be less than one-half of its revenues -- the main source of its cash flow -- while Coke's market cap was 4.1 times its revenues. Coke must be charging its bottlers monopoly prices for the syrup, thus squeezing their margins, earnings and cash flow while robbing shareholders of the forgone value.

ROBBING PETER TO PAY PAUL?

It looks like Coke's management is robbing Peter to pay Paul. Why would they do that? Well, Coke management probably would say that producing and distributing the drink is fundamentally less profitable than making the syrup. But it's more likely that in the trade off between shelf price and syrup volume, Paul has the upper hand. Coke has the power to exact a monopoly price premium from the bottling companies it owns as well as those it doesn't own.

Did it pay off? Sure looks like it did. Until you remember that Coke and its bottlers are married. And then you realize that this unhappy couple generates 52% of the sales revenues, but creates only 50% of the market cap! Combined, they have a -2 point competitive disadvantage, compared with Pepsi's +6 point competitive advantage!

This is just a small example of the dirty linens that surface when you examine the competition for customers and capital at the same time.

~V

The Origin of Brands

Once in a great while a new book comes along that stops you in your tracks. This is one of those books.

I read The Origin of Brands at the same time I was reading "Here Comes Trouble" in the February 2007 issue of Wired. The author says this is a story about the guys who "…Kazaa'd the music industry and Skyped the telcos. Now Janus Friis and Niklas Zennström want to Joost your TV. (That's a good thing.)"

Since "Skype … demonstrated P2P’s ability to stream data, in real time, on a global scale" it led Friis and Zennström directly to Joost. Friis says “We’ve taken the best things about television and added the best things from the Internet.” And it appears they've done just that, while sidestepping the copyright problems and preserving the 30 second spot!

I had just finished reading the Chapter 6 "Swiss Army Knife Thinking" and I thought: isn't Joost exactly what Laura and Al said would not happen? So I went back to read the chapter again and discovered the answer to my question was no! They said the convergence of the PC and TV in the form of interactive television had not happened in twenty-seven years after its founding. And Joost is not interactive TV.

The point is, you've got to be as careful in thinking and talking about convergence vs. divergence in marketing as Darwin was in biology. And even so, it's sometimes difficult to see the light. Especially if you're personally or professionally involved with a "new category" you just launched. And make no mistake, the authors show you how creating a new category by diverging from existing ones is where fortunes are to be made. Convergence (read clock radio) is where fortunes are lost. Remember the AOL/Time Warner merger?

Al and Laura Ries say "THE MOST DIFFICULT JOB IN MARKETING, and also the most rewarding, is creating a new category (Chapter 14, pages 227 through 255)."

If "…there is no definition of what the category is all about, there is no market, there are no distribution channels, and there are no competitors to benchmark … The first, and the most important question of all, is what's the name of the new category?"

At the risk of being pedantic I'm going to quote the nine main points I took away from reading "Creating a Category" in Chapter 14 (pages 227-255):

1. Simple names work best … marketing people are sometimes too literal. What matters most is not describing exactly what the benefits of a new category are, but expressing the essence of the new category in as simple a way as possible.

2. Marketing can be visualized as filling a hole in the mind.

3. Every product needs two names, not just one. A brand name and a category name.

4. People think generic first, brand second.

5. In the rush to build a new brand, the need to first build a new category often is overlooked.

6. When your brand doesn't stand for anything, you have to compensate by increasing your marketing expenditures!

7. Categories exist in the mind. You create categories in exactly the same way you create brands. By positioning the name of the category in the mind of prospects.

8. People THINK categories, but they TALK brands.

9. Categories are pigeonholes in the mind; brands are the names in those pigeon holes. The two names serve two different (and strategically important) purposes.

With an international business press totally committed to the Holy Grail of "convergence" you should read this important book. Not only is it a good read, it will open your eyes to the power of divergence in marketing. And this will stop you in your tracks.

These comments were taken from my replies to comments made this past week in the discussion forum on MarketingProfs.com Book Club. If you want to learn much more about this book check it out.

~V

Who's in Your Peer Group?

I have a friend, let's call him Sam, who manages a $250 million dollar portfolio for a small group of private investors. Sam is among the most successful managers in the business. On June 8, 2005, I called to ask him what stock he was trading:

He said: “The Home Depot.”

I asked: “What was the closing price?”

