It’s Friday, so Mark the CMO, Fiona the CFO and Shell, a representative of their agency, end the day by heading to happy hour. The casual environment (and probably a little wine) fuels an enlightening discussion about marketing’s role in the business as a whole.
Bartender: “What’ll you have?”
Marketing Mark: “Pinot Grigio, but Fiona is paying.”
Fiona Finance: “Just ice water. With all that Mark spends on marketing, we can’t afford anything else.”
Shell the Shill: “It’s on me, Fiona. I’ll have a Cabernet.”
Fiona Finance: “In that case, I’ll have a Martini. Hendrick’s!”
Marketing Mark: “And what’s with the crack about how much money I spend? Every dollar I spend makes you money!”
Shell the Shill: “He’s right, Fiona. He should be spending a lot more.”
Fiona Finance: “You both must have started early. We barely make money as a company. We had a 4% operating profit last year, and we’ll be lucky to hang onto that this year. The stock price is sucking wind, and folks on Wall Street are talking about us circling the tank!”
Marketing Mark: “But marketing is incredibly cost-effective! My marketing budget is only 10% of expected revenue! We have 50% margin in our product offerings. The variable cost of fulfilling a sale — credit card fees, sales commissions, pick/pack and ship — is only about 9% of revenue. That means if I can generate a sale for less than 41% of revenue, we make money!”
Shell the Shill: “He’s right, Fiona, you should be spending four times as much as you are now.”
What’s A Logical Level Of Marketing Spend?
Fiona Finance: “You’re hilarious. Do you really believe you’re driving sales at a 10% cost-to-sales ratio?”
Marketing Mark: “It’s right on the P&L!”
Fiona Finance: “You can’t just divide the marketing budget by the top-line revenue and get your cost-to-sales ratio.”
Marketing Mark: “Why not?”
Fiona Finance: “Because that would imply that every sale we make is produced by your marketing, which is absurd! I shop at the grocery store down the street from my townhouse. Do you really think if it stopped putting circulars in the paper and running ads on TV, I’d start shopping somewhere else? I’ve never seen an ad for Hendrick’s, but I always order it … if someone else is buying, at least. There’s customer loyalty, word of mouth, location, location and location, store signage — your budget can’t be credited with driving everything!”
Marketing Mark: “Okay, okay, you have a point, but you’re talking about businesses with a high purchase frequency, where habits build up over time and take time to change. But companies like Disney and Ford are smart to spend money even though some folks would buy regardless. There’s value in staying top-of-mind, particularly when the purchase cycle is episodic.”
Shell the Shill: “Right! Look at the long-term value of the marketing you already did. You keep getting the benefit from it! Heck, the marketing you did last year will drive half your sales this year, too, so it’s much better than a 10% cost to sales ratio!”
Fiona Finance (to Mark): “Why did you invite him?”
Marketing Mark: “Look, Shell is a shill, but he has a point. There is a ton of lifetime value in our customer base, which is why we can really afford to lose money on customer acquisition because it pays us back in the long run!”
Why Aren’t We Turning More Of A Profit?
Fiona Finance: “In the long run, we all die. If you geniuses have been so smart at spending money to drive business profitably the last few years, and there is so much customer loyalty paying us dividends after the initial acquisition, why do we have so little profit?”
Marketing Mark: “Ummm, well … umm.”
Shell the Shill: “Another round of drinks?!?”
Fiona Finance: “I’ll tell you why. The revenue doesn’t just have to cover the cost of goods, fulfillment and marketing expense. It also has to cover all the overhead of the business! It has to cover buildings, online assets, administrative costs, employee base salaries, IT infrastructure, your salary, your staff, and on and on. Oh, and the shareholders would like to make a little money, too; imagine that!”
Marketing Mark: “Okay, okay, but it’s different when you look at it as an incremental investment. You wouldn’t burden an incremental sale with all that overhead expense, right?”
Fiona Finance: “What do you mean?”
Marketing Mark: “Suppose my team found a way to reach a new set of customers. Suppose we could bring in those customers at a 35% cost-to-sales ratio, and they’re totally incremental purchases. Would you take that deal?”
Fiona Finance: “Hmmmm, interesting. Your point is: It doesn’t really change our G&A costs to make that deal. We don’t need more stores, a bigger warehouse, a website upgrade, more administrative staff and so on; we just need to cover the cost of fulfilling the additional orders, and the rest is profit.”
Marketing Mark: “Exactly right!”
Shell the Shill: “Bartender! Another round of drinks! And can we have some menus?”
When Is Incremental No Longer Incremental?
Fiona Finance: “But where does that logic end?”
Marketing Mark: “Huh?”
Fiona Finance: “What happens as that new program gets to be material?”
Marketing Mark: “What do you mean?”
Fiona Finance: “Well, let’s say that new program gets to represent half of our business. That would suggest a good chunk of the staff costs, the building costs, the websites, apps, et cetera, are being used to support that operation. At what point does it have to start sharing some of the overhead burden?”
Marketing Mark: “Okay, right. I see. But would you agree that if it’s a relatively small part of the business, you could reasonably ignore those costs, and that perhaps if the program scaled significantly, the overhead costs of the business wouldn’t scale linearly? I mean, we’d only need one CMO, right?”
Fiona Finance: “I certainly agree that it can be safely absorbed to some level of scale, but how much is a tough question. With respect to your last point, I’d guess the one CMO would want to get paid twice as much (wry smile).”
Shell the Shill: “Hey, that’s great, and I’ve got a million ideas of how we should spend the extra budget!”
The Eternal Question: What’s Working, What’s Not?
Fiona Finance (ignoring Shell): “Here’s the thing, though. How do we know that any marketing program is driving incremental revenue? The P&L says our marketing efforts aren’t uniformly terrifically successful. Some of your marketing programs may be throwing off money, but some of them — almost by definition — must be wasting it. How do we know which is which?”
Marketing Mark: “Well, there is sort of a solution to Wanamaker’s puzzle. Media mix modeling can give us a pretty good directional sense of where money should be best spent: where we’re spending too much, where we might be overspending. It’s not cheap, and it’s not perfect, but it’s something.”
Fiona Finance: “That would be something worth looking into. Can Shell’s agency do that?”
Shell the Shill: “Hey, look at the time, gotta run! Remember: ‘Ya gotta spend money to make money!’”
Marketing Mark (to Shell): “See ya, Shell.”
Marketing Mark (to Fiona): “For some reason, Shell has always advised against media mix modeling.”
Fiona Finance (with knowing smile): “You don’t say!?”
Marketing Mark: “Well, it’s not that we shouldn’t trust him. It’s just that his company’s roots are in creative strategy, not hardcore quantitative methods.”
Fiona Finance: “I have to admit this subject is a bit more complicated than I thought.”
Marketing Mark: “It’s more complicated than I thought, too.”
Both in unison: “We should talk more often!”
Fiona Finance: “Can we do this without Shell next time?”
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