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Marketing productivity: Issues and analysis

Article in Journal of Business Research · May 2002

DOI: 10.1016/S0148-2963(00)00164-8 · Source: RePEc

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M a rk e t ing Produc t ivit y: I ssue s a nd
Ana lysis

J AGDI SH N . SH E T H
Charles H. Kellstadt Professor of Marketing
Goizueta Business School
Emory University
Atlanta, Georgia 30322
Phone: 404-727-7603
Fax: 404-325-0091

R AJ E N DR A S. SI SODI A
Trustee Professor of Marketing
Bentley College
175 Forest Street
Waltham, MA 02154
Phone: 781-891-2000

Forthcoming, Journal of Business Research

J une 3 0 , 1 9 9 8
 M a rk e t ing Produc t ivit y: I ssue s a nd
Ana lysis

ABSTRACT 1

THE QUEST FOR MARKETING PRODUCTIVITY 2

RESEARCH ON MARKETING PRODUCTIVITY 2
Limitations of Traditional Perspectives on Marketing Productivity 3
Issues in Productivity Measurement 4
DEFINING PRODUCTIVITY AS “EFFECTIVE EFFICIENCY” 5
Compatibility Between Efficiency and Effectiveness 6
EFFICIENCY LESSONS FROM MANUFACTURING AND ACCOUNTING 7
EFFECTIVENESS LESSONS FROM CUSTOMER SERVICE AND R&D 8
IMPROVING MARKETING PRODUCTIVITY: FUNCTION-LEVEL CHANGES 10
CHANGE FROM MARKET TO CUSTOMER FOCUS 10
CHANGE FROM CUSTOMER ACQUISITION TO RETENTION AND ACQUISITION 11
Customer Loyalty and Marketing Productivity 12
The Need for Process Rather Than Program Thinking 13
IMPROVING MARKETING PRODUCTIVITY: CORPORATE-LEVEL CHANGES 13
MARKETING AS AN INVESTMENT RATHER THAN EXPENSE 14
DEFINING MARKET’S OUTPUT AS “CUSTOMER EQUITY” 16
A Systems Oriented Approach to Modeling and Measuring Customer Equity 17
BROADENING MARKETING’S SCOPE AND BUDGET 19
Resource Deployment to Enhance Productivity 19
Incentive Alignment 21
CONCLUSION 21

REFERENCES 22

ii
 ABSTRACT
The marketing function’s fundamental problem today, we believe, is low productivity: costs are
rising even as most indicators of marketing effectiveness are sliding. Marketing must focus on
delivering effective efficiency: delivering greater value to customers and the corporation at
lower cost.

Marketing can become more efficient by adapting approaches that the operations and
accounting functions have refined. From operations, marketing can learn cycle time reduction
and statistical process control. From accounting, marketing can learn more sophisticated cost
accounting methods, as well as the value of having well defined rules and regulations
governing the function.

Marketing can becoming more effective by becoming more customer-oriented, in the way that
highly successful customer service operations are. The key elements leading to greater
effectiveness are database technology, the use of “frontline information systems,” better
responsiveness and courtesy, and the competence and professionalism of customer-contact
personnel.

Two fundamental mechanisms at the functional level are important. First, marketing’s focus
must change from markets (aggregates) to customers (individuals). Second, marketing must
explicitly define its objective as customer retention as well as acquisition. Making these two
changes requires a major shift in the way in which the marketing function is organized and
managed.

In addition to these changes at the functional level, two additional changes are needed at the
corporate level. First, corporations should treat marketing as an investment rather than an
expense. Adopting this view would put greater responsibility for stakeholder value creation on
marketing. We suggest a systems modeling approach that is useful in assessing marketing’s
costs and resulting contributions to corporate value creation.

Second, marketing’s domain (and thus its budget) should explicitly include direct control over
all activities that have a significant impact on customer acquisition and retention. This would
require that the functions of sales, customer service, new product development and pricing (all
of which are only indirectly controlled by marketing in many corporations) be treated as part of
marketing. Marketing must quarterback the customer-centered teams that include these and
other business functions such as operations, finance and accounting.

It is not enough, however, to broaden marketing’s responsibilities and adjust its budget
commensurately. The marketing function will have to change its culture, adopt incentive
schemes that transparently align individual compensation with the achievement of efficiency
and effectiveness, and invest in infrastructural elements that enable it to better accomplish its
mission.

1
THE QUEST FOR MARKETING PRODUCTIVITY
As we approach the millennium, the marketing function is under intense scrutiny and
escalating criticism from many quarters. CEOs are questioning whether marketing adds value
to the corporation and its shareholders commensurate with its costs. Several respected
consulting firms have weighed in with analyses suggesting that the marketing function is
seriously failing in its fundamental objectives. The marketing academic community is
introspectively contemplating the state of the discipline, the soundness of its intellectual
foundations and its raison d’être within the corporation.

While many factors contribute to a sense of marketing malaise, we believe that one important
factor is that the marketing function has paid inadequate attention to the vital issue of
productivity: the ratio of marketing output over input. On the input side, much of marketing’s
spending has been driven by incrementalism (adjustments to previous years’ spending levels)
and parity-seeking with competitors. On the output side, marketing has long professed an
inherent lack of accurate measurability in many of its key outputs.

Research on Marketing Productivity

The marketing function has long been viewed as inherently inefficient, given the nature of its
objectives, domain and tools. Measuring marketing efficiency and productivity was believed to
difficult, if not impossible. For example, in 1948, Nil Houston of the Harvard Business School
wrote in his dissertation, “..a quantitative assessment of the efficiency of marketing cannot be
made” (Houston 1948).

Marketing productivity was the subject of considerable research in the accounting profession
during the 1950s and 60s. Schiff & Schiff (1994) conducted a thorough literature search on
marketing cost analysis. They found that during the 1950s and 1960s, most cost accounting
textbooks devoted a chapter to distribution costs, which covered many of the costs now
regarded as marketing costs. More than a thousand research articles were published during
that time describing approaches to analyzing marketing costs, and techniques to measure
profitability by product, channels of distribution, order size geographic market areas, etc.

