OIS' Role in Enhancing Marketing's Contribution to the Firm's Financial Performance

As a reminder, an OIS picture really is worth a thousand words.

“If you know where you are on the response function, you control everything.”

Dominique Hanssens, Bud Knapp Professor of Marketing, UCLA Anderson School of Management

2009 ISMS Conference, University of Michigan

INTRODUCTION: A brief review by the this author of relevant articles and books from Professor Hanssens’ research page yielded this author’s very high level summary of the current state of the financial performance/marketing academic art. (Note: What follows is paraphrased or quoted directly from the articles and books cited below in REFERENCES)

SUMMARY: There are two ways to parametrize how marketing contributes to a firm’s financial performance.  One is whether the variables are stock or flow.  The second is whether the effects are exogenous or endogenous. 

Stock variables are those which accumulate and include those represented on the balance sheet (e.g., inventories, accounts receivable, accounts receivable)

“A stock in and of itself does not (necessarily) produce cash but it may enable or enhance future cash flows and thus plays an important indirect role for financial performance.”  Marketing stock variables include such things as brand equity, customer equity, customer satisfaction, research & development and product quality. Stock variables such as these do not appear on the balance sheet.

Flow variables are those which represent changes in those accumulations (e.g., revenue, COGS, SG&A) and are represented in the income statement.  Those of the traditional marketing-mix like promotions are, obviously represented by the S of SG&A.  These marketing flow variables drive shareholder value in three ways:

  1. Higher profitability ( i.e., increasing the magnitude of net cash flows)
  2. Faster profitability (i.e., accelerating cash flows)
  3. Safer profitability (i.e., lowering the volatility of the cash flows)

“These impacts are often indirect as marketing’s primary role is in creating and stimulating demand which is typically measured by sales or revenuesThus, in order to arrive at marketing’s role in net cash-flow generation, we must start with models of sales or revenue generation, which are commonly known as market-response models or marketing-mix models.  Market response models should then be combined with the cost structure of marketing which may be fixed (e.g., an advertising campaign) or variable (e.g., sales compensation) or a combination of both.”

Endogenous factors are those under control of the firm and include both stock and flow variables, as described above.

Exogenous forces are those of the financial analyst and shareholder community and include the following considerations and opportunities:

  1. “The question remains however, to what extent marketing’s contribution to these cash flows is recognized by an important external audience, the shareholder or investor.”
  2. “Although much is known about consumer behavior, marketers have stayed away from understanding and influencing investors…Therefore, the study of investor relations represents a major research opportunity in marketing.”
  3. Future research #6: “Prescribing the critical marketing information elements that should be made available to investors.”
  4. “Thus, we must also address how investors perceive a firm’s marketing actions and their impact on its financial outlook.”
  5. “Firms still use a financial jargon at senior levels, and it will take some time before customer- or marketing-oriented metric become commonplace.”

Given the SUMMARY, above, it is this author’s view that:

  1. The bulk of the academic research as represented by the books and articles cited below are focused on the exogenous and stock cell in the  2 x 2 application schema described above.
  2. This is due to the fact the opposite cell, endogenous and flow, is a well understood and commercially successful cell.
  3. Finally, it is the author’s belief a recent integration of two analytical techniques, predictive analytics and MILP (both of which are familiar to practitioners and academics in the endogenous/flow cell in (2), above) has significantly broadened the relevance of the flow variables, for marketing’s performance impact on finance, both endogenously and exogenously.

This integration results in the creation of an optimized income statement (OIS) which mathematically assures the firm’s entire suite of  annual planning applications  (e.g., forecasting, marketing-mix modeling, FP&A, S&OP) will be aligned with  1) a projected income statement that is maximally profitable and a supply chain that is both 2) optimally  feasible and 3) optimally sustainable.

This integration will also significantly extends sales and marketing’s role in the annual planning process by leveraging their experience with sales and marketing-specific response models to the entire enterprise’s planning process.  This expertise, leveraged by the EMP model,  is what creates the significantly improved profit and sales and marketing ROI.

Firm’s Financial-Performance Improvement: Endogenous: The result of this integration is the ability to develop an OIS which benefits are summarized in the Market Response Function: An Application Comparison

Firm’s Financial-Performance Improvement: Endogenous: See comments, in bold, below:

1.     “The question remains however, to what extent marketing’s contribution to these cash flows is recognized by an important external audience, the shareholder or investor.” As OIS’s mathematical formulation is very straight forward; it integrates two extant commercially successful applications: marketing mix modeling and supply chain network design.  As such, the results are easily understood and credible. 

Further, an OIS guarantees the firm is ALWAYS on course for maximum profit going forward.  Also, additional objective functions can be used including revenue, EVA and CLV which, if they yield importantly different forecasts and the associated optimally feasible supply chains, puts senior management in exactly the position they want to be in:  choosing the result that most reflects their business objectives.

2. “Although much is known about consumer behavior, marketers have stayed away from understanding and influencing investors…Therefore, the study of investor relations represents a major research opportunity in marketing.” See (1) above.

3.Future research #6: “Prescribing the critical marketing information elements that should be made available to investors.”  See (1) above.

4.“Thus, we must also address how investors perceive a firm’s marketing actions and their impact on its financial outlook.” See (1) above.

5.“Firms still use a financial jargon at senior levels, and it will take some time before customer- or marketing-oriented metric become commonplace.” Nothing is more financially straightforward than an OIS maximized profit and ROI metrics.

REFERENCES

1.     Market Response Models, Hanssens, Parsons and Schultz, 2001
2.     Handbook of Marketing Decisions Models, edited by Wierenga,  Dekimpa, Franses, Hanssens and Naik, ,Chapter 11 and Chapter 15, Hanssens and Dekimpe,  2008
3.     Time series models in Marketing,” Dekimpe and Hanssesns, Marketing: JFM, 2010
4.     Order Forecasts, Retail Sales and the marketing mix for Consumer Durables,” Hanssens, Journal of Forecasting, 1998
5.     “Marketing Strategy and Wall Street: Nailing Down Marketing’s Impact,” Hanssens, Rust and Srivastava, Journal of Marketing, 2009
6.     “Marketing and Firm Value: Metrics, Methods, Findings and Future Direction,” Srinivasan and Hanssens,”  Journal of Marketing Research, 2009

7.      “The Direct and Indirect Effects of Advertising Spending on Firm Value,” Joshi and Hanssesns, Journal of Marketng, 2010

NEXT STEP: GET A FREE OIS PROPOSAL

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