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    CFA Institute

    The Investment Value of Brand FranchiseAuthor(s): Jack TreynorSource: Financial Analysts Journal, Vol. 55, No. 2 (Mar. - Apr., 1999), pp. 27-34Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4480152 .

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    T h e Investment V a l u e o f B r a n d FranchiseJack Treynor

    Brand loyalty manifestsitself in consumers' willingness to pay a higherpricefor the brandthey prefer.Some manufacturers hoose to limit theiroutput, sell only to customers loyal to their brand (theirfranchise),andchargethehigher price.Otherschoose to chargea lowerpriceratherthanlimit theiroutput. Becausefranchisescan contributeas much,or more,tofuture cash lows as their plants contribute,companies n thefirst groupsupporttheirfranchisesby largeinvestments in advertising,introducingnew versions of their products, and so on. Accountants, however,arereluctant to capitalize the expendituresthat support franchises, whichcauses gaps between marketvalue and bookvalue. If thefixed marketingcosts can beidentified,however, nalystscan estimate he investmentvalueof thefranchiseand the manufacturer's fficiency n defending t.

    conomists have a lot to say about the valueof plant, property, and equipment, but theyare silent on an element of investment valuethat, for some companies, is even moreimportant-brand franchise. Investors cannotafford to ignore the value of a brand franchise for acompany's future cash flows. Economists, by indis-criminately invoking the Law of One Price, treat allindustries as commodity industries, in which brandfranchise has no value. As a result of the strategicchoices companies make, however, consumersexperience the reality-the Law of Two Prices-onthe shelves of their friendly retailers every day. Theneglect by economists of the reality of franchisepricing results in a wholly unnecessary mystiqueregarding these high prices unnecessary becausethe marketing and economic aspects of brand fran-chises are easily linked.Accounting principles exacerbate the problemof valuing brand franchises. Churchill once said thatthe United States and Britain were two nationsseparated by a common language. Investmentanalysts and marketing strategists are two groupsof professionals separated by the language ofaccounting, which calls investments in brand fran-chises (e.g., research and development, advertising)"expenses." The neglect by accountants of theimplications brand franchises have for future cashflows results in high price-to-book ratios and highprice-to-earnings ratios.This article describes an approach analysts can

    use, if the fixed costs of supporting a brand franchisecan be identified, to estimating the investment valueof a manufacturer's franchise and the manufac-turer's efficiency in defending it. The valuationmodel has elements recognizable to the marketingstrategist-such as franchise, marketing effort, andlevel of rivalry-as well as elements recognizable tothe investment analyst-such as cash flow, presentvalue, and return on investment. But the model canhardly be called "traditional." The traditionalapproach to estimating value has been to ask whatdata public companies provide and then to let thosedata define the valuation methods. This articledefines what data analysts and investors need tovalue a company's investment in its brand franchiseand explains how to use the data.

    A valuation model cannot be formulated, ofcourse, with total disregard for the kind of data themodel requires. The data required for a satisfactorymodel should have the following characteristics:* The data should be verifiable, at least in prin-

    *ciple. When data are verifiable, "objectivity"ceases to be an issue. The data should not beopinions about the future. Opinions cannot beverified.* Data specific to a particular asset should reflectthe specifics of the asset-not the interaction ofthe asset with general economic conditions orsomeone's opinion about future prosperity. Asimple test for the specificity of the data iswhether the data would be the same in a differ-ent economic or market climate.

    * The data should not depend on arbitrary deci-sions by anybody-not the U.S. SEC, not the

    Jack Treynor s presidentof TreynorCapitalManage-ment, Inc.

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    FinancialAnalystsJournalFinancial Accounting Standards Board, andcertainly not the reporting company.

    Branch Franchise PowerThe key to the value of brand franchises lies inconsumer anxiety. The Law of One Price assertsthat, in the absence of transportation and distribu-tion costs, roughly simultaneous transactions in agiven good or service will have the same price. Thelaw assumes, however, that the parties to thetransaction have what lawyers call a "meeting ofthe minds." In actual transactions, the parties havetheir own mental images of what is being trans-acted, and these two images are rarely the same.