“Thirty-nine sixty seven.”

“How many shares were traded?”

“About seven million.”

“What was the low for the year?”

“Thirty two bucks.”

“What’s the company’s P/E ratio trailing twelve months?”

“Sixteen ninety two.”

Then I asked: “Who are Home Depot’s top three competitors?”

Sam said, “Lowe’s.”

“Who’s number two?”

“Just a minute while I look that up.”

A long silence, except for keyboard clicks.

“I’m not sure who that is. What do you think?”

Sometimes even the most astute financial managers forget that performance is relative. Unfortunately, identifying competitors is not as easy as you might think.

DIFFERENT VIEWS OF COMPETITION

Financial managers and marketing managers often have entirely different competitors in mind. CFOs may think first of companies with which they compete for capital. Since capital markets are global, the CEO of AT&T may include France Telecom in the list of competitors even though the French monopoly has few North American customers. AT&T and France Telecom only compete for capital today. Maybe they'll compete for customers tomorrow.

On the other hand, product markets tend to be bounded by geography and end use. The president of AT&T's North American Business Services (NABS) might list WorldCom, Sprint, BellSouth, and Qwest as top competitors. These companies share a large number of customers, but the NABS division is not a public company. It’s not traded on any stock exchange so we can’t assess the effectiveness of the NABS division in its competition for shareholder value. Perhaps in the future we can.

In either of these cases, the companies that managers think are their competitors will change from year-to-year, if not from quarter-to-quarter. Strategic groups are inherently dynamic collections of companies that compete simultaneously for customers and capital. The boundaries of a strategic group are fluid. Learn more by viewing my short audio slide show on Chapter 3 "Who's in My Strategic Group."

~V

Angels on a Pin

In my reply to John Dawson's insightful comments on "Eleven Cents Ain't Much," I said that:

In 1991 just 1/100^th of IBM's next market share point had an incremental cost of $15.6 million. The earnings from that market share basis point after SG&A expenses were $4.9 million. In other words, acquiring just 1/100^th of next revenue share point theoretically would have cost IBM $10.7 million in lost earnings after SG&A expenses.

How do I know this? "The Rule of Maximum Earnings." This rule is based on the most widely known (and seldom applied) principle of microeconomics.

Unless you studied in a seminary you almost certainly took a microeconomics course in college. You, like the great majority of "micro" students probably took the course only because you had to. If so you may have thought marginal cost and revenue curves were useful only in determining –- theoretically -- how many angels could dance on the head of a pin ... before one falls off! You may even have been among those who found micro mildly interesting. I confess I was one of the very few students in my class who loved it. This is all the more surprising because I was a fine art major.

MICROECONOMICS AND MARKETING

Microeconomics was the first course I took in my masters program. The way my prof made the marginal cost and revenue graphs dance across the blackboard was positively mesmerizing. Maybe it was just the steamy August heat in that LSU classroom without an AC. Or maybe it's because I was an art major that these graphs appeared to me to be more than just abstractions. They were abstractions with meaning! The intersection of these schedules identified the sweet spot in any measurable combination of costs and benefits. If I spent more at the margin then the benefits returned I was throwing money down the drain. If I spent less then marginal returns I was leaving money on the table. What an incredibly simple and powerful idea. One that even an art major could understand!

BUMPS IN THE ROAD

So why are marginal cost and revenue not part of the CMO's tool kit? There were three bumps in the road. The first bump was that marginal cost and revenue schedules are pure theory. Only in the last twenty years were methods developed to apply the theory to the real world of marketing.

The second bump? The methods were complicated. You couldn't apply the theory unless you were an econometrician working for a company in a highly regulated market -- like alcoholic beverages, pharmaceuticals, and tobacco -- or in closely measured markets like groceries, travel and entertainment -- because you didn't have the detailed data on competitors.

The third bump was the biggest. Even when you cleared the first two you ran up against a brick wall. You had no way to factor in the impact of competitive spending on your company's earnings. In other words, you couldn't calculate IBM's incremental cost and earnings per market share point.

If you're interested in finding out exactly how I ran the numbers for IBM (and Dell) check out my narrated Breeze presentation on Chapter 6 "The Battle for Your Desktop." And if you have questions, remember I'm just a comment away.

~V

Make an Elephant Dance

Suppose you’re the CMO of a public company and took my recommendation to get a user ID and password to one of its financial databases. Now that you have access, what do you want to know?