A recent review of research published in the Journal of Marketing over its history identifies the
1946-55 period as being characteristized by the perspective of “Marketing as a Managerial
Activity” (Kerin 1996). The key thrusts of published research during that period were
improvements in marketing institutions and system efficiency and the achievement of greater
productivity of the marketing function. Productivity analysis focused almost solely on cost
analysis; there were 28 articles published in the journal in this period that dealt with distribution
cost analysis or functional-cost accounting.

During the 1970s and 1980s, cost and management accounting texts greatly reduced
coverage of marketing cost analysis. The number of research articles addressing marketing

2
cost analysis dwindled to less than a hundred. Most articles that were published dealt narrowly
with physical distribution or logistics, rather than marketing costs in their totality. The literature
search did not uncover any empirical studies on management practices in marketing cost
analysis during this period.

In the 1990s, the cost accounting area has seen a small resurgence of interest in marketing
cost analysis, primarily driven by a need to improve decision making in an era when marketing
costs have been rising even as other costs have fallen. The marketing literature, on the other
hand, has seen few recent publications directly addressing issues central to marketing
productivity.

Limitations of Traditional Perspectives on Marketing Productivity

Marketing productivity has traditionally been viewed purely in terms of efficiency. The early
emphasis in trying to improve marketing efficiency was predominantly to attempt to minimize
marketing costs. This was driven by the recognized difficulty of adequately measuring the
output of marketing; it was also due to an implicit belief that marketing did not create value in
any tangible sense, and hence was an activity on which the minimum necessary amount of
resources should be expended. In his dissertation on the subject, Robert Buzzell (1957)
vigorously challenged this belief, and today we have ample evidence that judiciously expended
marketing resources can be tremendously productive.

Marketing cost analysis is important but relatively sterile; it can remove obviously misallocated
marketing expenditures (for example, to acquire customers that are highly likely to switch out
within a short period of time). Too often, though, marketing costs can be reduced, but at the
direct expense of customer satisfaction – a Faustian bargain indeed, akin to seeking
productivity improvements in a workforce by indiscriminately laying off a certain percentage.

Marketing costs are far more readily measurable than marketing effects, and have thus been
the focus. The inadequacies of this analysis were obscured by the fact that the outside world
was relatively placid; competitive intensity was low, and many basic needs of customers were
yet to be satisfied.

In addition, productivity measures were crude and disjointed rather than holistic; they
measured the impacts of different marketing instruments (such as advertising) separately. The
measures were also at the mass market level; subsequently, as marketing moved in that
direction, measures were developed at the segment level.

Some marketing measures of value for productivity analysis were estimates of various kinds of
elasticities (advertising, price etc.) measured at the market level. While this analysis was
certainly useful at the aggregate market level, it still hid a great deal of inefficiency in the
system and imposed very low hurdles for marketing spending. As long as the impact of
marketing spending exceeded its cost, elasticity analysis implied, that spending was justified.

3
Its aggregate nature meant that elasticity analysis hid the fact that only a small number of
customers may be driving the economics of the business. For example, a few highly profitable
customers may be subsidizing many less profitable or unprofitable ones.

Stevenson, Barnes and Stevenson (1993) suggest that traditional accounting procedures, in
the pursuit of uniformity and simplicity, have provided marketing with invalid and inaccurate
information. As a result, marketing decision makers are often misled about true costs, and
may thus develop poor strategies and make bad decisions.

Issues in Productivity Measurement

As Buzzell (1957) pointed out, marketing does not produce anything tangible; rather, it
performs functions around goods and services. This makes marketing productivity very
difficult to measure. Further, many functions that are performed by marketing may over time
become sufficiently routine that they become absorbed into other functional areas. For
example, many food products used to be sold in bulk to retailers, who would then sell to
customers in smaller packages. When manufacturers began shipping their products in
multiple sizes, a marketing function became a manufacturing function. Over time, this type of
shift can cause marketing productivity to appear to be diminishing. Most such manufacturing
changes are initiated by marketing; this “problem” may thus become even more acute in the
future, as more companies adopt “mass customization” approaches to manufacturing, and
many of marketing’s value-adding contributions are performed by manufacturing.

Notwithstanding these challenges, we believe there is so much to be gained from

improvements in marketing productivity that even imperfect measurements can be of great
value. However, we must measure the right things; otherwise, our attempts at improvement
will, by definition, be misdirected.

A systematic and quantifiable measurement process has been difficult to achieve for marketing
productivity. Some of the key responsibilities of marketers, such as the ability to recognize
new opportunities, are difficult to quantify but are of equal or greater importance than other
more tangible goals such as increasing market share.

There is no one-size-fits-all way to measure marketing productivity across industries; the

business and competitive context matters a great deal. The variables that determine
marketing productivity are very different for a new company or product compared to a well
established firm and a mature product. Companies in a new industry will differ from those in a
mature industry. Absolute measures are meaningless; measures must be considered relative
to feasible options, the performance of direct competitors and the company’s own past
performance. A marketing campaign may appear to be quite effective; however, there may be
many alternatives that could have been more effective or efficient, but were never considered.
Determining the feasible set of options is therefore very important.

4
In measuring marketing productivity, care must be taken to ensure that measures do not yield
spurious relationships. This can happen because of the multitude of factors that can impact
upon the variables of interest. Market share could increase due to the demise of a competitor.
Sales may grow due to an upswing in the economy. It would be inaccurate to use such
measures in relation to marketing productivity. To avoid this, it is useful to consider multiple,
independent indicators of efficiency and effectiveness.

Multiple measures are also needed because we need to understand marketing performance as
it pertains to customer acquisition and retention. We also need to understand marketing
productivity at the individual, group and market levels. Finally, we need to measure marketing
costs and contributions on an annualized basis as well as in terms of their long-term impacts.