    For example, in many markets, the sellerknows more than the buyer. This informationasymmetry is typical of the markets for used carsand second-hand watches, and even more charac-teristic of markets for consumables-headacheremedies, toothpaste, corn flakes, ketchup, soup,and so on. In consumables, the manufacturerknows what raw materials, what equipment, andwhat workers were used in the product's manufac-ture. In most cases, all the consumers can see at thepoint of purchase is an opaque container.

    The result is anxiety in the mind of the con-sumer, which often has its origins in the way theproduct is manufactured over its life cycle. Exhibit1 summarizes the differences between a fledglingand a mature industry. When an industry is new, thevery definition of the product is fluid and demandis low. So, using general-purpose rather than dedi-cated machine shops, foundries, and heat-treatingfacilities makes economic sense (what Buffa [1984]called "process-focused" production). Quality atthis stage is inevitably uneven and almost impossi-ble to control. But it is precisely at this point in thelife cycle of the product that consumers are havingtheir firstexperiences with the product and formingfirst impressions that will be as lasting as their firstimpressions of people.

    Later, when the role of the product is well

    Exhibit 1. Life-Cycle CharacteristicsFledgling Industry MatureIndustryProduct concept evolving Productconcept stabilizedrapidlySize of market uncertain Market establishedProcess-centeredmanufacturing Product-centeredmanufacturingFluid supplier relationships Stablesupplier relationshipsQuality hard to control Quality easy to controlConsumer disappointments Consumerdisappointmentscommon rare

    defined and potential demand is clearer, manufac-turers build production facilities dedicated to thenew product (what Buffa called "product-focusedproduction"). Day in and day out, the same peopleperform the same steps in the manufacturingprocess. The source of quality problems is identi-fied. Learning takes place, and as productionproblems are solved, knowledge about solutionscirculates throughout the industry.

    Consumers, however, cannot forget the pain ofthe early disappointments. They are still anxious,which is what gives the power to brand names.Indeed, brands can continue to be important longafter the industry has solved its quality problems.The day consumers do conquer the last of theiranxieties is the day the industry becomes acommodity industry. Fresh milk is an example.When pasteurization was new, the reputation ofthe dairy (e.g., Borden, Beatrice, Hood) wasimportant. Today, nobody worries about milkquality, and dairy brands with their premiumprices have largely disappeared.

    Marketing is most important in the middle ofthe cycle, when brand identities have been estab-lished in consumers' minds but consumers are stillworried about quality: "Almost as good as aXerox." "Not exactly like Hertz." Marketingexperts have known for years that consumers dealwith their anxiety about transactions by focusingon the manufacturer's brand. In a process notunlike falling in love, consumers replace theirgeneralized ideal of what a product should be withthe highly particularized image of a specific brand.If they prefer Fords, then every way in which aChevy differs from a Ford makes the Chevy lessdesirable. Their preferred brands become thestandards by which all other similar products arejudged. Consumers are not unwilling to buy theothers, but they are willing to pay more for theirideal brands. Of course, which competing productis the ideal differs for different consumers. Eachbrand, Chevy and Ford, has its own group of loyalcustomers-its brandfranchise.Marketingand the BrandFranchiseIdeally, a manufacturer would price each sale trans-action according to whether the buyer was in itsfranchise or not, but this approach is usuallyimpractical. In practice, the manufacturer thatchooses the lower price can sell everything that itcan economically make at that lower price (in eco-nomics, can realize the full value of the scarcity rentson its plant capacity) and, of course, because salesare not restricted to its franchise, the manufacturerwho chooses to sell at the lower price is free not toengage in product innovation, advertising, or pro-