HOW TO MAKE AN ELEPHANT DANCE

In his book “Who Says Elephants Can’t Dance” Lou Gerstner reported that his CFO Jerry York found their competitors were spending just 31 cents while IBM was spending 42 cents to produce $1 of revenue. He concluded that when they multiplied that eleven cents (inefficiency) times total revenue of the company they had a $7 billion dollar problem.

ENTERPRISE MARKETING EFFICIENCY

The math is simple. IBM’s sales in 1992 were $64.523 billion. When you multiply $0.11 time these revenues you get $7.1 billion. That was IBM’s “$7 billion dollar problem.” How did Jerry York come up with those eleven cents? I don’t know for sure, but it just happens if you take the company’s selling, general and administrative (SG&A) expenses in 1992 ($23.048 billion) and divide them into sales revenues in that year you get $0.40. If you do the same thing in the same year for the sum of Hewlett-Packard, Dell and Compaq you get $0.29. The difference between IBM’s and these competitors’ cost per dollar of sales just happens to be eleven cents! That was IBM’s enterprise marketing (in)efficiency in 1992. For a review of these expenses see my 12 minute audio slide show Enterprise Marketing Expenses.

SIMPLE BUT POWERFUL

SG&A expense per dollar sales is simple to calculate. But it has powerful implications, since it is a direct measure of a company's enterprise marketing efficiency [EME]. For IBM in 1993 the implication was that Gerstner had to cut $7 billion dollars out of SG&A expenses. These expenses had been built up over the years to a level that IBM no longer could sustain in the face of explosive competition from old enemies and new kids on the block. As a result, IBM shed 35.7 market share points over the next seven years.

WHAT’S YOUR EME RATIO?

What are your company’s (and its top competitors’) enterprise marketing efficiency ratios? Don’t you think you should know the answer to this question? Well, you can find out the same way IBM did. Just pull those revenue and SG&A numbers up on your screen and do the math. How do you compare with the competition? You can bet your CFO will be interested in the answer to this question.

~V

Enterprise Marketing Management

Enterprise marketing management is a fundamentally different way of looking at your business. It is, literally, the management of all activities that influence how customers think, feel and behave toward the enterprise. Not just about individual brands, but also about the entire portfolio of brands owned by the enterprise. It requires:

… integration and accountability in action on relevant customers insights across key enterprise constituencies such as marketing, sales, service, manufacturing, finance, human resources (HR), information technology, and so forth, increase the profitability of the business (“Enterprise Marketing Management,” Dave Sutton and Tom Kline, page 7).

INTEGRATION

An important dimension of enterprise marketing management is “integration.” There are many opportunities for integration across the functions of your business that you’ve never thought of because we all were trained to operate in functional silos. Here’s a simple example of the near global failure to take advantage of integration in traditional financial and marketing management. Every public company has two significant proprietary enterprise marketing assets: the corporate brand and the stock market ticker symbol. Take the case of Southwest Airlines for example. Every investor who has bought the company’s stock knows its ticker symbol is LUV. But few consumers know this. Why? Because they’ve never bought the stock. It may be held in a mutual fund, but customers don’t know it. Picture this. Every day hundreds of Southwest 737’s take off with a cabin full of passengers laughing at the steward’s last joke while looking right at the company’s logo (with its heart in the middle of a winged insignia). If LUV were to appear in the middle of that heart it would do two things: make passengers aware of the stock’s brand name on Wall Street and suggest that it might be a good idea to buy a share or two. But LUV doesn’t appear in Southwest’s logo? Why? It’s just another example of the separation between traditional marketing and financial management.

ACCOUNTABILITY

Marketing can’t achieve real accountability until it’s plugged into corporate financial statements. These are the single most important documents in your company’s flow of information, both inside and outside the enterprise. You’ve got to look beyond the market segment P&L. How can marketing possibly plug into the corporate income and cash flow statements? Good question. A first step would be for everyone that wears a marketing hat to get a user ID and PW to the company’s financial databases like COMPUSTAT or EDGAR Online. You can’t be plugged in if you don’t have a key to the kingdom! The next step would be to get your hands on a copy of Sutton and Kline’s book. They have redefined the domain of marketing. Because of this one book the discipline will never be the same. Their new take on enterprise marketing finally will achieve the broad reach across organizations that has been so elusive until now. “Enterprise Marketing Management” does even more for Chief Marketing Officers. It gives them a road map into the boardroom, with step-by-step directions for reclaiming their rightful place at the table.

