How is Finance related to Marketing? Marketing and Finance are deeply connected and one cannot make decisions, without consulting the other, if the objective is to maximize the firm’s success.
Tenured business leaders are well aware of this fact as they understand that Marketing focuses on generating more revenue and growing the company, which is the ultimate goal of the finance department.
Marketing is often perceived as being subjective and creative, this often drives professionals to perceive Marketing as Advertising + little bits and pieces along the way instead of what it actually is, a management philosophy.
Finance on the other way is often perceived by caring solely on numbers, cashflows and costs, only caring to meet ends and not on how to achieve it.
Both departments constantly try to answer the same questions;
- Who will buy our product at the best price?
- How can we increase the number of units sold
- More units per customer?
- More profitable customers?
- How can we increase customer loyalty and Customer Lifetime Value (CLV)?
- How can we increase our competitive advantage?
- How can we increase our price?
Marketing and Finance biggest concern is;
How can our firm sustainably increase in value?
Marketing is one of the main catalysts for earnings, growth and valuation* of the company. Finance on the other side is about measuring the effects of Marketing Decisions and operations.
Table of Content:
- Where Finance and Marketing Meet
- Measuring Marketing Operations.
- Closing Statement
* It’s very often the case that the market capitalization of a company is much superior to the assets on the balance sheet, and that’s often due to Marketing operations that result in such a positive overall evaluation from the public, that this phenomenon is possible. This extra valuation is often called and composed of Brand Equity.
Where Finance and Marketing Meet.
How do Marketing and Finance meet outside the office and the theoretical point of view? How does Finance relate to Marketing?
Let’s set up a real scenario to give more understanding out of abstraction;
- A customer walks into your store;
- He buys a $10 product and leaves;
- You paid $5 for that product;
- In financial terms, you just made $5 in gross profit;
A few questions should arise in the heads of every Marketing Manager, such as;
- Where did that customer come from?
- Why did she choose your business?
- Why that particular product and not another one or a similar one from another brand?
- Why was she willing to pay $10 for it, rather than $8, $7, or even $4?
- Is there any store in the proximity selling the same product for $4?
If there’s any store selling the same product for $4, you might have to drop your price and lose $1 every time that specific product is sold.
Marketers decide and are responsible for which goods are sold or not and at what price. Marketers, decide upon all the vital aspects of the business (Product, Price, Promotion and Placement) they need to work together with all other departments, Production/Manufacturing, Financial, HR, etc.. to make the best business decisions.
The World Marketing Forum has prepared a Practical Guide on Pricing if you want to Maximize Results. This article also includes a brief theoretical explanation on how prices are formed in an economy.
To make the best business decisions, options need to be compared. To efficiently compare 2 options we need to evaluate them in an objective way; The best way is often the financial way, as it exposes the presumable costs and benefits of each option, and here is where it comes the Income Statement.
The Income Statement.
For two people to understand each other they need to see the world in the eyes of the other.
It’s crucial for Marketers to always have in consideration that every decision they make will be analysed in financial terms. Their success or failure as professionals is tied to the financial outcomes of the company. All the rest are rainbows, flowers, and poetry.
For this article, I choose two companies that I personally like, that are in the same field, and that everybody knows (Big brand equity) the differences are that one is consolidated in the market and the other is a Market Challenger. I have brought you Tesla and Daimler (Group that owns Mercedes-Benz).
Tesla 2020 Q3 Income Statement.
All values are in USD Millions,
|Cost of Goods Sold||6.70B|
On Tesla Income Statement;
- EBIT= Net Income + Taxes + Interest
Daimler 2020 Q3 Income Statement.
All values are in EUR Millions,
|Cost of Goods Sold||32.70B|
On Daimler Income Statement;
- EBIT= Sales – COGS – SG&A
COGS: Cost of Goods Sold
SG&A: Selling, general and administrative expenses
Gross Income: Sales – COGS
EBIT: Earnings Before Interest and Taxes.
Net Income: Sales – Total Costs.
Income Statement from the Marketing Perspective.
You might be wondering, why do you even need to know what an Income Statement is and how it applies to Marketing.
From the Income Statement, you can retrieve precious information about the companies financial health such as the Gross Margin. And see the world through the lens of your colleagues in the Finance Department.
Gross Margin = Value of Goods Sold (Sales/Revenue) – Cost of Goods Sold (COG’s)
In the Cost of goods sold, it’s accounted all components used into building that “good” (product), in this case;
- Transmission and Propulsion Mechanisms;
The COG’s represents the Variable Costs, only, at the amount of steel, number of batteries and so on will depend on the number of cars built.
In the Auto & Truck Manufacturer industry, the average 2020 Q3 Gross Margin is 20.43%. (CSI Market)
- Tesla – 23.48% Gross Margin
- Daimler – 18.73% Gross Margin
What Information can we take from these values?
- Tesla is outperforming and Daimler is lagging behind the Industry Average for the same period;
- Tesla has a higher gross margin than Daimler, that might indicate that it has one or more competitive advantages;
We also have some questions that we can’t answer due to lack of data;
- Are Tesla and Daimler increasing their performance or decreasing?