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    The nvestmentValueof BrandFranchisemotion. The manufacturerhat chooses the higherprice is restrictingts brandedoutput, irrespectiveof how much capacity he manufacturer as, to thesizeof its franchisemarket.Therefore,his manufac-turerdoes whatever t canto increase ts franchise-product innovation, advertising,and promotion.The manufacturer ses thehigher-pricedmarketingeffort to increase (or defend) its shareof the fran-chisein its industry.When consumers choose to buy at the lowerprice, they are not affecting total supply or totaldemand.So, theirchoice s notaffecting he scarcityof productioncapacityor the scarcityrents on thatcapacity.Because he choicemerelyshifts consum-ers from one brand to another or to unbrandedcompetitiveproducts, it has nothing to do withscarcityor marketequilibrium-hence, nothingtodo with price theory.So, the task of analyzingthevalue of a franchisehas little in common with thetaskof analyzingthe value of plant,property,andequipment.The costs of marketingoften includea signifi-cant fixed element.1When the size of that elementis not known (i.e.,when firms do not reporttheirfixed costs separatelyfor manufacturingand formarketing),pricingthatinvestmentis a challenge.But analystscan estimatethe costs. This discussionof how to value a brand franchiseconsiders threeissues that brandfranchiseraises for investors:* theestimationproblem n the case where fixedcosts are either known or small enough toignore,* the economics of brand franchise when fixedcosts areimportant,and* the impact of brand franchise on monopolypower,with particularattention o fixed costs,sunkcosts,and ease of entry.

    The Estimation Problem. Customers are fickle.An industry may appearto have stable and un-changingfranchise hares,but it is actually n con-stantflux. Thecompetitors'ranchise haresare ikeswimmingholesin ariver;water s constantly low-ing in andflowing out,although he overall evelofeach hole may change little. To maintain its fran-chise, a manufacturermust take customersawayfrom itscompetitorsas fast as they are takingawaycustomers romthe manufacturer.Tobegin estimatingthe costs of supportingabrand franchise, assume that, net of any fixedmarketingcosts in the industry,a competitorcanromanceaway twice as many potentialcustomersif it spends twice as much and vice versa. If amanufacturer's ranchise s measuredby its grosscash "flow-back," (franchise haremultipliedbybrand premium) and its marketingeffort net offixed marketingcostsis defined as v (bothvariables

    at annual rates), then one-period changes in grossflow-back,Az, satisfy the equationAz= av- z, (1)

    where oc and a are coefficients that express thesensitivity of change in franchiseto, respectively,marketingeffortand initial franchisesize.At every point in time, gains and losses infranchisesharesum to zero;thatis,XAz = 0; (2)

    so, if we assumethatI, unlikeac,s the same forallcompetitors, hen0 = ,cLv- PIz, (3)

    with the resultthatI oav=' . (4)

    Obviously, X, ven if it is the same forall competi-tors at a point in time, can vary across time.But the efficiency with which competitorstransformdollarsof marketingeffort into changein franchise (gross of the ,-related losses) is in acertain sense relativeto the other competitors.So,then, an appropriately weighted average of theindividual efficiencies should be constant acrosstime-even if individual efficiencies or associatedweights arechanging.Letthataveragebe6c.Then,withoutany loss of generality,we can writeYav = &Xv, (5)

    and assertthat & s constantacross time.The basic model then becomesAz = ov -&- z (6)

    izwhere the expression in parentheses, like v, isobservable.The unknowncoefficientoc snotneces-sarilyconstantacross ime for thesamecompetitor.Considerregressionestimates of the undeter-mined coefficients a and o&:n the cross-section,large v's are likely to be associatedwith large z'sand, therefore,withlargevalues of (Xv!/ I z. So,the two independent variables are highly corre-lated. Standarderrors of estimate will be corre-spondingly large.We can minimize this problemby recasting he regression n theform

    =z=c a([a J (7)

    Now,considera single-variableegression f Az/zon

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    FinancialAnalystsJournallviz: Thesuppressedexplanatory ariableviz isplausibly uncorrelatedwith v ,z, both acrosscompetitorsand across time. We use the resultingestimateof oc o computevalues of cc foreach datapoint(i.e., oreachcompetitor teachpointin time).We can use this resultto distinguish,compet-itorby competitor and periodby period,betweenlevel of marketingeffort and efficiency.A smallgain in franchise share achieved with high effi-ciency may represent a better job of marketingmanagement than a large gain achieved with anexorbitanteffort.We can make this useful distinc-tion, however, only when fixed costs are littleknown or unimportant.