~V

Cook on Shareholder Value

Over the four week period from October 16 through November 13, 2006 Chris Kenton discussed Competing for Customers and Capital with me on his web log. All the dialog was carried out through blog postings and comments. The final question in the series was how marketing creates shareholder value. What follows is an edited transcript of that discussion.

CK: Today we're going to look at some new ways to understand how marketing creates shareholder value. But instead of looking at financial measures of stock performance like, say, price/earnings ratios, we’ll look at a company's performance within a competitive group and at how marketing impacts performance. I’ll begin with this question: Vic, what’s missing from the investor's tool kit in measuring the value of a company on the stock market and how does that relate to marketing?

VC: The answer to this question is pretty simple. What’s missing is the effects of product markets, competitors and people on a company’s stock price. The lion's share of the value creators in the investor's tool kit come from the balance sheet. Product markets interact systematically with stock markets in creating value. But we know surprisingly little about this interaction. Consider this fact. If you searched all the scholarly articles published in economics, business, and finance journals with the words "value" and "revenues" in the same paper how many would you find? Out of thousands of articles only forty use both these words in any combination. And only one refers to the “value/revenue ratio.” What's the point? Product market performance relative to stock market performance is missing from the investor's tool kit because it was missing from the literature they studied in business school. Investor’s also overlook the impact of competitors on stock price. And they have no rules for maximizing the contributions people make to the market value of their company. These are missing from the investor's tool kit.

CK: There's something profoundly ironic about the lack of metrics to track competitive performance in creating shareholder value. I mean, so much of corporate strategy is intensely focused on competition--in fact, many would argue too much focus on competitors, instead of customers, stifles innovation.

VC: Corporate strategy tracks competitors through the lens of Michael Porter's five forces model. Which means the strategy guys don't study the data from competitors' income statements and balance sheets like Porter recommended in his lesser known but important book -- "Cases in Competitive Strategy." Neither do investors. Without the help of a simple model to guide the way it's very difficult to figure out what to do with the data from these two basic financial statements.

CK: Twenty years ago, the difference between a company's value on the balance sheet and its value on the stock market wasn't nearly as great as it is today. Now, investors have to understand and explain the tremendous gap in a way that helps them pick winners.

VC: Yes, but where does this difference come from? Is it due to a relative expansion in market value? Or, is the size of the pie unchanged relative to the growth in the economy? The value to revenue (v/r) ratio is a good way to answer this question. Because the combined sales revenues of companies propel the economy and also because there is very little wiggle room in reporting sales revenues to the SEC. The answer is important, because if the pie is relatively unchanged, than the increased importance of intangible market value is far more significant than if the pie has gotten bigger.

CK: Do you happen to know how the ratio of market value to sales revenue has changed over the years?

VC: Yes, it varied a lot over the years between 1950 and 2005. I just finished a study on the v/r ratio. In the 1950s it was 0.95. In the decade of the 1960s the ratio was 1.29. In the 1970s and 1980s the v/r ratio was less than 1.0 (actually 0.57 and 0.58 respectively). Then in the go-go 1990s it rebounded to 1.28. In the first five years on this century it was 1.32. Over the entire fifty-five year period the value/revenue ratio stood at just over one (1.10). In relative terms, the pie is the same size. What does this mean? Two things. The first is obvious: market value is driven by sales revenues. By the way, this often is forgotten by everyone except sales VPs, CFOs, and CEOs. Second, the shift from tangible to intangible market values takes on much greater significance. Whether it was from 25% to 75% or 30% to 70% doesn't really matter all that much. What matters is this: relative to the size of the economy, intangible assets have become the driving force behind market cap.

CK: Along that same line it seems to me that there's a dark hole that needs to have a light shined in it: SG&A expenses in the income statement. It seems that just as investors haven't looked at competitive performance or product markets, they haven't compelled a better accounting for the expenses that make up Selling, General and Administrative expenditures.

VC: Those selling, general and administrative expenses will soon become the brightest light in the income statement. Because in manufacturing organizations, SG&A expenses account for the costs of most of the people who create a company's intangible market value.

