Imagine that you work for the Chief Executive Officer (CEO) of Coca-Cola. He asks you for an opinion on a recommendation by the company’s Chief Marketing Officer (CMO) to raise their advertising budget from $3.2 billion to $3.5 billion. Should Coke spend an additional $300 million on advertising? The Chief Financial Officer (CFO) is opposed, saying the money would be better spent elsewhere.
Alternatively, keeping the ad budget flat will increase earnings and drive the stock price up. The CMO counters that the increase in ad spending is actually an investment in the brand, and one that will result in higher sales and earnings over time as well. This was an actual decision facing Coke’s senior leadership in 2013. Already the largest advertiser in the beverage industry, Coke was spending 6.9% of its revenue on advertising at the time.
What should Coke do in such a circumstance? What would you advise the CEO? Is marketing an expense or an investment in an intangible, but extremely valuable, asset known as the brand? Is it both an expense and an investment? How should a company treat marketing from a financial point of view?
There is a fallacy that marketing and finance are separate disciplines. In reality, they are closely linked. They often overlap, and they inform one another about the current and future health of the business. This is the case even when the people performing finance and marketing functions either don’t know or believe that they’re interdependent. When executives see marketing from a financial perspective and finance from a marketing perspective and operate with this insight, good things tend to happen in a business and other types of organizations as well.
Looks can be deceiving. Finance appears to be a numbers game, a cold, fact-based area of the business world where money talks and everything else walks. Marketing, in contrast, is often viewed as subjective, an arena for creative, artsy types who love talking about soft-edged concepts like brand aura and emotional engagement with the customer. However, finance is not only about money and marketing is about a lot more than image. In truth, both disciplines are about the same thing: how a business sustainably earns, grows, and increases in value. Marketing is one of the main drivers of earnings, growth, and valuation. Finance is about measuring the effects of marketing—from the decisions to operate in specific markets and serve specific customers to pricing, basic advertising and messaging, product design, and the scope of product lines.
Applying these concepts to the Coca-Cola situation, consider the following conundrum: in the middle of 2018, Coca-Cola’s balance sheet showed total assets of $89 billion. Yet, the company’s market capitalization, the total value of the company, was $199 billion at that time. Why are the two numbers so different? The $110 billion premium of entity value over the book value of its assets signifies how the market values the Coca-Cola brand. What is it about Coca-Cola that creates such value in the investment community?
Going further, is the Coca-Cola brand worth more than that of its competitors? Perhaps, a look at the ratio between the stock price and the company’s earnings (the price-to-earnings ratio or P/E) is instructive. Coke trades at around 33 times its earnings. In contrast, Pepsi’s P/E is just 21. Thus, in rough terms, a dollar of earnings generated by Coke’s marketing machine is worth $33 to shareholders versus $21 for a dollar of Pepsi’s earnings.
But wait. Aren’t stock prices based on expectations of cash flow? Yes, they are, give or take various other influences. And there is a connection between brand (powered by marketing) and future cash flows. The value of a brand surfaces in the stock price because of its ability to generate and assure future cash flows. Good products, ubiquitous distribution, television commercials, and a host of other marketing activities transform consumers into cash-generating customers. From this perspective, the intersection between marketing and finance becomes clearer. We can see the nature of marketing and finance, both as individual disciplines and as synergistic partners.
Contributed to Branding Strategy Insider by: David Stewart, President’s Professor of Marketing and Business Law, Loyola Marymount University, Author, Financial Dimensions Of Marketing Decisions.
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