Thoughts

Brands in crisis: Be careful what you cut

May 12, 2020

“Why do CEOs devote so little of their time and intelligence to the care of their most important asset? – I advance this explanation: Brands are fiendishly complicated, elusive, slippery, half-real/half-virtual things. When CEOs try to think about brands, their brains hurt.”  Jeremy Bullmore, WPP

In business, what gets measured, gets managed. The problem is, some of the most valuable financial assets of an organisation are essentially invisible to it. And that puts them at significant risk of harm in a crisis.

Specifically what I’m talking about are the things termed ‘market-based assets’ — the assets that arise from the interaction of the firm with entities in its external environment. For example brand equity, distribution channels, partnerships, customer relationships etc.

For pretty good accounting reasons, these assets don’t exist on the balance sheet. But that doesn’t mean that they don’t have real and considerable financial value to the firm.

Amongst these, brand equity is perhaps the hardest of these assets to measure, but equally is among the most important to preserve. Tim Ambler, one of the world’s leading marketing academics, frames it as “the present reservoir of future cash flows”.

But it’s in times of hardship that this hidden asset is suddenly at risk of accidental harm. And the true ask of Marketing, as custodian of this asset, becomes real.

INVISIBLE ASSETS

It’s not the CFO’s fault per se. Brands are just inherently difficult to understand.

It’s because, put simply (or as simply as I can), brands are just memories. That is, your ‘brand’ is the associations and connections in the mind of a person about you. And therefore your ‘brand’ asset is the sum total — the strength and relevance and recency and positivity — of these connections in the minds of potential buyers in the market.

It’s easy to forget that your branding, your tone of voice, your positioning documents or purpose statements are not your brand. They are just tools to help you manage it. The brand, the important financial asset, is what’s actually out there in the minds of people in the market.

The reason this 'brand' is so important is because these memories  distort customer behaviour. A strong brand means you are called to mind in more purchase situations, and it increases a customer’s willingness-to-pay, allowing you to command a price premium. It’s the difference between someone being willing to pay £10 or £110 for the same t-shirt. Beyond that, the familiarity of your brand increases the chance your marketing will be noticed, and it increases the chance you will be spoken about, driving word-of-mouth.

Flowing down and through the financials of the business, the health of this asset is visible as a halo over the operational and financial metrics. Pricing is more resilient, sell-through is faster, inventory turns quicker, working capital is more efficient. Marketing is more effective, footfall is stronger, stores and channels are more generative. Cash flows are healthier, and ratios more attractive. Simply, everything is more productive.

And it’s this productivity that means strong brands, in the words of Warren Buffett, ‘gush cash’. They are a multiplier on activity.

But financial reporting, and therefore the business, doesn’t ‘see’ this asset. It is by definition intangible, not recognised by accounting standards, and notoriously hard to measure. We can see its effects, but only indirectly. And only if we know where to look.

So while it is real, it is essentially invisible.

VISIBLE COSTS AND INVISIBLE BENEFITS

People tend to think of marketing and sales investment as simply generating revenue, because that is how the accounts represent it. Put money in, get sales out; did it work or did it not work? And while it’s true in part — you run some marketing and get people in the door — for the most part it misses a step in the middle. MOST of your activity doesn’t go directly towards immediate purchase intention. It goes towards building these memories, this brand asset, that in turn yields income in the future.

It works a little like this: you invest in marketing, then that marketing (along with other interactions) creates connections and associations, building brand equity in the minds of consumers. At some (random) point in the future a purchase need arises, and that brand is called to mind, which may yield a sale. But in the interim, this investment exists as memories in the potential customer’s mind. The ‘brand’ asset (or equity) is the store of these future cash flows, because it is a store of future customer demand.

So a large part of generating revenue for a business is a two-step process: Invest time and money in building market-based assets. Then the market-based asset is converted to cash in the form of future sales.

But this disconnect in space and time creates a risk.

The canonical example is cutting marketing to improve profit. Because marketing is expensed through the P&L in the period it occurs, cutting it creates a direct improvement on quarterly costs. But because much of today’s revenue is driven by the store of assets you’ve built out in the market, revenue is less responsive. That is, you can cut spend by X and see revenue fall only by a percentage of X. So quarterly profit goes up.