    The Economic Impact of Fixed Costs. Thefixed costs of product development and advertis-ing representthe competitor'sadmissionticket tothevariable-costgame.2We canmeasurecompeti-tors' total marketingeffortsby the cash outflow uandtheir totalfixedmarketingcosts (assumingthecosts can be measured) by F (all variable annualrates).Then, the variable-costportion of a com-pany'smarketing ffort s u- F. Inindustrieswherefixed advertising and development costs areimportant,changein franchise s

    Az= a(u - F)- ,z. (8)Thevalue of z to investors is reducedby the mar-keting effortrequiredto maintainthe company'smarket share. The maintenance value of u (thevalue at which franchisegainsjustoffsetfranchiselosses)can be termedu*; ubstitutingu* oru in theexpressionforfranchisechange produces

    c1(u*-F) - z = 0,u*-F =fz

    andu*= (z+F. (9)

    Net flow-back from the investment is grossflow-backminusthemaintenance evel of effort,orZ-u z ] (10)

    = Z(1-)-F.Forthe industryas a whole, we have

    XAz = c(u- aXF-I3Xz (11)= 0;

    hence,l(u-F) = z (12a)

    and

    (12b)Substitutingin the expression for net flow-backproduces

    Z- = Z 1 _-

    F) (13)iz

    Recall thatour firstcriterion or a satisfactorymodel was thatthe databe verifiable.One variablein the formula for measuring franchise valueshouldprobablybe treatedas aforecastrather hanas a verifiablefact-and, indeed, a forecast thatdepends on events outside the industry. Thatvariable is -z the industry's total franchise,measured n grosscashflow. Itdepends on overallindustrysales,whichusuallydepend onprosperitybeyond the industry.Wheninvestors forecastthisnumber,they are "timing" he industry. The wayto avoid suchtimingis to use the forecast hatbestexplains the currentmarketpricesof companies ntheindustry.(Thecurrent alue of ,z is observablebut probablynot relevant.)The other variablesin the formulaare verifi-able.Theyarespecificto the firmandits industry,andtheyare not influencedby anybody's forecastsoranybody'sarbitrary ules:

    Az2 a(z)-a E (14)

    Maintenance evel v*of v is definedby0 =aV)& ,(15)

    so

    v*=Z(),,L (16)

    Then,net flow-back sZ-v* = z 1-() | (17)

    In thisresult,fixed costs are not explicit.Whenweintroduced ixedcosts, we definedvas equalto uF and v*asequalto u" F if,on average,allcompet-itors have the samefixed costs.On the otherhand,Equations13-19 assume away differences n mar-ketingefficiency-that is, assume a = a fordiffer-entcompetitors.The present value of a franchise share z

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    The nvestmentValueof BrandFranchisediscounted atmarketratep is

    _ Z ]_ - PF (18)

    Foranestablishedcompetitor, he incremental ateof return sa(z-u*) a(zzu*) azau - az au

    = (u - F)- (19)L z

    The rate of returngoes up with the gross flow-backfrom the industry's ranchise,goes down with thelevel of rivalry,Xu, and goes up with the numberof competitors.Brand Franchise and Monopoly Power. Ina marketingwar,the level of rivalry s so high that

    net flow-backbecomes negative. The bigger thefranchise hare,thebiggerthe rate of loss. Market-ing warsarebasicallywars of attrition ntended toexhaust competitors'borrowingpower. For exam-ple, if CompetitorA has the same size franchiseasCompetitorB (andthe same marketingefficiency)but more untapped borrowing power, B will runout of steam soonerthanA;A will win the war.If,on the otherhand, A and B have equal untappedborrowingpowerbut A's franchise hence, ts rateof loss) is bigger,then B will win the war. To winsucha war,a companymust have a higherratio ofborrowingpower to franchise han its competitorshave.Because hepurposeof amarketingwaris toforce a competitorto abandon its franchise, norational ender will rely on franchisevalue as thesecurityfor a loan.So, borrowing power dependson the value of the plant (less liabilities).3Amarketing war ends when a competitor eitherexhausts its borrowing power or, seeing that itscause shopeless,abandonsdefenseofits franchise.Eitherway, a marketingwar shiftsfranchisesharetoward the competitorwith the highest ratio ofborrowing power to franchise.And becausemar-ketingwars benefit those competitors, hey canbemoreaggressivein marketingpeace.Whenrivalryescalates,high-ratiocompetitorsead theway,withlow-ratiocompetitors ollowing willy-nilly.

