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Preventing the Unkindest Cut: Why Now is the Worst Time to Cut Your Marketing Budget
By Sharan Jagpal

When times get tough, companies have a knee-jerk tendency to start slashing & burning. They lay off employees. They search for cheaper healthcare benefits and eliminate holiday bonuses. They seek ways to reduce overhead and extraneous costs. Sometimes this crude surgery improves the health of the overall organization; sometimes it doesn't. But in the thick of all the "bad economy" clear-cutting, there's one business function that should never get the ax—and yet, it's all too often the first victim.
Marketing.

That's right, says Sharan Jagpal, Ph.D. To cut back on your efforts to market your products and services when people are already reluctant to buy is akin to corporate suicide. "In a recession, it's harder to gain new customers, to convince existing customers to buy more, and to win back customers who have left," says Jagpal. "So companies often need to be spending more money, not less. They just need to be smart about it."

It's this simple: During any period of economic hardship, there are winners and losers. Choke your marketing efforts down to a trickle—or just as bad, direct your dollars into the wrong channels—and you'll surely find yourself among the latter group. Overhaul your approach to marketing and you'll be positioned to swoop down and grab some of the customer dollars that previously went to a competitor or even capture an untapped market.

"Consider, for example, that in a good economy the vacation and videogame industries do not compete with each other," says Jagpal. "In a bad economy, consumers may have no option but to forgo vacations. But to compensate for this loss, they may reward themselves with a small, affordable purchase such as a videogame. And that's why it's important to pay attention to shifts in consumer spending—if you're a videogame maker, you may well benefit from a dramatic increase in your marketing right now." Before you, the hypothetical videogame maker, can achieve such a feat, you must first get your marketing and finance departments working together rather than clashing against each other. It's no secret that finance people typically wield the cost-cutting blade—while marketing people are perceived as free-spenders who have a tough time quantifying their ideas. Fortunately, says Jagpal, common ground does exist.

"When these two groups stop talking at each other, when they get out of their functional silos and start working together, they can create marketing strategies that help an organization thrive even in the grimmest economy," he notes. "But that means Finance must squelch its knee-jerk reaction to cut the marketing budget, and Marketing must learn to create metrics that demonstrate the bottom-line impact of their ideas."

How can this be done? Jagpal offers the following insights to help you get started:

• "Old school" resource allocation methods are woefully inadequate. In many companies, resource allocation decisions are based on cash flow inputs dictated by the finance department. However, cash flows are critically dependent on the company's marketing decisions: the price charged for a product or service, the advertising budget for the product or service, the channels of distribution used for selling it, and so forth.

And here’s the real problem: It's difficult to know how these marketing decisions affect cash flow. In particular, says Jagpal, it's hard to measure the degree of uncertainty involved when a company chooses a particular marketing policy. Decision makers agonize over questions like:

"How can I measure the effects of my company’s marketing policies on cash flow?"

"How can I quantify the uncertainty in cash flows when my company chooses a particular marketing strategy?"

"What are the short- and long-term effects of different marketing policies on my company's performance?"

Clearly, such a transformation is easier said than done! There must be fundamental changes in the mindsets of managers at all levels in the organization and across functional areas.

• Marketing people must shine some light into the murky waters of the profit and loss statements and balance sheets. Finance people often perceive marketing as a bottomless pit into which money disappears. Marketing professionals, perhaps rightly, see this perception as unfair. Still, their indignation doesn't change the fact that they must convince others to get behind their ideas financially, Jagpal points out. While behavioral measures such as share of voice and product awareness are fine as subgoals, they are simply inadequate tools upon which to base resource allocation.

"The marketing department must explicitly recognize that a whole new set of metrics is urgently needed," he reflects. "That means marketing people can't stay inside their silo anymore, but must reach across the aisle and coordinate decisions with the finance department."

• To avoid strategic blunders, Marketing and Finance must work together to measure risk and balance it against return. Let's say you're comparing two marketing strategies, each of which requires the same dollar expenditure. You can either 1) focus on acquiring new customers, or 2) focus on retaining the customers you already have. Now, let's say the market-growth strategy will, on average, produce higher average profits than the customer retention strategy. You might assume the decision is a no-brainer, but Jagpal says it's more complex than it first appears.