“Marketing expenditure at Gap Inc. was trimmed 18% during the quarter, driven by the absence of TV ads for the Gap brand, company executives said. That contributed to a 40% jump in profits at Gap Inc., compared to the same period a year ago.”

These dynamics mean when profit comes under pressure, most CFOs will make the same decision: Cut.

Because, whilst they may understand business economics, they mostly don’t understand brand economics. Their perception is that marketing is an expense and a short-term lever, to be used in good times and cut in bad times. It’s a visible cost and invisible benefit.

But by making that cut, they’re only stealing value from the future. As the ‘reservoir of future cash flows’, they are reaping the benefits of your previous brand investment, whilst robbing themselves of the same benefit in future periods. In essence, they are cashing in the market-based ‘brand’ asset.

And because the asset is invisible to the financial reporting, they aren’t penalised.

When companies pull moves like cutting maintenance capex to pump profit, it’s immediately seen for what it is: financial chicanery. But when it’s an invisible asset like a brand, no one says boo. And because brands are so poorly understood, you are as likely to see the company applauded. Or worse: “we cut marketing and sales hardly declined, so that spend mustn’t have been effective. We can probably cut it further…”

THE GROWTH TRAP

Alone this type of behaviour would be harmful. Unfortunately though it’s easy for this decline to become systemic - a vicious cycle of profit pressure and brand decline we call the ‘growth trap’.

The growth trap, and the multiplier effect of brand equity.

It works something like this.

First, there is a hit to profit of some sort. It might be a bad quarter, some unforeseen costs, or a global pandemic.

A gut response is to cut marketing. As described above, this results in a short-term profit bump because in the short-term revenue is relatively inelastic in response to the cut in investment — thanks to the strong store of existing brand equity you’ve built over the years.

The problem is, without the ongoing support levels, the brand equity starts to erode invisibly. And with it, its multiplier on performance.

As your brand starts to weaken (which may take a few months or quarters of mild neglect), you find your traffic or footfall is trending down, despite your new stable level of marketing spend.

To the casual observer, it looks like your marketing isn’t particularly efficient. And if I was a CFO, I’d want to know why I’m spending all this money on marketing that’s not working. In reality, it’s because you’re seeing less ‘organic’ traffic driven from your brand equity — those coming to you simply because of what is in their minds, which is slowly fading.

And then you find your product isn’t selling as well as it was. Similarly, not because the product itself has got worse, but because the brand isn’t providing the halo it once was, and therefore not supporting the price premium. In turn, your product isn’t moving as quickly, and you’re having to rely on more discounting and promotion to hit your numbers.

And slowly a shadow falls over your financials. Revenue is shaky, customer acquisition costs are increasing, margins are under pressure, working capital is less efficient, free cash flow drying up. Everything is a bit less productive. Trading conditions seem hard.

But it’s the second-order effects that are the insidious ones. The dangerous combination of an invisible asset in decline, slow feedback loops between activity and outcome, and the indirect effects on metrics, encourages misinterpretation, and sets the scene for entirely the wrong interventions.

Specifically, the business assumes it’s the things it can see that aren’t working.

The marketing is less effective, so its refocused on activation and direct-response activities to pump short-term demand and drive CPA efficiency, further undermining brand-building.

On a second-quarter earnings call with investors, Gap Inc. CEO Art Peck spoke about the “challenging retail environment.” He noted the company’s namesake brand is planning on “improving marketing effectiveness” with more “measured investment.”

The product isn't selling, so they attempt product and merchandising initiatives to solve the issue — when brand is the lens through which the product is perceived — getting the causality entirely backwards. And the invisible brand withers further.

“The brand once known for its peppy, elaborate commercials has struggled in recent years to attract consumers in an increasingly competitive retail environment. But now that it’s shelved TV advertising — the brand has been off the airwaves for several quarters — and is focusing on merchandising initiatives, Gap seems to be on the right financial track.”