    But here s nopoint enteringanindustry fyouaren'tsufficientlywell capitalizedto defend yourentry. Companies do not have to compete forfranchise n order to enter an industry,but whenthey enterthe battle for brandfranchise, heyincurthe maintenance-level costs of their marketingefforts.So,maintenancecost (see Equation9),X (U-F)U= Z +F, (20a)

    can be used as the measureof ease forentrants hatexpect to compete for franchises.We can rewritethisexpression asu* = Frl-, J+z (20b)

    Differentiatingwith respect to n producesau* FzAn J:z (21)

    Because F, z, and L are all positive, entry of acompetitor always lowers maintenance cost forexistingcompetitors.Weconclude that whatestab-lished competitors should fear is not entry but,rather,entry of financiallystrongcompetitors.Lawyers often assume thathigher fixed costswill make entry more difficult. Does it payestablishedcompetitors to increase the industry'sfixedmarketingcosts-for example,by increasingthe frequency of new-product introductions?Dif-ferentiating he maintenancecost expressionwithrespectto Fproducesau* 1-- . (22)

    A new competitor'smaintenance evel of uwill fallwith increasingFif its franchisesatisfiesn= Average z. (23)

    So,acquiringcompetingcompanies, f theyarelarge,evidently pays. (Consider heextremecase ofCompany Q acquiringa company of negligiblesize:CompanyQ'sz doesnotincrease,butitsnfallsby 1.) Calculatinga Sz)= Sz (24)An -n n2

    shows thatwhen acompany s acquired i.e.,whenn falls by 1), the industry average increasesbyIz/n2. So, the rule is: Never acquirea companywith franchisez such thatz< Xz/(n2). Largeestab-lishedfirms benefitby encouragingnew firms,notmerely because entry reduces their maintenancecosts,butbecauseit lowers thethreshold oracqui-sitiontargets.(Smallcompanieswho would preferto be priced as potential takeovertargetswill alsofavorentry.)The TwoMeaningsof "Competition"Wheneconomists alkaboutcompetition, heir dealis an industrythat pushes output up to the point

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    FinancialAnalysts Journalwhere marginal cost equals price. Unless demand isperfectly price elastic, however, increments in out-put will lower equilibrium price-penalizing alloutput and causing marginal revenue to be less thanprice. So, it usually pays an industry not to produceup to the perfectly competitive level.

    The owner of the industry's marginal capacity,however, is concerned only with the price penaltyon its own output. If this manufacturer is small-ifit has limited capacity-the price penalty will beless important to it than if it is big. The manufac-turer will push output closer to the point at whichthe unit cost of producing on the marginal capacityequals the price-that is, behaving more like theeconomist's ideal. So, the economist worries when,as a result of business combinations or barrierspreventing new entrants from starting small, anindustry is divided up among a few large firms.

    The word "competition" has a different mean-ing for marketing strategists than its meaning foreconomists or accountants. They use it to refer tothe battle for brand franchise. In industries wheresuch franchises are valuable, companies oftenspend hundreds of millions of dollars a year in thebattle. (As in "competitive sports," one company'sfranchise gain is another's loss.) When the level ofrivalry is high enough, however, it takes moremoney than the brand itself can generate. At thatpoint, competitors turn to their other financialresources-scarcity rents on their plant capacity.But the only plant capacity with high scarcity rentsis capacity with a low variable unit cost of produc-ing, which, of course, is why the valuable franchisesend up in the hands of low-cost producers.