Defining Productivity as “Effective Efficiency”

While various conceptual and operational definitions of marketing productivity exist, there is no
agreed upon definition. For example, Hawkins, Best & Lillis (1987) defined marketing
productivity as “relative market share times relative price divided by marketing outlays.”
Thomas (1984) identified two aspects of marketing productivity. The first relates to the
management of the marketing mix. The second pertains to the efficiency of marketing
spending. The overall productivity of marketing is clearly related to the way a firm manages
both of these elements; it must develop a marketing mix appropriate to the segments that it
seeks to serve, and then efficiently execute the specific marketing actions necessary to
achieve the desired marketing objectives.

In other words, the firm must create the “right” product, set the “right” price for it, distribute it
using the “right” distribution channels and the “right” number of outlets, and achieve the “right”
level of informational and persuasive communication. Having defined the meaning of “right” in
each of these contexts, it must then efficiently expend resources to achieve the desired results
in each of the areas. The efficiency of these expenditures must be measured relative to
competitors within its own industry, as well as relative to benchmarks established in similar
industries.

This suggests that a firm should first strive for effectiveness, then seek efficiency in the
achievement of that effectiveness. The effectiveness and efficiency dimensions of productivity
are multiplicative; neither is enough by itself, and one cannot compensate for shortcomings in
the other.

We define marketing productivity conceptually as the quantifiable value added by the

marketing function, relative to its costs. Marketing’s ability to add value results from its
success in retaining and growing existing customers, as well as generating profitable new
customers. It follows that a good measure of marketing productivity must include the
economics of customer acquisition as well as retention.

5
Marketing productivity as we define it includes both the dimensions of efficiency (doing things
right) as well as effectiveness (doing the right things), as depicted in Figure 1. Ideally, the
marketing function should generate satisfied customers at low cost. Too often, however,
companies either create satisfied customers at unacceptably high cost, or alienate customers
(as well as employees) in their search for marketing efficiencies (the classic example of this is
telemarketing; with $40-60 billion a year in estimated telecommunications fraud in the U.S.
alone, this has fast become the more efficient way ever devised to alienate customers). In far
too many cases, the marketing function accomplishes neither.

Insert Figure 1 About Here

Compatibility Between Efficiency and Effectiveness

Day, Jocz and Root (1992) identified the apparent tradeoff between a stronger market
orientation and improving marketing productivity. As they put it, “Subtle resistance to top
management entreaties for greater market orientation is often rooted in the perception that the
benefits of improved customer relations are ephemeral while the costs of extra attention to
customers are real.”

Anderson, Fornell & Rust (1997) examined the extent to which the pursuit of customer
satisfaction might conflict with the drive to raise productivity. Their study investigated the
conditions under which there are tradeoffs between customer satisfaction and marketing
productivity, and concluded that such tradeoffs are most likely for services and least common
for manufactured goods. In other words, service firms are hard pressed to improve customer
satisfaction simultaneous with increasing productivity, because the latter requires a reduction
in assets that have direct bearing on customer satisfaction. To a large extent, this is because
the demands for customization tend to be higher in service contexts, while standardized
products are perfectly acceptable to most customers of manufactured goods.

The implicit trade-off between marketing spending and customer contentment must be broken
if marketing is to achieve nontrivial improvements in cost-benefit performance. That this can
be achieved may be demonstrated by examining the marketing spending levels of some of the
companies with the highest levels of profitability and customer satisfaction; as often as not,
such companies allocate fewer resources to marketing than their direct competitors (Reichheld
1996).

What is needed is a design for a marketing system that delivers both efficiency (lowered
marketing costs for a given set of outputs, the traditional understanding of productivity) and
effectiveness (greater customer satisfaction and retention).

Marketing today resembles the manufacturing function in the “pre-quality” days. Before the
TQM philosophy took root, the manufacturing process often resulted in large numbers of
defects (which were mostly ignored), a great deal of wastage, high costs and alienated

6
workers. The TQM philosophy changed much of that; a similar change is still awaited in
marketing (though a few researchers have discussed “Total Quality Marketing,” the idea is still
largely unexplored).

Efficiency Lessons from Manufacturing and Accounting

To improve efficiency, marketing can adapt some successful practices and mind-sets from the
fields of manufacturing and accounting.

The manufacturing function in the past faced issues similar to those confronting the marketing
function today. The function has overcome its problems to become very efficient and
productive in the post industrial age, through innovation and adaptation. Marketing has much
to learn from this experience. For example, two contributions that manufacturing can make to
marketing are cycle time reduction and the use of statistical process control to lower the
number of defects.

Cycle time reduction: The operations area has spent considerable time and resources on
reducing the “white space” or idle time between activities, and on redesigning activities and
processes to increase speed and lower costs. Supply partnering has enabled operations to
function very effectively with minimal levels of inventory. The new product development cycle
has been greatly speeded up through the use of concurrent engineering. Switchovers
between products has been speeded up through the use of information technology and flexible
automation.

Statistical process control (SPC): The adoption of SPC by operations has enabled
companies to greatly reduce the incidence of defective products, thus increasing efficiency.
The essence of SPC is to adjust and closely monitor the production process at each stage,
rather than attempting to ensure quality by more stringent inspections at the end of the
production process. Likewise, marketing would benefit greatly from a more formal adoption of
a process control viewpoint. In general, as its focus moves from customer acquisition to
retention and acquisition, marketing must move from a program orientation (creating the right
“recipe” to attract the largest number of customers) to a process orientation (developing new
ways of doing business on an ongoing business with customers to improve system-wide
performance).

The common thread in these changes is a move from an aggregate to a disaggregated view of
the world.

From the accounting discipline, two key areas for emulation are the use of sophisticated cost
accounting techniques and the adoption of well defined rules and regulations that govern the
discipline.

Cost accounting: Marketing needs to get a much better handle on its costs than it currently
has. Costs have to be allocated in a defensible and consistent manner across customers and

7
activities. In recent years, accounting has made major strides in the areas of activity-based
costing and its variations. New thinking in target costing is also important for marketing to
understand and adapt.

Agreed Upon Standards: One of accounting’s real strengths is the consistency with which it is
applied. Through the FASB and other governing organizations, the accounting profession has
evolved a highly detailed set of rules and regulations that govern how accounting is to be
conducted, especially in the audit process. This makes accounting-generated information
more readily comparable over time and across companies and industries. Marketing needs to
evolve similar rules and regulations governing many of its measurements and auditable
activities.

