What Does Wall Street Reward?

A recent analysis said that, all things being equal, a heavy reliance on marketing spend will hurt a company’s stock valuation. Of course, we say. Duh, we think. But have we ever really thought about how much a factor that is?

Let’s think about it using an example.

There are two stores in the middle of town. One has a product/service that customers love, and as a result, customers flock to the store day in and day out all on their own. These customers then tell other potential customers, and through this “word of mouth” process, the customer base grows even larger.

The second storeowner advertises frequently, and all new customers are a result of this advertisement and promotion (which obviously costs $$).

Which business would you prefer to own?  Which one would likely have higher cash flows?  If you have to “buy” or “rent” your customers, you have a non-optimal business model – plain and simple. The empirical data backs this up. You will be hard pressed to find a company with a heavy marketing spend with a high price/revenue multiple.

Now let’s think about it in a specific context.  One of the very best Internet companies that invests heavily in marketing is Netflix (marketing is about 15% of sales in their recent quarterly filings). When it comes to execution, Netflix is considered by many to be the best of the best. So you have a company that is highly regarded for their management prowess, and that was growing over 50% year over year. 6 months ago, they traded at 4X 2011 revenue estimates and 3X 2012 estimates. And this is the best of the best. The majority of companies that are heavy marketers trade at price/revenue multiples well below Netflix. Today, Netflix stock reflects the recent customer defection, and the related increased burden it will have to take on to grow it’s customer base back (if it can).

So what did Netflix get dinged for in the marketplace? Not understanding the new social rules as it relates to customer love. Today, using the social web, customer acquisition can happen because of people sharing links, sharing enthusiasm online, and often trying products before paying for them. It doesn’t have to be done in more traditional ways of buying channel partners, or shelf space, or buying lists to market to. Where product or service usage used to be an after-effect and at the end of the process, it is more visibly starting the process. We see it heavily in software of course because of the ability to deploy and then buy… An enterprise software company, My SQL became a dominant player by “giving away” usage but asking for payment for those that need support and maintenance. There were 6M users and 5K customers (.083%) but that garnered $34M in revenues. You might remember they got bought by Sun. Evernote customers are known for declaring their “love” of the product as they buy.

These two (albeit software heavy) examples show relationships that are not transaction focused (did you buy from me?) but love-based. As in, pay if you love it. Or learn about me a lot before you buy. Or participate before committing. Or ask me to share this with a friend if I liked the experience. There are lots of ways this does and can show up in today’s marketplace.

This kind of “love” embodies a social construct. I talked about this extensively in the LOVE Model ~written about 2 years ago, here.

Companies that can shift their worldview from thinking about customers as transactions to engaging with them in a vibrant, two-way relationship experience gains that range across the entire scope of business operations. Of course, social business models certainly lower the financial overhead of a firm, but they don’t come without a cost. The more an organization depends on others, the more you need to bring that into consideration. If people give to a cause, they expect to be treated in relationship.

The excerpt above was from a larger post on the fact that companies get a 10x return due to this LOVE factor that comes from the social construct. The post is a little wonky for most, but I think it is the single best assessment of how wall street values companies today.

Wall Street rewards what? Love.

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