Imagine what you would say if your production manager attempted to justify the purchase of a new piece of capital equipment by arguing that the lease payments will bring you in line with industry benchmarks for capital expenditure!
I’m guessing that you wouldn’t appreciate the employment of such irrational thinking to the purchase of machinery.
However, I’m also guessing that, on occasion, you might have been tempted to evaluate your marketing expenditure by comparing it to industry benchmarks.
I’m afraid that this approach to marketing expenditure is just as irrational. Let me explain why.
A Relationship-centric business should spend money on marketing for two reasons (and two reasons only):
- To acquire new customer relationships.
- To add value to those customer relationships. (You do this by encouraging customers to spend more money with you.
Now, allow me to ask you two simple questions:
- Is it reasonable to expect to see a positive return on an investment in each of these objectives?
- Would such a return be measurable?
I hope you’re nodding!
The truth is, the same criteria should be used to evaluate an investment in marketing and an investment in your manufacturing plant.
I’m guessing that you’d evaluate a proposal to invest in the latter by putting a dollar value on the benefits of the purchase, and then comparing this figure with other options.
Specifically, you’d calculate the net present value of the benefits the machinery would deliver over its lifetime, and then compare this figure with the returns you’d receive from investing the same capital elsewhere.
This exact approach is perfectly suited to evaluating marketing expenditure.
A customer relationship provides you with an income stream for a period equal to the life of the relationship. In other words, it is an annuity.
The value of this annuity is equal to the total gross profits earned over its life, discounted for the cost of capital. (Of course, this is the net present value calculation.)
Once you can put a dollar value on a customer relationship, you can easily calculate your return on marketing expenditure. And once you can calculate this return, you can determine your marketing budget by comparing this department’s return on capital with that of other departments — and allocating funds accordingly.
So, next time a marketing person attempts to use industry benchmarks to convince you to commit more funds to marketing, ask them to formulate a new argument based upon return on capital.
If he or she has trouble producing such an argument, you’d have to wonder about the degree of scientific method employed in the design and management of your sales process!
Scary thought, huh?