CK: So, if I understand this correctly the relationship between what companies earn in revenue and how those companies are valued on the stock market hasn't changed. But intangibles have grown to greatly outweigh tangible assets in creating the value of those companies. As a kind of analogy, would that be similar to saying that a company today could drive the same revenue relative to market value, but have vastly fewer tangible assets? Instead of creating value primarily with machinery, equipment and inventories, more value is being created with people, processes, knowledge and other intangibles. Is that a valid analogy? If it is, than it sounds like you've quantified the shift to an information economy.

VC: Exactly. That's why selling, general and administrative (SG&A) expenses have become so important. This is the account that reports the cost of the people, processes, knowledge and other contributions to intangible market value. And it really doesn't matter if these contributions show up on the balance sheet. When a company maximizes the return on these expenses, its rewarded by investors with a higher market cap relative to competitors.

Editorial note: I want to thank Chris for asking these questions, because I would never have thought to ask them myslef. And also for teaching me the art of blogging!

~V

My Blinders

I got in on the ground floor of the positioning concept when in 1963 I became the second doctoral fellow at the Marketing Science Institute in Philadelphia. Shortly after my arrival at MSI Paul Green began to work with Joe Kruskal at Bell Labs to translate his multidimensional scaling method into what would become one of the most powerful marketing technologies in the world. As a point of reference see “Nonmetric Multidimensional Scaling: A Numerical Method,” Joseph B. Kruskal, Psychometrika, 29:2 (June 1964), pp. 115-129.

THE BATTLE FOR YOUR MIND

Since MSI was then a small organization I often found myself in a conference room with Paul and his colleagues as they hammered out their first applications of this new psychological scaling technology to marketing. What began as a break-through scientific paper in Psychometrika took the marketing world by storm with the publication in 1982 of Positioning: The Battle for your Mind by Al Ries and Jack Trout.

Beginning in 1982 I worked for ten years as a consultant to the board of a European computer manufacturer. Our mission was to get marketing and sales to work together to challenge IBM. I put nearly 2,000 middle and senior managers around the world through several two-and-one-half day programs, including four with the board of directors.

You can get a sense of what we were up against if you view my audio slide show on the The Rule of Maximum Earnings. That European engagement was at once a huge corporate success and professional disappointment. It was a huge corporate success because we changed the way marketing and sales worked together. This change was in some degree responsible for turning the company around. It was a professional disappointment because the finance director really never believed my numbers. Why? I wasn’t able to link profits (and losses) in market segments to the company's financial statements and stock price.

IS MAXIMIZING PROFITS ENOUGH?

If you maximize profits at the segment level (in that consulting engagement we worked with hundreds of market segments in about eighty countries around the world), then you maximize the company's earnings. Right? Maybe so. But the question remained, how did that affect stock price? In 1986 I resolved to find an answer to this question. At the time the only thing I knew for sure was this: I had to understand stock valuation models and the financial accounting data on which they relied. The problem was I was trained in marketing and microeconomics. I didn't really understand finance or accounting. These were my blinders. If you're a CMO these may be your blinders too.

PENETRATING THE MIST

You don't need to have an accounting degree, but it’s probably an advantage if you do. In either event, it takes is an open mind, dedication and hard work. And it's critical that you penetrate the mist of financial accounting because for the first time you have a doorway into a financial system of measurements that allows you to demonstrate the value-creating capability of enterprise marketing in terms that a CEO (or CFO) will appreciate. Stay tuned. The price of value is some where down the line.

FULL DISCLOSURE

I neither own positions in nor trade any of the financial instruments mentioned in this web log. Findings and opinions expressed in my articles must not be taken as either a recommendation to buy, sell or hold a stock, or a reliable forecast of a company's future performance.

~V

The Value of Clouds

A lot of folks think we need more transparancy in our capital markets. I have a friend who hates transparency. He prefers to deal in thin/opaque markets. Those where he can leverage uncertainty. It's a very risky way to invest. For us mere mortals the transparency provided by (more or less) efficient stock markets is a good thing. Because these markets are jam-packed with information.

"Financial price data provide a viewing window into the firm through the market's evaluation of the securities issued by the firm and the changes in these values over time. Accounting data, on the other hand, provide information on the resources used by the firms. Thus, comparing accounting data and financial valuation data offers the opportunity to examine performance, the difference between inputs, on the one hand, and output, on the other (Eric B. Lindenberg and Stephen A. Ross, "Tobin's "q" Ratio and Industrial Organization," The Journal of Business, Vol. 54, No. 1, (Jan 1981, pp 1-32)."

