Where Does Marketing Fit into the Capital Budgeting Equation?

Article excerpt

ABSTRACT

In order for a firm to grow, the firm must often implement various growth-oriented projects. After a number of new project ideas have been generated, the initial list of ideas is screened and those ideas that are inconsistent with the organization's strategy or are otherwise deemed inappropriate are eliminated from consideration. Ideas that survive the initial screening process are then examined for financial feasibility using any or all of the recognized capital budgeting techniques to select which projects should be pursued and funded.

However, financial projections are all too often made on the assumption of "all else being equal." The significance of marketing activities that may determine-or increase-the value of a particular project under consideration by a firm, is seldom directly recognized in finance. This discussion examines the significance of marketing in evaluating the investment potential of a project, which in turn determines whether a given project is-or is not-approved.

INTRODUCTION

In order for a firm to grow over time, the firm must often implement various growth-oriented projects. These projects may include adding a new product line, making an acquisition, building a new plant, or expanding operations internationally. The growth process begins by brainstorming a number of new project ideas. After a number of new project ideas have been generated, the initial list of ideas is screened and those ideas that are inconsistent with the organization's strategy or are otherwise deemed inappropriate are eliminated from consideration. Ideas that survive the initial screening process are then examined for financial feasibility.

There are six commonly recognized capital budgeting techniques that might be utilized by a firm's financial management team to analyze projects in an effort to determine which project (or projects) should be funded. However, financial projections are all too often made on the assumption of 'all else being equal.' Finance tends to take marketing as a 'given' in financial analysis. So the significance of marketing activities that may determine-or increase-the value of a particular project under consideration by a firm, can easily go unrecognized.

Only recently have researchers examined the interrelationship of marketing and finance, including Davidson and Hussey (1999), Zinkhan and Verbrugge (2000), and Loomis, Schlosser, Sung, Boyle, and Neering (2001). For example Barwise, Marsh and Wensley (1989) tells us "The financial criteria used to decide if a proj ect will be profitable are entirely consistent with the tenets of competitive marketing analysis." Harrison-Walker and Perdue (2004a) point out that marketing and finance share a common goal in the economically viability of the firm, but take different approaches to reach their common goal. "Rather than thinking that one discipline is 'correct,' the more appropriate view is to understand that they constitute different parts of the same team." (Harrison-Walker and Perdue 2004b) The current discussion specifically examines the complementary roles and significance of finance and marketing in evaluating the investment potential of a project, which in turn determines whether a given project is or is not approved.

This paper is presented in four parts. We begin with an overview of capital budgeting and review those aspects of the weighted average cost of capital (WACC) formula that are controllable or otherwise thought to be influenced by finance. second, we discuss the role of marketing in terms of stabilizing revenues and reducing cash flow volatility, specifically as marketing's role relates to the WACC. Next, we look at the role of marketing in terms of revenue and marketing expenditure projections for a new project. We conclude our discussion of how marketing fits into the capital budgeting equation by examining the various means by which marketing acts to enhance cash flow.

CAPITAL BUDGETING

Capital budgeting is part of the overall strategic management of the firm. …

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