Effectiveness Lessons from Customer Service and R&D

On the effectiveness dimension, we believe that marketing can learn from the areas of
customer service and R&D management. Changes in the latter function were discussed
earlier in the paper. From the customer service area, marketing can learn three things:
leveraging database technology, the value of front-line information systems and the
importance of having the right employees.

Leveraging database technology: Customer service departments have led the way in making
productive use of database technology to directly benefit customers. Marketing’s focus on
using database technology has been heavily geared to better targeting of prospects rather
then the delivery of superior value.

Front-line information systems: A vital component of ongoing business success is the

provision of cutting-edge information technology to sales, customer service and other front-line
personnel. Figure 2 depicts the importance of “front-line information systems” or FIS. As it
shows, the most companies that are the most successful at achieving dramatic impacts
through information technology are those that deploy it at the front lines, where it can directly
impact customer satisfaction. The information that companies need for management control
purposes (the domain of traditional MIS and EIS systems) is collected as a by-product of doing
the work.

Insert Figure 2 About Here

The right employees: The key employee attributes that contribute to customer service
excellence are responsiveness, courtesy, professionalism and competence. The marketing
literature gives short shrift to the role that front-line employees play in fostering customer
loyalty and thus profitability. Evidence suggests that retaining the right employees can
contribute significantly to customer loyalty, which in turn leads to greater profitability.

8
Reichheld (1996) suggests that employee productivity rises over time due to two factors:
vertical and horizontal learning. Vertical learning refers to technological and process-related
changes that allow employees to become more productive. Process redesign, automation and
the use of sophisticated front-line information systems can greatly raise employee efficiency,
while maintaining or increasing customer satisfaction and thus retention. Horizontal learning
refers to time-based learning; the longer an employee stays with a firm, the more productive he
or she is capable of being (though the improvements do plateau after several years). The
combination of vertical and horizontal learning can greatly increase employee productivity.

In some industries, however, such productivity gains do not translate into cost reductions,
because employees harvest the gains for themselves. Therefore, there is a strong need to
align and adjust incentive systems for employees to achieve dramatic productivity
improvements and then share them with the company.

This doesn’t happen in most companies; if employees become more productive, their workload
is adjusted upwards without any significant adjustment in their income. This is a major
disincentive for employees to seek or reveal productivity enhancements.

The second area from which marketing can learn how to increase effectiveness is R&D. It is
interesting to note that many of the issues surrounding the management of the R&D function
are similar to those facing the marketing function. For decades, companies spent large
amounts on R&D with low levels of accountability. In most companies, it was difficult to
discern the impact of R&D spending on business performance. The lion’s share of the output
of R&D departments never made it into commercial applications. Most R&D efforts had little
market relevance, and marketers had little knowledge or understanding of what was being
done in the R&D labs of their companies.

Rather than cut R&D spending across the board, many companies have changed how they
manage it. Key changes include:

§ Forcing the R&D department to seek most of its funding from operating divisions rather
than from the corporate budget; this immediately forced a higher level of relevance on R&D
units.

§ Freed corporate divisions to contract out R&D work to outside entities if the internal R&D
unit was not able to meet their needs in a timely and cost effective manner;

§ Freed R&D departments to market their capabilities and output to outside customers
(provided these are not direct competitors);

§ Treating R&D as a capital investment rather than an expenditure;

§ Some companies turned the R&D function into a profit center; Texas Instruments, for
example, generates approximately $1.4 billion a year in licensing revenues from its
technologies, while spending under a billion dollars a year on R&D.

9
§ Rotating R&D personnel through marketing and vice versa; this facilitated the development
of more appropriate technologies and the transfer of technology already developed.

As we discuss later in this paper, these changes foreshadow some changes that are likely to
become necessary in marketing.

IMPROVING MARKETING PRODUCTIVITY: FUNCTION-LEVEL CHANGES

In order to make significant improvements in marketing productivity, changes are needed at
two levels: at the marketing function level and the corporate level.

Within the marketing function, two broad shifts are necessary: changing from a market focus to
a customer focus, and from a customer acquisition orientation to a balanced emphasis on
retention and acquisition.

Change From Market to Customer Focus

Over time, the marketing function is moving from mass marketing to segment marketing and
ultimately to account marketing. This was not as possible in the past as it is today, given the
lower costs and better capabilities of the supporting technologies that are required.

Marketing’s focus should shift from markets to customers, i.e. from aggregated representations
of groups of customers to individual customers, be they persons or companies. Companies
will use direct channels to reach most customers above a certain size threshold; others will be
reached via intermediaries that are themselves treated as customers, but are in fact proxy
representations of markets. Thus Wal-Mart is both a customer of P&G’s as well as a large
market, now representing over $120 billion a year in annual sales. From P&G’s perspective,
achieving effective market coverage requires establishing long term relationships with selected
“gate-keeper” retailers, each of which reaches a large and loyal customer base.

Consumption patterns in many industries are highly concentrated; for example, about .02
percent of the U.S. population accounts for 25 percent of all car rentals in the country
(Peppers and Rogers, 1993). The value of targeted marketing efforts is greatest in such
industries, allowing firms to increase profits by deselecting some customers. Marketing costs
are often high because of baggage that such unprofitable customers bring to the process.
Removing those customers, or at least lowering the resource allocation to them, can
immediately impact profitability.

A market rather than customer perspective hides a great deal of inefficiency. A small group of
customers typically account for a large share of revenues and an even greater share of profits.
These customers effectively subsidize a large number of marginal and, in many cases,
unprofitable customers; the costs to serve the latter are comparable and sometimes higher
than they are to serve the most profitable customers.

