Marketing Profs

The main job of an organization is to create value, according to Peter Drucker, one of the greatest business thinkers of the 20th century.

In a previous article on MarketingProfs.com, entitled “A Question of Value,” I detailed a more qualitative and abstract definition of value creation around perceived costs and benefits. Although this conceptualization is important, it does not necessarily resonate with all functional departments, such as finance.

In today's uncertain economic environment, most marketing investments (for example, branding campaigns, various initiatives, etc.) need to be vetted by the finance department, and in general, must show a strong Return on Investment (ROI) in order to be funded. Therefore, it is important for marketing professionals to be able to intelligently discuss true value creation from a financial context. I've created an acronym as a mnemonic to help remember how a company creates WIDER levels of value.

(Please note that my explanations just skim the surface of this important area, and don't account for numerous permutations and cost/benefit factors, but nonetheless, are quite useful for better understanding the whole value based management/decision making process. See Economic Value Added [EVA] applications for additional insight.)

W = Weighted Average Cost of Capital (WACC; pronounced ‘Wack')

Rather than get into the particulars of how to compute a company's WACC, the main point to know is that it is a weighted average of the company's cost of debt (e.g., bonds floated at 7%) and equity (e.g., investors require a return of 12% given the perceived risk of the business).

Each of the terms is weighted depending on the capital structure of the company (for example, debt is 20% and equity is 80%). The WACC is also called the discount or hurdle rate and is often used to discount cash flows in capital budgeting decisions.

With all of that said, if a company is not getting a return on its capital that is higher than the cost of that capital, they are destroying value vs. creating value.

If you know your company's WACC, and a project's internal rate of return (IRR; an annualized rate of return, taking into account both the amount of money invested and the length of time it has been invested), then you can determine whether value creation is happening from a financial standpoint (IRR should be > WACC).

For each marketing investment (e.g., initiative, project, etc.), try to understand the WACC that your company is using and the different ways that it might be able to lower this hurdle rate (e.g., restructuring capital costs, mitigating project risks, etc.)