June 11, 2009
University of Iowa study shows marketing impacts a firm's risk
A solid brand does more than just move products off the shelves. New research by a pair of University of Iowa business professors suggests strong brands also improve a firm's financial performance by lowering the cost of debt and insulating the company from a down economy to reduce the overall firm risk.
The researchers said their findings are a clear example of how different functions within a firm should work together to maximize shareholder wealth, and that marketing investments contribute to an improved bottom line.
Lopo Rego, assistant professor of marketing at the University of Iowa's Tippie College of Business, said the attributes of a strong brand--high levels of consumer loyalty and commitment, insulation from competition, and diminished price sensitivity--contribute to higher levels of more stable cash flow. Those are attributes that also appeal to investors.
"Strong brands are associated with stronger cash flows that are more reliable and predictable in the future," Rego said. "That means debt and equity holders have an easier time predicting the firm's future cash flows and that makes them less risky investments, increasing their long-term financial stability."
The research, by Rego and Matt Billett (right), a Tippie professor of finance, will be published in a forthcoming issue of the Journal of Marketing. The paper, "Consumer-Based Brand Equity and Firm Risk," was co-authored by Neil Morgan, associate professor of marketing at the University of Indiana.
Rego and Billett used data from Harris Interactive, a survey firm that annually polls more than 20,000 U.S. consumers on their perceptions of more than 1,000 consumer brands. They used that data to compile a Consumer-Based Brand Equity (CBBE) score, then compared the CBBE with the product's parent company's bond rating and variance of stock price.
The research found companies that own the strongest brands also had the highest credit ratings, or lowest debt holder risk. Those companies also exhibited decreased stock variability, especially in economic downturns, when the stock prices of companies with strong brands were more stable than the price of companies with weaker brands.
Higher credit ratings make debt cheaper to obtain and expand a firm's capacity to take on more debt. Billett said a one point increase in a brand's CBBE corresponded to a full two-category improvement in the firm's credit rating.
For an average company in their sample -- which had $10 billion in long-term debt with a BBB+ credit rating -- Billet said a two-category improvement would save the company almost $40 million in annual debt service alone.
Rego said the results make a convincing case that firms should invest in marketing efforts because they have a tangible effect on shareholder wealth.
"Most corporate executives see marketing as a cost center, not as an investment, but this study should remove all doubt that brands are assets and should be managed as such," Rego said. "This tells us that a firm's ability to build a strong brand using marketing reduces risk and raises the firm's overall value, and will help especially during a downturn."
STORY SOURCE: University of Iowa News Service, 300 Plaza Centre One, Iowa City, Iowa 52242-2500.
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