10
Moving to a customer orientation enables a company to focus is resources on the most
profitable customers; it also makes the company less vulnerable to focused competitors that
may seek to “cherry pick” its most attractive customers (depicted in the Figure 3 as “low

Insert Figure 3 About Here

Moving to account marketing or individualized marketing implies changes in marketing

programs, processes, systems and measurements, all of which have to be considered at the
individual level. In making this transition, effectiveness is enhanced or maintained while
efficiency is improved significantly. As Treacy (1993) has suggested, “Without innovation, all
marketing investments turn to fat. New marketing techniques peak in efficiency when the third
or fourth competitor adopts them. Major investments (such as large sales forces, product
proliferation, service bolt-ons) continue because we do not know how to disengage. Marketing
needs to surgically retreat via micromarketing.”

Keeping marketing’s focus primarily on customers and less on markets imposes greater
discipline and accountability on the function. Markets are amorphous, undemanding,
impersonal, devoid of feelings but ultimately unforgiving. Customers are tangible, emotional,
potentially loyal, demanding but capable of forgiving. It is easy to lose your edge and drift out
of focus when dealing with markets; it is well nigh impossible to do that with customers and not
get an earful in the processwell in time to do something about it.

Change from customer acquisition to retention and acquisition

Evidence is quite conclusive that it costs far more to acquire a new customer than retain an
existing one. The question that arises is whether it should be marketing’s responsibility to
retain customers once they are “in the fold.” The traditional view was that it is not; once
acquired, customers are served through operations, logistics, customer service etc. For “one
and done” situations, wherein customers make a single purchase over a long period of time,
this would appear to be a reasonable way to organize responsibilities for customer care. In
situations where revenue flows from the customer to the company continue over time, keeping
the customer “sold” becomes imperative, and marketing’s continued involvement becomes
essential. Marketing’s focus becomes developing relationships with customers rather than
processing one-time transactions.

Given that customer retention costs less than customer acquisition, including existing
customers in the productivity equation could become a quick accounting exercise in making
marketing appear more productive. The essential element, then, is that reconceptualizing
marketing’s role to include customer acquisition and retention should lead to greater benefits to
the organization than the formerly separated structure did. These benefits could accrue from
factors such as increased retention rates, more cross-selling, expanded revenues from value-

11
added services and the development of revenue-seeking partnerships with selected
customers. In other words, the purpose of the exercise is not to reapportion existing value but
to create new value. Therefore, the expected contribution from “marketing-owned” customers
should substantially exceed contribution from the same customers when managed by other
entities within the corporation.

Pre-acquisition marketing efforts should be highly targeted while post-marketing (after

acquisition) should be increasingly customized over time.

If customers purchase in a product category very infrequently, if the company offers no other
products that are of interest to them, and if word-of-mouth communication has little impact of
purchasing behavior in the category, marketing scope could reasonably be limited to the
acquisition of profitable customers. However, if any of these conditions are violated, and if the
annual revenue stream associated with the typical customer is sizable, then marketing scope
should be defined to include acquisition as well as retention.

Customers must be viewed under this new paradigm as an extended part of the company
itself, providing input, for example, into new product design, testing of new advertising
messages etc. Managers must be sensitive not to “overmarket” to this valuable group; any
post-acquisition marketing to them must be highly customized to each individual’s preferences
based on prior purchasing history and stated preferences.

Customer Loyalty and Marketing Productivity

Reichheld and Sasser (1990) empirically demonstrated the link between customer loyalty and
firm profitability. They analyzed more than 100 companies and concluded that the companies
can boost profits by 25-125% by increasing retention by 5%. Greater customer loyalty
produces spectacular results in industries as varied as banking, publishing, industrial
laundering, advertising agencies and many others. In insurance brokering, a five point
improvement in retention translates into a doubling of margins. Credit card issuer MBNA found
that a 5% increase in retention increased per-customer profit by 125%. Insurance company
State Farm found that a 1% increase in retention could eventually increase its capital surplus
by more than $1 billion.

According to Reichheld (1996), the “customer loyalty effect” has two dimensions: the
“Customer Volume Effect” and the “Profit-Per-Customer Effect.” The Customer Volume Effect
measures the impact of loyalty on a firm’s inventory of customers. Over time, as attrition rate
drops, the number of customers in "installed base" grows. Consider two companies: A & B,
both acquiring customers at the rate of 10% per year. If company A has a customer retention
rate of 95% and company B has a customer retention rate of 90%, company A will double in
size in 14 years, while Company B stays the same size. A 10% retention advantage translates
into a doubling every seven years.

12
The Profit-Per-Customer Effect is usually more significant than the Customer Volume Effect.
This is because the longer a customer stays with a company, the more profitable that customer
is. The economic consequences of losing mature (and thus highly profitable) customers and
replacing them with new ones (on which the firm makes little profit or incurs a loss) are
dramatic. The operating costs of serving customers decline over time, since customers
become more efficient as they get to know a business, and companies become more efficient
as they get to know customers. For example, financial planners log five times as many hours
on a first-year client as on a repeat client. High employee turnover therefore leads to high re-
startup costs, to recapture client knowledge and move down the learning curve.

The Need for Process Rather Than Program Thinking

As companies move to a relationship approach, they must align their business processes to
move to a much higher level of efficiency. The long-term nature of relationships, coupled with
the very significant cash flows associated with them, encourages both sides to invest in
infrastructural assets that are specific to the relationship.

This is depicted in Figur4 in the well known “bow tie” model, which was first manifested in the
relationship between P&G and Wal-Mart. As it shows, the relationship between the
companies, rather than being limited to the sales and purchasing areas, spans a number of
operational areas within both companies.

Insert Figure 4 About Here

IMPROVING MARKETING PRODUCTIVITY: CORPORATE-LEVEL CHANGES

With the introduction of new business models such as virtual organizations and successful
experiences with outsourcing and the use of third party distribution channels, analysis of
marketing productivity should include the analysis required to answer the question: Is this the
best way to get the marketing job done? In many instances, innovations in designing the
optimal configuration for the location of marketing activities could require major organizational
changes.

Marketing’s role in the modern corporation has evolved in a number of ways over time, as
detailed by Webster (1992). Many activities that used to be marketing sub-functions have
been “taken away” from marketing in many corporations, including product development,
pricing and logistics.

The marketing function has been a somewhat passive spectator as these changes have been
implemented. We believe that marketing needs to convince senior management at the
corporate level to treat marketing as an investment rather than an expense. Marketing also
needs to articulate a new role for itself and make the case for broadening its scope and
budget.