"The market-growth strategy is not necessarily superior," he insists. "Even though, on average, this strategy will produce more profits than the customer retention one, it is much riskier. Indeed, depending on the magnitude of the uncertainties involved, after comparing risk and return, it may be better to focus on the strategy with lower average profits."

So, regarding the "market growth" vs. "customer retention" question, how should a company decide which is best? Jagpal says two steps are necessary:

1) The marketing department must provide quantitative estimates of the risk and return of the cash flows from these two strategies, and

2)The finance department (or senior management or CEO) should determine which strategy provides a higher return after adjusting for risk. In this analysis, the ownership structure of the firm is critical. A publicly owned firm should focus on market risk—i.e., the risk to stockholders after they have diversified their holdings across firms. A privately held firm should choose the optimal strategy based on the owner's tolerance for risk and return.

"Starbucks is a prime example of a company that made the mistake of focusing on market growth at the expense of risk," notes Jagpal. "In October 2006, the company dramatically raised its long-term store opening goal to 40,000 from its prior goal of 30,000. The stock market responded positively to this announcement and the company"s shares closed higher by 7.6 percent that day. But subsequently, Starbucks's share prices plunged and the company paid the price for choosing the wrong strategy. It paid a high price for ignoring risk!"

• Involve both Marketing and Finance when designing salesforce compensation plans. How a company pays its salespeople can have a dramatic impact on profits. Consider a PC manufacturer like Dell that sells to two segments: the transaction segment where customers buy once and the relationship segment where customers make multiple purchases over time. What types of compensation plans should the PC manufacturer use for people who sell to these segments?

To address this question, says Jagpal, the PC manufacturer should view the effort of a salesperson who sells to the relationship segment as an investment. Decision makers must keep in mind that the profits generated by that salesperson are uncertain. Consequently, it is best for the manufacturer to share both current and future profits with her. In other words, it should pay the salesperson targeting the relationship segment a lower base salary and a higher commission rate than a salesperson targeting the transaction segment. Interestingly, the salesperson targeting the relationship segment will, on average, make more money than the "transaction" salesperson. However, her income will fluctuate more.

"Odd as it may seem, the PC manufacturer must employ different sales force compensation plans for its salespeople who target different market segments, even though they are selling the same products," says Jagpal. "And in order to choose the optimal pay plan, the company must coordinate the decision across its marketing and finance departments. Why? Because each plan has a different effect on the firm's net risk and return after paying the salesperson."

Of course, these tips barely scratch the surface of the valuable information in Fusion for Profit. But they do illuminate the overarching truth that inspired the book: The best marketing strategies, those that yield long-term value, are based not on trends, anecdotal evidence, or past "success stories" but on rigorous new scientific methods explicitly developed for analyzing data that are often imprecise.

"What worked yesterday won’t necessarily work tomorrow," he points out. "And what works for a large publicly held corporation won't necessarily work for a privately owned small business. Every company is different. If you want solid, long-term performance, you need a marketing strategy that's organic, that's understood and agreed-upon by marketing and finance leaders, and that's backed by state-of-the-art empirical methods.

"Fusing marketing and finance may sound daunting, but the hardest part is making the psychological leap," adds Jagpal. "Once you’ve bought into the idea, you’ll get excited about the possibilities. There's great opportunity out there—yes, even in an economic downturn—and when key players work together, your company can seize it."

About the Author:
Dr. Sharan Jagpal is an internationally recognized expert in marketing and in other fields. He was educated at Columbia Business School and at the London School of Economics, and regularly publishes articles in top journals in marketing (e.g., Marketing Science) and in other disciplines including economics and statistics (e.g., International Economic Review and Journal of Classification). His first book, Marketing Strategy and Uncertainty, laid the foundation for his current book Fusion for Profit. For further information, please visit www.fusionforprofit.com.

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