Justifying Marketing System Investments
David M. Raab
DM Review
June 2007
Marketers often find it difficult to
justify investment in new technologies. This
is partly because many new marketing systems are intended to improve how the
company interacts with its customers.
Since how customers will respond is rarely known in advance, any
financial analysis is inherently uncertain.
But there’s another reason
marketers’ value estimates are so often questioned. Quite simply, many managers outside of
marketing view those estimates as unreliable.
Over the years, marketers have often justified their activities using
measures like brand awareness, customer satisfaction or response rates. While these make sense to marketers, other
managers find it hard to relate them to traditional financial measures: profit,
cash flow, and return on investment. This
confusion may have earned marketers some freedom from supervision, but at the
cost of the trust of their peers.
The fundamental uncertainty of
marketing investments is unavoidable.
But marketers can at least present their estimates in conventional
financial terms. This will remove some
of the mystery surrounding their work and help other managers see the value of
their activities.
Natural marketing measures are connected
to standard financial metrics through lifetime value. That is, marketers can estimate the impact on
lifetime value of changes in marketing measures, and then convert lifetime
value into standard financial terms. But
just adding an estimated change in lifetime value will not make a marketing
projection any more credible: if anything, it will seem like an even more
arbitrary number that was cooked to justify whatever marketing wanted.
The way to make lifetime value
credible is to break it into meaningful components. Fortunately, this is not hard.
Start with the customer life
cycle. Although customer management
methodologies use different terms to describe them, most identify three basic
life stages: acquisition, retention and growth.
Acquisition refers to getting the first order from a customer, or, more
simply, to adding new customers. Retention
refers to gaining repeat orders, or keeping existing customers. Growth is expanding the customer relationship
by selling additional products. This is
often referred to as cross selling.
Almost any accounting system can
associate a date and product with revenue-generating transactions. In systems that can also tie those
transactions to individual customers, it’s fairly easy to classify revenues as
belonging to initial purchases, repeat purchases, and cross sales. Where purchases cannot be directly linked to
customers, it’s often still possible through research to estimate how revenues
are divided among these categories.
A proper financial analysis includes
not just revenues, but also costs. These
can be divided into marketing and fulfillment expenses. Marketing costs are discretionary: they include
activities that promote purchases. Fulfillment
costs are everything else: they include products, customer service, and
overheads. Some firms might further
distinguish variable fulfillment costs (directly related to specific purchases)
from fixed costs (incurred whether or not a particular transaction occurred).
The precise allocation of costs is a
topic of endless fascination among financial experts. This is good news for marketers, because
getting finance involved with the definitions used for lifetime value analysis
builds credibility for the final results.
Once corporate finance has helped determine the appropriate cost definitions,
they also provide expertise to extract the values from the company financial
systems. Knowing that the lifetime value
figures are tied into the official accounting system—even if nobody outside of
finance understands precisely how—is immensely reassuring to senior managers
who might otherwise question the values’ validity.
The three purchase types (initial,
repeat and cross sale) with their three cash streams (revenue, marketing cost,
fulfillment cost) lend themselves to a tidy 3×3 matrix of LTV components. These are much easier to understand than a
single consolidated figure. Moreover, because
most marketing investments affect only some LTV components, listing these
separately clarifies how a proposed investment is expected to achieve its goals
and lets managers assess whether the assumed changes are reasonable. Finally, the lifetime value component matrix
is by definition comprehensive, so when you’ve considered the impact of a
project on each component, you’ve captured its impact on the entire
business. This sort of thoroughness is
important for any investment proposal, but is especially useful in helping
marketers gain credibility. As a side
benefit, the component-by-component review often finds incremental benefits beyond
the original investment purpose.
This still leaves the challenge of
estimating the component changes themselves.
For this, marketers must still rely on whatever research, experience and
intuition they have available. The
lifetime value model used to generate the component figures can also help with
this process, although it cannot remove the inherent uncertainty surrounding
future marketing results. What the
lifetime value approach can do is help ensure other managers understand where the
estimates came from and what the estimates mean.
* * *
David M. Raab is president of ClientXClient, a consulting and technology firm specializing in customer value management. He can be reached at draab@clientxclient.com and writes a blog at http://customerexperiencematrix.blogspot.com/.