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Marketing as an Investment Rather Than Expense
In most companies, sales and marketing expenditures are several times greater than capital
expenditures. Yet, capital expenditures are subject to a far greater amount of analysis and
evaluation than marketing expenditures.

Marketing activities (with the exception of sales promotion) involve a substantial lag between
action and effect. When marketing is treated as an expense, the causality often becomes
reversed, as marketing budgets are often determined by sales forecasts. Treating marketing
as an investment forces companies to come to grips with the temporal relationship between
marketing actions and marketplace reactions.

Slywotzky and Shapiro (1993) provide several arguments in favor of treating marketing
spending as capital outlaysinvestments that drive revenue over timerather than annual
expenses. This is more than just a reopening of the old debate about whether advertising is
an expense or an investment. First, it covers virtually all aspects of marketing expenditure.
The arguments in favor of treating marketing spending as investments in the long-term health
of the company are much stronger today. This is primarily driven by the widespread
acceptance in recent years of the relational paradigm in marketing. This should translate into
a long term assessment of resources invested in building, maintaining and growing customer
relationships.

Questions asked by expense-driven Questions asked by investment-oriented

marketing manager marketing manager

• What are my projected sales figures for the • What are my long-term marketing goals?
upcoming year? • What returns am I earning from my marketing
• Are my dollars of advertising per case on par investment?
with my competitors’? • What is the quality of my market share—do I
• Are my spend ratios in line with industry have customers who will stay with the product
norms? for many years?
• Am I gaining or losing share this year? • Which new customers should I seek, and which
ones should I avoid?
• How can I reduce my marketing expenses?
• How can I leverage my investments so that I
can reduce customer acquisition costs and
maximize my returns?
Source: Slywotzky and Shapiro (1993)

Well spent marketing resources applied to a brand in its early years can build a stock of value
that can be sustained or even enhanced with very small amounts of spending. Marketing
investments can pay off particularly well if they are well timed and well targeted. Investments
made at the right stage of the product life cycle and directed at the most profitable customers
deliver superior returns.

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Sustaining a viable market position requires far fewer resources than establishing a new one.
Unfortunately, many companies sabotage their marketing investments by engaging in reckless
promotional activity. This causes erosion of the accumulated marketing equity, which leads
even deeply engrained brands to continue to spend heavily on advertising.

Marketing investments should be geared towards developing a quality customer base and the
infrastructure required to serve them with continually increasing levels of efficiency and value
creation.

Some customers have specific needs that can only be met through marketing investment. This
is becoming particularly true as customers partner with their suppliers to meet the needs of
their own customers. The return on marketing investments made to serve and cultivate such
customers can be enhanced as they reduce the number of suppliers.

Perkins (1993) points out that there are two important obstacles to treating marketing as an
investment. First, the right accounting tools do not exist to enable marketers to separate
marketing spending into proportions that are responsible for driving immediate sales and those
that relate to building for the future. How should each year’s spending be allocated against
subsequent years. Second, major marketplace shifts can render cumulative marketing
investments suddenly worthless.

While these are clearly legitimate concerns, they reflect more the need for the accounting
profession to develop a new discipline of “marketing investment accounting” (in conjunction
with the marketing discipline) than an indictment of the fundamental logic of treating marketing
as an investment. Second, the risk of making uneconomic investments exists in every context,
and would not be unique to marketing. As with any other investment, poor decisions about
how much to spend and what to spend it on can result in extremely poor payback rates.
Clearly, certain types of marketing investments represent higher levels of risk than others, and
should be avoided. Well developed techniques for risk management can be applied to
marketing investments as they are to other kinds of investments.

Marketing investments are not only directed at acquiring and retaining customers; they also
include activities such as building brand equity and achieving market coverage. Marketing is
also concerned with the creation of new products, which may be offered to new customers,
existing customers or both. Of course, each of these plays an indirect role in customer
acquisition and retention.

Sales promotion too can be treated as an investment if it is strategically implemented as a

targeted customer acquisition exercise. In reality, most sales promotions are so untargeted
that they represent little more than giveaways to customers that would have purchased the
product anyway or non-customers that are unlikely to stay with the company beyond a single
purchase cycle.

15
Marketing productivity must also be viewed in light of the alternative use of resources. All
resources have an opportunity cost for their use, and if that use is not productive, there is a
good possibility that those resources could be better used elsewhere in the company. It is
important, then, that the measurement of marketing productivity be done in a way that allows
for these kinds of assessments.

Treating marketing as an investment requires major changes in how accounting is done for
marketing, how budgeting is done, tax planning etc. The change is clearly not a trivial one.
One of the key aspects of making the change is to define “customer equity” as the output
variable of interest.

Defining Market’s Output as “Customer Equity”

Srivastava, Shervani & Fahey (1998) have developed a framework for defining and measuring
the value of “market-based assets,” defined as assets that are based on the interface of the
firm with its external environment. Such assets include customer relationships and strategic
partner relationships. The authors suggest that these assets increase shareholder value by
accelerating and enhancing cash flows, reducing the volatility and vulnerability of cash flows
and increasing the residual value of cash flows.

Blattberg & Deighton (1996) suggest that marketing’s success be measured in terms of its
contributions to what they term “customer equity.” A company’ marketing budget can be
allocated between customer acquisition and retention activities in varying proportions; the
optimal split is that which maximizes customer equity. Customer equity is measured as the net
present value of all customers (existing and new) at the company’s target rate of return for
marketing investments.

All marketing-related investmentsin new product development, new programs, new customer
service initiativescan be evaluated based upon their impact on customer equity.

The authors suggest the use of decision calculus to estimate response functions for customer
acquisition and retention. Managers are asked to provide estimates of current spending per
prospect and conversion rate; they are then asked to estimate what the likely conversion rate
would be at a saturation level of spending. A simple exponential curve is fitted to these two
data points. Likewise, response curves are estimated for customer retention. Though the
methodology proposed by Blattberg and Deighton is relatively crude, it can still result in useful
insights and an improvement over “seat of the pants” decision making on acquisition versus
retention activities.

