The big irony about shareholder value is that it is, in large part, a guess. The tangible assets are only about 20% of a typical company valuation. All the rest is essentially an educated guess that the future revenue and profit is worth a premium over tangible assets. The entire capital market revolves around this multi-trillion dollar guessing game, involving your board, the investor relations people, the analysts and the big investors. It drives merger and acquisition activity and it's what makes your CEO pile the pressure on the marketing department. When targets are increased and spending is cut, you can be sure that shareholder value is driving those decisions.
Investors and CEOs alike are searching for a way to reduce the guessing and increase certainty. If an investor can be more sure of a company value, the company valuation will be higher than for an equally profitable company of higher risk. A risk reducing process already exists for tangible assets, called the due diligence process, which carefully measures the 20%. What all involved need is an equivalent process for the 80%. Just such a process, called marketing due diligence, has developed from new work at Cranfield School of Management. Essentially, the process consists of three sub-processes that answer the three key questions facing CEOs and investors and, because they concern the marketing strategy/finance interface, they matter to marketers. This article, although it can only be an overview, is intended for marketers who care where their salary is coming from. Marketers who cannot adequately answer these questions will be relegated to a support function, and probably deservedly so.
Company valuation begins with an assertion by the board of its future revenue and profit promises, followed by the first key question from investors: where is that money going to come from?
The days when boards could simply say "trust me" are gone, investors need the confidence that comes from explicit data. The first part of the marketing due diligence process creates that data and is summarised below.
How will you make the money?
Have you correctly defined the market?
Have you defined the market segments (including a market mapping process if necessary)?
Have you defined and evaluated the competitive strength factors for each segment?
Have you defined and evaluated the market attractiveness factors for the company as a whole?
Have you constructed a current, quantified, directional policy matrix?
Have you constructed a future (for example five years ahead) quantified directional policy matrix?
Have you identified and stated the strategies that will lead from the current situation to the future situation?
This process is based on Directional Policy Matrix, a technique familiar to strategic marketers. It takes our knowledge of the market and uses it to create a statement of strategy, eg what we are going to do with each market segment in order to either maintain, grow or exit. Essentially, it makes the marketing strategy of the company explicit and takes us away from the platitudes and spin that could mean anything, and so often mean nothing.
We now know the sources of our future revenue and profit, or at least what the board claim to be those sources. A clear statement about where the money is coming from removes a lot of the uncertainty about company valuation, but it also leads to the next question from the investors. What is the probability that your strategy will work and that you will hit your targets? In other words, is your planned strategy strong enough to win in a competitive market? This has long been a nightmare for investors and a hiding place for weak boards. The technical detail involved in most markets is very hard for an outsider to fathom and allows CEOs to be deceptive. What is needed is a set of diagnostics tests for strategy that apply across any industry and that can be simply applied by investors. Just such a set of strategy diagnostics has been developed by Cranfield, see below.
Will the strategy work?
Does the strategy define true segments, not products, channels, descriptor groups or other false segments?
Does the strategy define segmentspecific propositions, or does it attempt to sell the same thing to everyone?
Does the strategy leverage strengths and minimise weaknesses, or does it fail to correctly assess these?
Is the strategy different from the competition, or does it involve similar propositions to similar segments?
Does the strategy create internal or external synergies, or does it fail to understand these?
Does the strategy direct tactical actions, or does it allow for tactical uncertainty?
Is the strategy proportional to the business objectives, or is it expecting big results from small changes?
Does the strategy fit with market changes, or is it designed for yesterday's market conditions?
Is the strategy properly resourced, or will it fail from inadequate funding?
Does the strategy make clear the basis for competition, or is it trying to be all things to all customers?
The strategy diagnostic process, built on new research at Cranfield, takes apart a company's strategy in detail. It identifies what is strong and weak about it and quantifies the chances that the strategy will deliver the promised revenue and sales. Just as importantly, it provides recommendations for improving the strategy and increasing the probability of achieving financial targets.
Convincing an investor that your strategy will deliver your promised sales and profit is not enough. Shareholder value is only created when returns are higher than could be obtained elsewhere for the same level of risk. Investors demand higher returns when the risk is either high or unquantified. CEOs must demonstrate that the risk of their strategy is quantified, minimised and that the returns justify that level of risk.
Traditionally, companies take a simplistic approach to risk. They often apply a single rate of return objective for all investments across the whole company. This works against low risk/low return strategies like customer retention and in favour of high risk/high return strategies like diversification. This crude approach, while easier for boards to manage, is no longer sufficient for investors and they need a process that assesses the shareholder value created in the context of the risk involved. The process for doing this is the third part of the marketing due diligence process and is summarised by the questions asked below.
Have you allowed for risk
Has the relative risk of the strategy been properly assessed, compared to current, alternative and competitor strategies?
Has that risk been minimised, by delaying investment or appropriate use of market research?
Has the level of risk been allowed for in the required rate of return?
Does the expected rate of return match or exceed the required rate of return?
Have the key elements of the strategy that drive value creation been identified?
Have leading key performance indicators been developed to measure those value creators?
The risk in a strategy comes from its newness and its ambition. Growing with the market is the lowest risk and, even if it is unambitious, has a low required rate of return. New products, new markets or diversification are riskier still. All marketers know this lesson from Ansoff, but not all apply it. The important point is not that the strategy is high or low risk, but that the expected returns are worth that level of risk. This part of the marketing due diligence process ensures that the sales and revenue promises of the company actually justify the investment, as well as suggesting ways to minimise the risk involved.
The marketing due diligence process has important ramifications for CEOs, investors and marketers. By answering the three crucial questions, it takes company valuation from an art to a science. Investors will see the benefit of reduced commercial risk and the board will see the benefit of improved and less volatile valuations.
For marketers, the role they play in marketing due diligence is central. They provide the information and create and execute the strategies that deliver the sales and profit stream. In addition to the corporate benefits, marketing due diligence positions marketers where they belong – in the boardroom.
