THE ROLE OF POWERFUL BRANDS IN CREATING SHAREHOLDER VALUE


Professor-Malcolm-McDonaldThe most common financial objective of modern commercial corporations is the sustainable creation of shareholder value (SVA). This can be achieved only by providing shareholders with a total return from capital growth and dividend yield that exceeds their risk-adjusted required rate of return for this particular investment.

The failure of the marketing community to get to grips with shareholder value is the real reason so few companies have a marketing person on their board.

In today’s highly competitive environment, the major sources of shareholder value creation are the intangible marketing assets of the business, such as brands, customer relationships and channels of distribution, the 80 per cent of the company’s value that does not appear on the traditional balance sheet. Consequently, the critical future marketing strategies of a company, which indicate how these assets are to be developed, maintained and exploited, should be subjected to a rigorous review process. Unfortunately, although most companies conduct rigorous financial due diligence analysis on major acquisitions and strategic investments, the one major area that has most commonly been excluded from this approach has been the marketing strategy of the business. This article briefly describes how the marketing community should address this major deficiency.

The risk and return relationship

In Figure 1, a minimum positive required rate of return is shown where the risk/return line cuts the vertical axis. This minimum required rate of return carries a zero-risk perception, which means guaranteed, certain future returns.

Figure 1 Risk-adjusted required rate of return

Logically, therefore, a normal, rational, risk-averse investor requires an increase in the expected future return from any more risky investment in order to compensate for any potential volatility. Shareholder value is created only when total returns are greater than the risk-adjusted required rate of return.

A process of Marketing Due Diligence (MDD)

As the common term for assessing financial risk is Financial Due Diligence, a useful term for this marketing risk-assessment process is Marketing Due Diligence (MDD) which subjects any proposed marketing strategy to a structured, sequential process

Required rate of return

that will indicate the probability of such a marketing strategy leading to increased shareholder value. The whole basis of shareholder value is the direct linking of the level of risk to the level of financial return that is required.Looked at through the lens of business risk, as investors do, a strong strategy reduces the risk associated with a promised return, so managing risk is as important as managing returns.

In essence, and at the highest level of detail, all business plans say the same thing. They make three basic assertions, which can be summed up as:

1. The market is this big.

2. We’re going to take this share of the market.

3. That share will make this much profit.

Each of these assertions carries a level of risk that it may be wrong. Each of the three assertions may fall short of its promise. A summary of the probabilistic risk-assessment process used is given below. As simplistic as it appears, this structure captures all of the hundreds of possible reasons a business plan can fail to deliver its promises. Fickle customers, aggressive competition and flawed forecasts are all addressed within the three components of business risk.

 

Turning MDD into a financial value

This probabilistic diagnostic process, therefore, should result in a risk- adjusted set of forecast sales revenues and net free cash flows from the proposed marketing strategy. We now need to assess these adjusted expected cash flows as to whether they are shareholder value-enhancing. This is done by putting them into the context of the capital employed in implementing the marketing strategy and the resulting required rate of return on this capital employed.
Not surprisingly, the capital employed that we use for this computation is the genuine capital that is required in the business in order to implement this marketing strategy. In other words, it includes the value of the relevant intangible assets owned and used by the business and is not limited to the historically based, tangible asset-oriented balance sheets published by most companies.

The role of powerful brands Brands are a major component of intangible assets.

One of the most well known acquisitions was Gillette by P and G. They paid £31 billion for Gillette, but got only £4billion of tangible assets, meaning that they paid £27 billion for intangible assets, a big chunk of which was for the brands.

The importance of brands can be illustrated by reference to famous brands, such as Shell. Looking at stakeholder perceptions: customers pay a premium price and pay more; suppliers give lower prices, better terms and are more willing to partner; employees are better qualified and are retained longer; shareholders get a higher PE ratio, lower volatility, lower borrowing costs; etc.

A successful brand provides superior experience at every touch point between a company and its customers and it is this that creates super profits (another expression for SVA)

In conclusion, it can be stated that everything an organisation does and stands for – from R and D through to after sales service – converges on the proposition – the strategic plan – that is projected to the customer via the corporate or product brand name.

It is for this reason that more organisations are beginning to understand the need to value intangible assets in the context of shareholder value added.

The responsibility of Boards is still focused on reporting future financial prospects, so it is critical that strategic decisions are based on accurate and rigorously risk-assessed information. MDD is based on many years of research in which business successes and failures were examined. As with looking at the black boxes of many crashed aircraft, this allows us first to group the reasons for failure and then to suggest ways to avoid it. In that sense, MDD can be considered as analogous to pre-flight checks, with the same implications for the reliability and success of the business plan.MDD has many important implications for the marketing community and of course for the board and for shareholders. It is also how CEOs can hold their marketing directors to account and ensure that their marketing strategies do deliver shareholder value.

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