Blattberg and Deighton also suggest several ways in which customer equity can be increased
without requiring additional marketing spending:

§ Investing in highest-value customers first;

§ Transform product management into customer management;

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§ Use add-on sales and cross-selling;

§ Look for ways to lower acquisition costs;

§ Track customer equity gains and losses against marketing programs;

§ Monitor the intrinsic retainability of your customers; and

§ Consider separate marketing plans and separate marketing organizations for acquisition
and retention efforts.

A Systems Oriented Approach to Modeling and Measuring Customer Equity

Measuring value added is different than simply looking at profits for a given time period.
Profits are short term. Value is derived from sustainable, longer term benefits to the firm.
These benefits may be financial in nature, such as a stream of cash flows, or intangible, such
as brand equity or goodwill within a community. The valuation of these intangibles must be
measured as best as possible (e.g. “What is the dollar value equivalent to the good image that
this advertisement presents to customers?”) and must include any benefits that are believed to

Systems dynamics is an integrative approach that combines systems thinking and the
principles of cybernetics (Senge 1990). It incorporates causal-loop diagramming (to show
sequences of cause-and-effect relationships) and stock-and-flow diagrams (to represent
systemic effects of feedbacks on the accumulations and rates of flow in the system (Behara
1995). These two representations of a system are coupled in order to simulate the behavior of
the system. Modeling and simulating the system helps managers recognize and understand
the dynamic patterns of system behavior.

Apparently logical responses to business situations can often have unanticipated

consequences, sometimes the opposite of those expected. This is due to “dynamic
complexity,” a common but seldom recognized characteristic of most real world situations. In a
complex world full of interactions, simple actions can cause perplexing, counterintuitive
reactions (Davis and O’Donnell 97). Dynamic complexity results from the way that factors
relate to one another through a series of feedback loops.

The concepts of systems thinking and system dynamics are used by many firms (such as IBM,
Ford, Shell and Coopers & Lybrand) to improve decision making and planning. According to
Jay Forrester of MIT, this activity is doubling about every three years. He suggests that
corporate involvement with system dynamics is under-publicized, because much of the work is
confidential.

Senge (1990) observes that “..it is very difficult for business executives to accept … complexity
because many of them need to see themselves as being in control. To accept it means they
must recognize two things at a gut level: 1) that everything is interconnected, and 2) that they

17
are never going to figure out that interconnectedness.” He identifies some of the key issues
that managers need to be aware of in order to think systematically:

§ They need to focus on interrelationships and processes, not things and events;

§ Dynamic complexity arises when cause and effect are distant in time and space, and when
consequences of actions are subtle, especially over a longer time period;

§ The most obvious solutions are usually short-term and cause more problems in the long
run;

§ Management interventions usually focus on symptomatic quick fixes.

A search of the marketing literature reveals an almost complete absence of research applying
systems thinking to marketing contexts. Meade and Nason (1991) apply a systems approach
to develop a unified theory of macromarketing. Slater and Narver (1995) discuss it briefly in
the context of market orientation and the learning organization.

This gap is surprising in light of the fact that marketing is a discipline that is highly suited to use
of systems thinking concepts and constructs. Marketing decisions have indirect, delayed,
nonlinear and multiple feedback effects. Behara (1995) suggests that systems thinking has
maximum impact when applied to:

§ High stakes issues that require a significant amount of management time;

§ Issues involving high degree of complexity and dynamic behavior;

§ Situations involving multiple interconnected operational issues;

§ Issues that span multiple disciplines;

§ Situations involving chronic problems; and

§ Problem situations that have resisted traditional solutions.

We believe that systems dynamics offers a very useful approach to model the customer
acquisition and retention process. The conceptual model presented in Figures 5a-5d attempts
to capture the impact of marketing spending on customer acquisition and retention. The input
variables are the amounts of marketing resources devoted to acquisition and retention of
customers. The outputs are the revenues realized during the time period of interest (usually
one year) as well as the impact of spending during the time period on the expected net present
value (NPV) of the customer base (which is equivalent to customer equity, as discussed
above). The latter includes the effects of adding customers to the customer base, changes in
revenue per customer and changes in the expected longevity of customers given the churn
rate. When compared with a year earlier figure, this provides a measure of value created by
marketing during the effort period. In some cases, current revenue may be relatively low, but
the NPV goes up significantly, suggesting that the benefits of marketing efforts will accrue in
the future.

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 Insert Figures 5a-5d About Here

In other cases, current revenues may look strong, but the NPV may have remained flat or even
fallen, suggesting that long term performance will deteriorate.

In this framework, marketing productivity can be defined as the ratio of the change in customer
base NPV for a “response period” and the marketing spending during a corresponding “effort

Broadening Marketing’s Scope and Budget

Notwithstanding marketing’s clear need to reduce its costs, we argue here that the scope of
marketing needs to be explicitly expanded to include customer retention in addition to
customer acquisition. This would then require that spending that directly relates to customer
retention needs to come under marketing’s purview as well, in order to ensure that acquisition
and retention are treated in a holistic, integrated manner. The net impact of this should be to
lower overall costs for customer acquisition and retention while improving performance
indicators.

An important reason why this should happen is the mere fact that in most corporations, there is
no direct center of responsibility for customer retention. The activities that are the
determinants of customer retention are widely dispersed under multiple commands. By
imposing a “customer manager” structure, the disparate resources bearing on retention can be
focused and orchestrated more effectively.

Resource Deployment to Enhance Productivity

In their classic book Free To Choose, Milton and Rose Friedman present the matrix shown in
Figure 6 as a framework for evaluating the relative productivity of spending in different
circumstances.