    "Low" and "high" as they apply to cost, how-ever, are relative. How does the high-production-cost type survive in such an industry? By notcompeting for franchise share. Instead, their out-put is distributed as off-brand, generic, or housebrand products. So, such industries have twotypes of companies-competitors who battle forfranchise share and producers who do not-andtwo kinds of entry.

    The producer type is critical to the industry'swillingness to use its high-cost capacity. Becauseproducer types own that capacity, they decidewhether or not to use it, even though the decisionaffects selling prices for all the companies in theindustry, including the competitor types.

    If the industry has important fixed costs thatare the same for small companies as for large com-panies small-scale attempts at entry will fail.4 Ifmarketing expenditures entail significant fixedcosts-space in national media, creative spots forads good enough to justify the space, developmentof new products good enough to justify the ads-it

    does not pay a company to have a franchiseunlessit is a big franchise.(Introductionsof new brandsintosuch anindustrymaybe few and farbetween.)A big marketing effort is needed to defend a bigfranchise. And if the industry requires low-costcapacity to defend a franchise, it takes a lot oflow-costcapacity o defend a big franchise. nsuchindustries, ow productioncostsandbig franchisestend to go together.When competitor ypes are large, they have abig stake n industrypricing.Whencompetitorsarelow cost, theyhave a big stake n output.Willthey,nevertheless,withholdsome of theirproduction? fa competitorproduces less than its own franchisedemands, hecompetitionbenefitsattheexpense ofthe competitor, which weakens the competitor'sability to defend its franchise.(Becausemarginalproducers will increase their output when alow-cost competitor reduces its output, the netreduction in industry output a competitor canachieve s never morethan halfitsgrossreduction.)Entry nto the battlefor franchise s obviouslydaunting.But for a producertype, entry requiresonly some plant with a high unit variablecost ofproducing and, hence, a low second-hand value.Some ndustrieshavefixedcosts ofproduction,buteven those costs are usually small comparedwiththefixed costs ofmarketing.So,in anindustrywithhigh fixedmarketingcosts, producer ypes tend tobe smallcomparedwith competitor ypes.Implications for AntitrustWhenhighfixed costsin anindustryareassociatedwith marketingrather than production, they putpressureon competitor ypes tobecome as largeaspossible,whichdiscouragesentry nto the battleforfranchise and produces industries in which thelow-cost companies are large and the high-costcompaniesare small-which is tosay, ndustries nwhich the companies that own the marginalcapacityhave little incentivenot to use it.High fixed costs may have discouragedentryand competitive pricing in the commodityindustries-the railroads,steelcompanies,and oilcompanies-that preoccupied trustbusters in the1890s.Tryingto extrapolate hatexperienceto thekind of modern industries discussed here maylead to confusion between the two meanings of"competition"with consequences that are disap-pointing or even perverse.

    Iwould ike o thankThomasK.Philips ndBarrRosen-bergforpointingout a logicalflawn theoriginaldraftof thisarticle.

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    The nvestmentValueof BrandFranchiseAppendixA:Sunk Costs versusFixedCostsAntitrust lawyers have recently discovered theconcept of sunk costs. The lawyers' discoveryattests to their recognition of industries in whichmarketing, as well as production, is important-inwhich competitor types as well as producer typesare important.A sunk cost is an investment that is certain tobe worthless if you change your mind. Examplesare* leasehold improvements,* creative costs of a discarded advertising pro-gram,* investment in a discarded brand, and* abandoned new-product development pro-grams.Sunk costs differ from simply making risky invest-ments. If you make an investment in a liquidsecurity and change your mind, although you haveno guarantee that you can recover the cost (so, theinvestment is risky), you do have a chance torecover it. If the buyer's expectations are suffi-ciently rosy, you can sell the investment and

    recover the cost. Sunk costs are gone with nopossibility of recovery.

    One kind of investment has social value; theoriginal investor is merely the first of what mayultimately be several owners. The sunk cost hasvalue only to the original investor.