CLOUDS IN THE SKY

Accounting data also are jam-packed with information. But there are some things these data can't tell you. To continue with the metaphor I introduced in my narrated power point presentation on Chapter 1 "A Bridge to Tomorrow,” accounting data can't tell you the value of "clouds in the sky" because there's no way to hold legal title to them. And "assets" are things to which you hold legal title, otherwise you can't buy and sell them.

THICK MARKETS

To find out the market value of tangible assets traded in a "thick" market, like gold or common stocks, all you need to do is look up their price online. The market value of a common stock is it's closing price times the number of shares outstanding. Calculating the market value of a public company is the first step in estimating its intangible market value.

TRICKY "IN BETWEEN" ASSETS

Two other two general categories of assets (plant/equipment and inventories) are less liquid, but they have accounting values: depreciated book value and replacement cost. The depreciated book value of technologically outdated assets may be a poor measure of their replacement cost. Estimating the replacement cost of such an asset is tricky because of the need to impute the value of improved technology. If you want to dig into the details of how to do this, check out the Lindenberg and Ross paper I cited above. For relatively new assets, like digital images, it's reasonable to assume depreciated book value is a fair estimate of their market value. This also is true for old assets with a very long life, like oil refineries. In either of these cases, the second step in estimating the market value of intangibles is to look up the net book value of tangible and intangible assets on a companies balance sheet.

OIL vs. IMAGES REVISITED

Which brings me back around to the OIL vs. IMAGES story I posted last time. For those of you just joining me, that story was about Getty Oil and Getty Images. The biggest deal in US history up to July 11, 1984 closed when the Federal Trade Commission approved by a vote of 4-to-1 the purchase of Getty Oil by Texaco for $10.1 billion. On December 31, 1983 the closing price of a single share of Getty Oil common stock (ticker GET.1) was $98.125. The number of shares outstanding on that date was 79,135. This made the total market value of the company $7,765.1 million. In its final SEC filing Getty Oil declared the book value of intangibles was $0.00.

MARKET & ACCOUNTING DATA

The total market value of a company (v) equals the value of its tangible assets (v1) plus the value of its intangible assets (v2). Now with a little arithmetic we can combine these accounting and financial market data to estimate what Getty Oil was worth just before the merger. Here's the equation: v = v1 + v2:

$10,385.1 = $10,385.1 + $0.00. Texaco paid $10,100 million for Getty.

THE VALUE OF CLOUDS

The intangible market value of Getty Images can be estimated using a combination of accounting data and total market value. In case you missed the first story, Mark Getty is the founder and CEO. But while his grandfather's oil company was very 19th century, Getty Images is sooooooo 21st century. The common stock of Getty Images closed at $89.27 on December 31, 2005. With 62,295 common shares outstanding the market value of the company was $5,558.4 million.

The Getty Image balance sheet reported the book value of total assets as $1,663.1 million. The book value of intangibles was reported on the balance sheet as $885.1 million. Subtracting the one from the other we estimate the book value of tangible assets was $808.1 million. Rearranging the terms and combining the accounting data with the financial market data we can estimate the intangible market value of Getty Images:

v2 = v – v1 $4,750.3 = $5,558.4 - $808.1

Notice, the book value of intangibles under-estimated the market value of those assets by 83%. That's because accountants can't agree how (or even if) these intangibles should be reported on the balance sheet. So, now you know how to calculate the value of "clouds in the sky." But remember my cautionary note about the assumption that the book value of tangible assets is a reasonable estimate of their replacement cost. When you apply this logic to your own company, ask accounting for their estimate of the replacement cost of tangible assets (they have one) and compare that with reported book value.

WHAT’S THIS GOT TO DO WITH MARKETING?

Why all this fuss over market and accounting data? Because if you don't know how much intangible market value your business is creating, you can't possibly figure out how much of that value is due to enterprise marketing. And you can’ find that out in the company’s financial statement because intangible book value underestimates intangible market value. On average by about 63%! When you figure out your company’s intangible market value, the next step is to begin pinning down how it’s created and what it costs … the price of value. Stay tuned.

~V