- Who’s the most stable company over the years?
- How’s the Marketing performance of these two brands?
Having a positive and high gross margin is the first determinant for the success or failure of a company. The bigger the margin, the better the company is performing, for high volume companies having a gross margin of 20% is a good indicator. Each industry has it’s own margin average, therefore you always need to look at the numbers with some consideration.
Variable Costs are not the only ones that need to be accounted for, there’s also the support activities such as, facilities, directory board, support staff, etc… these costs also need to be inputted. This costs are known as Fixed Costs.
Fixed Costs are a little bit harder to attribute and each company has it’s own rules, some simply distribute the fixed costs by the bulk of production. Fixed Costs = Total Fixed Cost / Total Units Produced This will make it depend on the number of units sold, so it varies with performance/production.
Measuring Marketing Operations.
In Marketing there are also Fixed and Variable Costs, and they often follow the same logic;
- Variable Marketing Costs will apply if it varies according to the number of goods sold, for instance, a Discount on a product.
- Fixed Marketing Costs are often set in annual advertising plans with media sellers. The cost will not depend on how many units are sold.
By measuring and analyzing the outcomes of Marketing activities and comparing them to previous analogous scenarios or simply past results is often the best method to judge the Marketing Decisions and aligns the Marketer with the company final objective: To increase its value over time.
Note: It’s very important to previously determine the time preference of the management board and stakeholders. Some Marketing decisions might be good or even extraordinary in the short-term but compromise the results in longer time-frame.
Nowadays, the big majority of decisions in the western world are taken to match the Quarterly Investor/Market expectation. This often means to retrieve the highest stock price possible in moment zero, instead of mid/long term planning.
To successfully measure the outcome of marketing operations is not an easy task because;
- Some operations create immediate outcomes;
- Other marketing operations create both immediate and long-lasting outcomes;
- Some others, like product development or internationalization, can be only measured in the medium or long run;
Managers need to conform to the market demands and operate accordingly if a company is openly traded or the shareholders are more focused in short term gains the Marketer needs to plan its strategy accordingly.
All Marketing Costs need to be imputed to the bulk of products sold, as it is often hard to attribute what was really the determinant touch point and/or factor that contributed to the sale. Even a PPC campaign where one can accurately measure the conversion and behaviour of all incoming traffic, should you determine that it was exclusively due to that campaign that your audience bought your products or services? Surely not. There’s a whole structure giving the campaign support.
Marketing and Time-Value of Money.
If you want to see your Marketing Budget increased or get a specific amount for a given Marketing Operation, You need to present it in terms that the financial department understands. The financial department as seen above mostly analyze numbers, results and outcomes, so if you present your plan with some financial data they will not only listen to your proposal but also possibly approve it.
Because each Marketing Operation has a different result time frame, we have to compute the presumed results/earnings as we do for any other sort of “investment”.
You do that by attributing a Discount Rate that should match your industry standard rate and by calculating the Future Value of money.
The Discount Rate and Present Value.
You must be familiarised with the concept of Inflation, but even if you aren’t you know that money tends to buy less and less over time. This means that with 100USD today you can buy more goods than in 1 years time (general rule). There’s also Risk when making business, and even all other things that a person can’t predict or that rarely happens (acts of God). All of these variables are often computed and we get to the Discount Rate.
The Present Value is a simple computation of the Capital that you invested, depreciated at a given rate (predetermined accordingly to your assumptions as seen above)
Present Value = C / ( r + 1 )^n
C – Capital
r – Discount Rate
n – Periods of Time in consideration, can be weeks, months, years, or whatever is determined.
How to Choose between different Marketing Projects?
You are the Chief of Marketing Office (CMO) of a Company, and You have a 300.000USD Marketing Budget that you can allocate, your objective as CMO is to maximize the value of your company. You need to decide which projects you are going to propose to the management board. There are several marketing operations with different times frames and different financial outcomes such as the table below;
|Project||Investment (USD)||Duration (Months)||Discount Rate (%)||Present Value (USD)|
It seems obvious that you should pick Project C. Not only it depletes the budget, but also retrieve the highest Present Value of all projects, including their sum (206.833USD). As a general rule of thumb, in fact, you should choose Project C.
But if your management is driven by short-term gains or in a crisis situation, like Covid-19 in 2020, choosing options A+B+D could reveal to be wiser, even retrieving a Lower Present Value, this is because the duration of the projects, that is smaller, the discount rate that is much higher (higher safety for unlikely variables such as Covid-19), and because you will not exhaust all your budget into one single investment (conservative approach).
How to Make Good Marketing Decisions?
Economics is the science that studies the economic behaviour of a given society.
An Economist job is mostly directed to public policy, as laws and regulations have a determinant impact on the livelihoods and welfare of society. But before going to Macro, there’s the Micro aspect, this is, the reality of a small community, this can be translated into a certain industry, and a certain company.