    By this test, investment in capital goods-inproductive capacity-is rarely a sunk cost. Inparticular, if the original buyer fails, the plant stillhas potential value to other buyers. (To be sure,most capital goods are not as liquid as securities.They raise the same kind of uncertainties in apotential buyer's mind that a used car raises.)

    By the same test, investment in a brandfranchise is almost always a sunk cost:* It has no social value. Instead, it merely trans-fers franchise from one competitor to another.* If the owner abandons the brand, or an acquir-

    ing firm replaces it with its own brand, all priorinvestment in that brand becomes worthless.These considerations suggest that if sunk costs

    pose a special problem for new entrants, it is thecosts of marketing, rather than the costs of produc-tion, that pose the problem.

    Notes1. Classic examples of fixed marketing costs are the creativecosts of an advertising campaign-costs that must be

    incurred before a single TV spot or page in Newsweekhasrun. Costs of developing a new product may also be consid-ered part of marketing costs. Development costs must beincurred before the sales force can sell the product, beforeadvertising can promote it, and so on. Typically, these fixedcosts must be incurred in order for the "variable" costs ofmarketing to have any value, and the fixed costs are inde-pendent of the scale of the marketingprogram-specifically,of sales volume, the size of the sales force, the size of themedia buy, and so on. A car maker can choose to economizeon its manufacturing fixed costs-rearranging the chrome,for example, when a competitor introduces a genuinely newmodel. But this choice is not rigidly dictated by the size ofits franchise or the scale of its marketing effort. And the carmaker is deferring, rather than actually reducing, its costs.For long-range planning or investment analysis, represen-tative or long-term averages of fixed marketing costs areappropriate.

    2. The cost of product development is a marketing cost. Doesthe competitor develop its new products (or productimprovements) in a comer of the factory? Do the key pro-fessionals wear laboratory smocks rather than the powersuits favored by the company's salesforce? If so, should weconclude that product development is a cost of production

    rather than marketing? No because what matters (in ana-lyzing production, as well as marketing) is the purposeforwhich the competitor incurs the costs.When we distinguish between competitors, who careabout the size of their brand franchise, and producers,whodo not, we find that product development, like advertising,is a cost producers choose not to incur. So, we know whatthe purpose of product development is.

    3. The value of the plant derives from its economic, or scarcity,rent.This rent is the difference between the unit variable costof producing in that plant and (in a competitive industry)marginal cost-the unit cost of producing in the marginalplant. On the one hand, per unit of capacity, the higher theunit variable cost of producing in the plant, the lower the renton the plant. On the other hand, the risk regarding the futurerentdepends only on the unit cost for the industry's marginalplant (i.e., on uncertainty about which plant will be mar-ginal). So, the absoluterisk is the same for all plants irrespec-tive of the absolute rent. And when industry demandexpectations change, competitors' borrowing power doesnot change proportionately. Still, a useful generalization ispossible: Other things being equal, the competitors withlow-cost plants cope more effectively with both marketingwars and marketing peace.

    4. Keep in mind that lawyers make an important distinctionbetween fixed costs and sunk costs (see Appendix A).

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    FinancialAnalysts JournalReferencesAxelrod, Robert. 1984. TheEvolutionf Cooperation.ew York:Basic Books.Buffa, Elwood S. 1984. Meeting the CompetitiveChallenge.Homewood, IL: Dow Jones-Irwin.Oxenfeldt, Alfred R. 1962. Models of Markets.New York:Columbia University Press.Porter, Michael E. 1976. Interbrand hoice, trategy ndBilateralMarket ower.Cambridge, MA: Harvard University Press.

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    . 1986.MarketingWarfare. ew York:McGraw-Hill.Spence, A. Michael.1974. MarketSignaling.Cambridge,MA:HarvardUniversityPress.Srivastava,RajendraK.,TasadduqA.Shervani, ndLiamFahey.1998. "Market-Based Assets and Shareholder Value: AFramework or Analysis."Journal f Marketing, ol. 62, no. 1(January):2-18.Yip,GeorgeS. 1982.Barrierso Entry.Lexington,MA:LexingtonBooks.

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