Insert Figures 6 About Here

This framework suggests that resources are spent most optimally when they are “owned” by an
individual and spent by that individual for his or her own purposes. In buying a family car,
individuals are likely spend what they know they can afford and get a car that they are satisfied
with. On the other hand, cell 2 illustrates the case when an individual is able to spend
someone else’s money on themselves. An individual buying an expense account meal is likely
to get what they want (effective) but will probably spend more than if they were paying their
own money (inefficient). In cell 3, the individual is spending a budgeted amount of money
(efficient) to purchase a gift which is unlikely to optimally satisfy the recipient (ineffective). In
cell 4, individuals (e.g. bureaucrats) are charged with spending other people’s money (e.g.
taxpayers) on things that do not impact them directly (e.g. welfare). This kind of spending is
ineffective as well as inefficient.

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Unfortunately, many corporations concentrate a great deal of their spending in cell 4, and very
little in cell 1. For example, centralized procurement departments make purchases for field
units. Corporate R&D dollars are spent with little bearing on the needs of operating units.

Consider how marketing budgets and customer-related responsibilities are typically allocated in
companies. The marketing budget usually covers advertising, sales promotions, market
research and some portion of distribution costs. It may include the cost of the sales force,
though in many companies it does not. It almost never includes the cost of customer service,
and usually does not include product development.

Thus, it would not be unusual to find situations in which sales, customer service and new
product development are funded out of budgets that are not under marketing’s control, and
over which marketing may have minimal influence.

If marketing is charged with maximizing customer equity (i.e., the net present value of the
successful base), it will find that a relatively small portion of the spending occurs in Friedman’s
cell 1. Customer acquisition is impacted by product development and sales, both of which may
be outside marketing’s purview. Customer retention is impacted (among other factors) by
sales (through which expectations are set) and customer service (responsible for delivering on
those expectations). The marketing budget clearly impacts both acquisition and retention, but
that impact may be swamped by the impacts of spending in the other areas.

We suggest that the best way to resolve this is to give marketing both the incentive as well as
the responsibility for increasing the NPV of the customer base, as well as effective control over
all the spending areas that directly impact upon that. To increase marketing productivity, then,
a logical approach would be to expand the scope of marketing (and thus the marketing budget)
to include all activities that directly impact upon customer acquisition and retention. In other
words, marketing should control sales, customer service and new product development, as
well as areas such as pricing in which marketing’s role has also diminished.

Organizationally, this requires decentralization of marketing resource allocation (costs) and

revenue generation to the customer or account level. As much of this as possible should be
controlled by small customer-focused teams, which are charged with getting, keeping and
growing a customer or group of customers. The teams must be given direct incentives to
increase customer profitability, by creating well-designed profit sharing mechanisms that
operate at a local rather than corporate-wide level.

Customer loyalty is often regarded as a marketing issue; however, lasting loyalty can never be
achieved via a marketing program in isolation. A total customer focus is needed across the
total business; loyalty-building efforts across business functions must be complementary. This
implies major changes in the way most businesses are organized and operate. Reichheld
(1996) found that in companies that he terms “loyalty leaders,” 80-90% of spending occurs in
cell 1. This achieves the highest possible level of alignment between self-interest and

20
corporate interests. It also leads to a much more aggressive and creative search for
productivity enhancing innovations. New value is thus created, which is then shared between
the individuals, the local unit and the corporation. On the other hand, laggard companies tend
to concentrate a heavy proportion of spending in cell 4.

Incentive Alignment
The above analysis suggests that there is a need to create transparent incentive schemes to
focus all marketing personnel on the essentials: the profitability of what they do and the
maintenance of high levels of customer satisfaction and retention.

Consider the advertising field. According to Jones (1993), the flat 15% commission, in place
until the 1980s, meant that agencies received all the scale benefits as advertising budgets
rose. This led to overstaffing and windfall profits. It also created an incentive for poor quality
advertising, since higher quality advertisements do not need to be run as often as mediocre
advertisements to achieve the same impact. As advertising budgets fell, and advertisers
simultaneously put pressure on agencies to lower the 15% rate (down to 9% in many cases),
agencies were devastated. Many became highly conservative and myopic, focusing on ways
to preserve their own profitability at the expense of client satisfaction. Advertising agencies
need to move to an incentive-based fee structure, a practice that has been implemented
successfully in Northern Europe (Jones 1993).

Incentive alignment should be a guiding principle for improving marketing productivity. Other
examples include creating sales force compensation schemes to reward customer satisfaction
and retention (as the insurance industry has done in recent years) and incentivizing new
product development teams to create high quality new products in a short time without
consuming inordinate resources.

CONCLUSION
Marketing is the biggest discretionary spending area in most companies; it is also the area
which many companies wish they could devote even more resources to. Yet, there is no
question that marketing dollars are often poorly used, sometimes even to the detriment of the
business they are supporting.

In this paper, we have examined the issue of marketing productivity from a broader
perspective than is usually applied. Marketing productivity problems can be traced to over-
marketing (e.g. advertising, coupons, constant sales, too much reliance on internal sales
forces, over-built distribution systems), under-marketing or mis-marketing. While the
measurement challenge remains a considerable one, we are more concerned here with some
of the fundamental obstacles to the achievement of higher levels of marketing productivity.
Some of these obstacles are within the marketing function, and require a changed orientation
to overcome. More of them are at the corporate level, where its long history of marginal

21
performance has rendered marketing less influential and credible than it should be, given its
vital role in engendering success in the marketplace.

There is a belief that the push for productivity in marketing spending is inherently contradictory
to creating and maintaining a market orientation. In other words, the belief is that being
customer-oriented means having to spend more on marketing. As we have discussed, this is
not necessarily so. The mechanisms we have described should improve both customer loyalty
as well as marketing productivity.

Marketing spending should be opportunity-driven; it should correlate with the size of the
opportunity. Opportunity is usually not reflected in terms of simply dollars. For example, there
is little opportunity for advertising to achieve an impact (and thus be productive) for a brand
which already has a high awareness level and a high “ever tried” level. This requires that the
marketing budgeting for a brand be decoupled from the current revenue level of the brand, and
be coupled instead to the opportunity for revenue and profit growth that the brand presents.

Companies that thrive today have an intimate understanding of and lasting codestiny
relationships with their customers. They place great emphasis on the lifetime value of existing
customers, and strive to make the voice of the customer heard everywhere, from the factory to
the boardroom. Marketing’s role should be central to the achievement of these outcomes.

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