August 31, 2009

Many Happy Returns on Marketing

Measuring marketing ROI need not be elusive. Don Sexton explains how firms can measure and increase the marketing contribution to the bottom line.

Topics: Marketing

Q. Why have companies struggled to measure marketing ROI for so long?

Marketing managers have tended to focus too much too long on trying to measure the impact of tactics with easy-to-understand measures that are of questionable worth. Click rates for Web advertising are easy to measure, but what do they really tell us? Or consider ad agencies doing copy testing with measures such as awareness that typically do not connect to long-run financial performance. The measures commonly used to evaluate marketing tactics are often easy to apply but provide little insight into marketing ROI, especially over the long run.

We should be focused on evaluating not just tactics but both strategies and tactics. Strategy is about positioning and targeting: positioning consists of what the company is providing the customer and targeting concerns to whom they are trying to sell. If the positioning is wrong and the target market is wrong, rarely can tactics alone save the day.

We should also be asking, what is the overall impact of all marketing activities: the positioning of the product or service, the targeting and all the tactics taken together, including communications, promotions, pricing and distribution. The solution to evaluating marketing ROI is to take a broad look at how marketing really drives the financial performance of organizations rather than narrowly focusing on specific tactics.

We can take that broader look by focusing on measuring perceived value — which I define as the maximum that the target customer will pay for a product or service. Perceived value takes you back to the basics of what marketing does. That’s why I define marketing as managing perceived value.

Q. In your book you note surveys that show that neither financial managers nor marketing managers have much confidence in the ability of marketing people to predict next year’s sales. How can that lack of confidence be countered?

First, we should reconsider the marketing models currently in use. Many models have become folklore and are perpetuated by marketing texts and professors and consultants, even though they have been shown to be conceptually unsound.

For example, the hierarchy of effects model is in every marketing text and is even promoted by some well-known consulting firms. The model posits that a customer starts by becoming aware of a product or service, then moves to knowledge about it, then to liking, then to preference, and eventually decides to buy. This process sounds perfectly reasonable but most research shows it works only in very specific situations: usually when a very important purchase is going to be made on rational grounds.

If I’m in a deli and I’m thirsty and see a brand of orange soda I’ve never had before, I’m probably just going to buy it. I’m not going to look at Consumer Reports to see what they say about that brand of orange soda. If I don’t like it, I’ll throw it away. If I like it, I’ll buy another — it’s very immediate and does not require a hierarchy of effects process. Yet the hierarchy of effects model continues to be taught with few reservations. In turn, that model spawns measures — such as awareness — which may be of limited usefulness. Without sound models it is no wonder that marketing managers in many companies have few sound measures of marketing effectiveness.

Q. In a nutshell, what is CVA® and how does it work in conjunction with perceived value?

CVA — customer value added — is the difference between the perceived value that a customer places on a product or service and the incremental unit cost of providing the product or service. Keep in mind that perceived value is not price; it’s the ceiling on price — the maximum a customer is willing to pay.

If the perceived value is lower than unit cost then CVA is negative and the company is producing something that is not worth the cost of the labor, capital, and the materials being employed. If CVA is negative, then the value to the customer is not greater than cost and the company is in trouble. If CVA is negative for a while, the company will go out of business.

You can estimate perceived value in a variety of ways. None are exotic techniques — all are well-known procedures: value-in-use, constrained choice models, multivariate statistics and judgment. One issue in evaluating marketing ROI is that some marketing managers are not as comfortable with statistical analysis as perhaps they can and should be.

All these methods estimate the maximum price someone is willing to pay for a product or service and also identify how much the brand contributes to that perceived value and how much different benefits contribute. If a customer values a courier service at $30, it’s possible to evaluate which part of the $30 is due to the service’s brand, to their tracking service, to the courtesy of their employees and to their on-time performance.

Q. Design and communication are the more traditional purviews of marketing managers. Where do these fit in CVA?

CVA depends on perceived value which in turn depends on design and communications.

Always keep in mind that CVA also depends on variable costs and these variable costs include marketing costs such as promotions. But the main determinant of CVA from the marketing side is perceived value.

Perceived value depends on design and on communications. Design affects the actual value of the product or service. Communications ensures the customer knows the value the product or service provides.

Actual value is usually higher than perceived value because if a customer overvalues a product — in other words, if their perceived value is above actual value — then they probably will not buy that product again. If your perceived value for a restaurant was so high that you were willing to pay $100 for a meal but when you visited the restaurant the wait staff spilled soup on you and were surly, then you probably won’t go back because their behavior showed that the value you perceived for that restaurant was overly high.

Even if a product or service has high actual value, the customer may not award it high perceived value unless they know about the product or service. That depends on a company’s communications. The “Have You Driven A Ford Lately?” advertising campaign is a good example of how to fill the gaps between actual and perceived value in the customer’s mind. Ford had improved their product but they still needed to fill the gaps and persuade people at least to check out a Ford automobile — which they did with their campaign.

Some companies make the mistake of running such a communications campaign without first improving their product. But the most creative campaign in the world will fail if a product’s actual value falls short of what the company says it is. Great advertising makes lousy products fail even faster.

Q. Why are you adamant that companies not use last year’s marketing budget to set this year’s marketing budget? How can a company use CVA for budget planning?

Many marketing models are based on sales histories of perhaps three to five years and may include variables such as ad spending, pricing and deals. Such models are used to estimate next year’s sales. Do companies really expect that the coming years will be similar to the past five years — especially when the environment is constantly changing, with new competitors and new technologies?

Instead of using sales over the last few years to predict next year’s sales, companies would have more useful information for their decisions if they identify measures that are leading indicators of revenue and contribution.

It turns out that perceived value can be shown — in theory and in practice — to be a leading indicator of revenue and, similarly, CVA is a leading indicator of contribution. In my work with one large consumer packaged goods firm, we found that perceived value predicted revenue and CVA predicted contribution, both with R-squared values of over 90 percent. An R-squared value of 100 percent would mean predicting with certainty so an R-squared value over 90 percent is excellent and was much better than simply trying to predict by using last year’s sales and contribution.

Unfortunately, many methods for evaluating marketing that are in common use in companies, such as using last year’s budget to predict next year’s performance, have become mechanical. The one argument for such mechanical techniques is that they are simple. Why? Because they do not require much thinking. Thinking is a barrier to trying new approaches because thinking may result in change, which is often anxiety-producing.

CVA requires that we sit down and really think about what we’re doing with our marketing, how we are satisfying customers and the impact on our financial performance. When we do that, we can evaluate how marketing drives ROI.

Donald E. Sexton is professor of marketing and director of the Jerome A. Chazen Institute of International Business at Columbia Business School.

Read the Research

Don Sexton

"Value Above Cost: Driving Superior Financial Performance with CVA, the Most Important Metric You've Never Used"

View abstract/citation 

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