To be an outperforming Marketer you need to Master Economic Concepts and apply them accordingly to maximize the outcome of your activities. Concepts such as Time Preference, Price, Elasticity, Game Theory, Scarcity, Utility, and many others.
I will illustrate the need that a Marketer has in knowing this with an example;
Daimler and Tesla both produce cars. Cars use steel in their body frame and other components. If the price of steel substantially goes up, this will necessarily increase the cost of production of the cars, as they use steel in the process. It’s the Marketer Job as seen above to determine the price of the products, what option does the Marketer has?
- Increase the price of cars;
- The customers will absorb the price increase and the company will maintain its margins.
- Maintain car price unchanged;
- The company will absorb the price increase and will have lower margins.
How can He accurately decide which of the following he will put in action? How customers are going to react to a change in price and by how much?
- Will customers halt their purchase in case of a price increase? (Lower sales volume)
- Are the customers open to absorb this increase in price? (Constant sales volume)
- What will our competitors do?
For a Marketer, knowing how much a % change in the price will affect the goods that the company sell is paramount. Having this information will allow him to please the Financial Department if they’re in need of higher a higher cash flow, and also, how it will affect the sales in global, anticipating scenarios and so on.
Now, imagine that what changes are the price of Petrol or Electricity. Tesla runs on batteries and electric power, and Daimler cars mostly run on Petrol/Diesel. Another economic concept comes in – Substitute Goods. This concept also affects Price Elasticity.
Demand Price Elasticity.
Price elasticity is a ratio that can be briefly defined as the changes in quantity demanded when a price rises or falls;
P.Elasticity = Change in Demand (%) / Change in Price (%)
- If E>1 , it means that an increase or decrease of let’s say 10% in price will have a greater increase/decrease in quantity demanded, let’s say -20% – Elastic Goods.
- if E<1 , it means that a change of 10% in price will have a smaller effect on quantity demanded, let’s say -5% – Inelastic Goods.
You can check Investopedia comprehensive guide on Elasticity for more in-depth information regarding this matter.
It’s important to mention that it’s impossible to reach to the accurate value of elasticity and to know the real effect beforehand, any value that you get will be an Estimation, and it should be treated as indicative and not blindly followed.
It normally also applies to every single product, this means, that for instance a limited edition from Daimler or another version sales volume might not be impacted by any change in price. Human reality is complex, treat it as such. Your objective is to sustainably increase the value of the firm. The best way to do it is by undertaking marketing operations that will increase the gross margin at the same time that you maintain or enhance Brand Equity.
Brand Equity stands for a Premium valuation of the company visible through the difference between the share price and the asset-based (“real”) share price. Favourable market perceptions of the brand, trust, reliability, future expectation, etc… are often attached with a higher perceived value of the products traded by a company.
This ultimately means that the Marketer is more comfortable to practice higher prices and that consumers will be less affected by price changes.
Increasing Brand Equity has several Benefits such as;
- Increases Sales;
- Increases Sales Value;
- Increases Consumer Loyalty;
- Increases Shares Price;
Marketing Operations that enhance Brand Equity will get in good eyes with the Financial Department.
Brand Equity if done wrong can also be devastating. Gillette (Proctor & Gamble) made a terrible campaign in January 2019 that had such a severe backlash that the company end up losing billions of dollars (8 Billion USD). Another recent event was in made by Nike in Japan, still to soon to account for the financial Impact.
You need to be very careful, rely on deductive reason, and never forgetting what is seen and “not seen” before making a decision.
Brand Equity by Investopedia is you want to explore more about this concept.
Deductive Reasoning – Understanding your Audience is the Key.
In the end, it’s all about your customers and their individual preferences. An Outperforming Marketer needs to know economics, and more importantly, good economic doctrine. If one wants to be successful in a given Industry they need to listen to their audience, and study, their wants and needs in an on-going process.
“Listening” to your audience is paramount for success.
Use a portion of your Marketing Budget for Research and Intelligence. Ideally, in-house staff will be trained and allocated to the task, but if that’s not possible due to budget constraints, outsourcing that service will give you more assurance and certainty when presenting your Marketing Projects to the Board and your Marketing Decisions. It will also allow you to more easily convince the board to expand your Marketing Budget and risk on new ventures.
The Empirical (Scientifical) way is often chosen for the primacy of information. Even though, on the majority of cases, the information they convey is accurate and conveys reality, in some other cases they are bluntly inaccurate. This very often happens in Social Sciences Empirical Studies, therefore, I strongly recommend You to instigate free, deductive reasoning as the primary source of intelligence.
All Marketing Efforts are going to be judged by their effects on the valuation of the company.
Your success as a Marketing Manager is tied with the financial outcomes as I previously exposed. To have success You need to convince the managing board that your Marketing Activities are the best to increase the value of the firm. The best way to do it is to present it in financial terms.
This article doesn’t cover in full how is finance related to Marketing, but I hope it entices you to investigate a little bit more and ultimately become a better Marketing Professional.