And then the cycle deepens. This time it’s ‘cut advertising, ‘remove unprofitable locations’, 'reduce service costs', ‘cut product costs’ to protect margins. And they stop optimising and start to cut away at the actual offer itself, and its reach and distribution. Pulling back from the market and accelerating the brand’s decline.

Quickly this becomes a vicious cycle of managing margins within a trajectory of slowing demand. Of blaming competition and trading conditions and bad management. And of 'operational efficiency' and tightening budgets,  squeezing out the space and investment for innovation and growth initiatives.

At this point suggesting the only real route to snapping the cycle — i.e. a big reinvestment in brand-building to kick-start it back into expansion — becomes a career-killer for the marketer ‘wise’ enough to suggest it.

And what was a short-term decision to stop investing in a brand is not short-term at all.

It’s a dismal story, but an easy trap to fall into. The above is a disguised case study of more than one brand I've worked with (and obviously Gap, which spent the 7 years prior to 2013 with almost no TV advertising).

So what’s the solution?

THE ROLE OF MARKETING

Really, CFOs should love their brand.

Brands aren’t the fluffy, creative pursuits as they’re so often depicted. They are, for most businesses, the economic powerhouse underpinning their financial performance.

Strong and expanding brand equity makes customers prefer you, your marketing more effective, your product more attractive, your pricing more acceptable, your launches more successful, your channels more profitable, your working capital more productive, your financial ratios more pleasing. When the brand asset is healthy, cash seems to pour from the business.

It’s the heart of a positive-sum cycle of growth and expansion. But the opposite is also true.

But it’s here that Marketing needs to step up to the plate.

Finance needs Marketing to have a seat at the table. As custodians of one of the most important financial assets in the business, and more-so one which no one else at the table understands, they are all that stands between the business and the creation, or accidental destruction, of enormous value. Of a positive-sum world of growth, or the vicious cycle of decline.

And this is twice as true in times of trouble, when the instinct is to cut, and cut deep.

But to deliver on this role, marketers need to improve. They need to become fluent in the link between brand economics and business economics. To learn to draw the connections between the health of the brand and operational performance. To start sketching out the intermediary mechanics of the brand asset that sits between investment activity and financial outcome. To build this understanding for the business, and make real the implications of the business's decisions — and support it in knowing when and how to invest to create value, and when and how to cut to preserve value.

It may be easier to spend time worrying about the tools of the trade — managing campaigns and comms, policing brand identity, building new propositions. But these are all simply means to an end.

As Tim Ambler put simply years ago now: ‘Marketers are sidetracked by the latest fashionable thing and don’t do the basics right. The central thing is to understand brands and brand equity.’

This remains the opportunity. Everything else is nice to have.

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If you’d like a more technical explanation of the dynamics here, get in touch. We’ll be following up with a couple more posts on the reconciliation of brand and business economics, and the implications of this for brand management.

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Al Cottril is a partner at Class35, looking after all things strategy. Al has sat on both sides of the fence, starting his career in brand and marketing strategy, delivering brand portfolio, brand architecture and brand management strategies for leading Australian companies, before turning his hand to business strategy and innovation as Head of Strategy for Medibank, Australia’s largest health insurer, and Director of Business Design at EY-Seren. You can contact him at al.cottrill@classthirtyfive.com

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Sources:

https://adage.com/article/news/tv-ads-a-waste-money-back-black-gap/127310

https://adage.com/article/cmo-strategy/gap-focuses-digital-holiday-campaign-wont-air-tv/2209046

Byron Sharp, 2008, Brand Equity and Market-based Assets of Professional Service Firms, Journal of Professional Services Marketing, (USA), Vol.13 №1, p.3–13

Byron Sharp, How Brands Grow: What Marketers Don’t Know, 2010

Rajenda K. Srivastava, , Tasadduq A. Shervani, and Liam Fahey, ‘Market-Based Assets and Shareholder Value: A Framework for Analysis’, 1998, Journal of Marketing 62 (1): 2–18.,

Tim Ambler, Marketing and the Bottom Line: The Marketing Metrics to Pump Up Cash Flow, 2003