Interview: Professor Malcolm McDonald
Marketing Due Diligence:
Reconnecting Strategy to Share Price
Steve Macaulay
Hello, I am Steve Macaulay and today we are going to
interview Professor McDonald about a book that he has
co-written called Marketing Due Diligence: Reconnecting
Strategy to Share Price.
Now Malcolm, we are very familiar with due diligence as
a financial process, as a business process, but not
marketing due diligence. What actually is it?
Malcolm
McDonald
We are familiar with financial due diligence. It’s a pity
it’s not always rigorously applied, as in the case of the
Lloyds Banking Group and their purchase recently of
HBoS, and they have admitted that they didn’t even do
proper financial due diligence on that. But you are quite
right Steve, that financial due diligence in major
organisations certainly there is usually a formally
constituted audit committee doing financial due diligence
on things like acquisitions and major capital expenditure.
And they do things like probability, they do risk
assessment using probability theory, real option analysis,
they do discounted cash flows, of course. And it’s a well
documented process.
Unfortunately, for what constitutes the major value of an
organisation, the intangible assets, there is rarely
anything so formal and if you think about it, it’s public
knowledge that in the United Kingdom for example, 85%
of all corporate value is in intangibles, not in tangibles.
In America it is 87% of all corporate value is intangibles.
And I think the best example of this is Procter and
Gamble’s purchase of Gillette in 2006, when they paid
£31bn – think about that, it’s more than the gross
domestic product of many nation states – they paid
£31bn for Gillette, of which only £4bn was tangible
assets, which means they paid £27bn for intangible
assets.
And we at Cranfield via our research clubs run by myself
and people like Professor Keith Ward, one of our finance
professors, we started researching this many years ago
and saying this is absolutely ridiculous; we need to get a
better handle on how you assess risk and do that kind of
audit with those intangibles. That was the basis of the
research club and it was the basis of the book.
Professor Malcolm McDonald
Steve Macaulay
Now you have split marketing due diligence into three
areas of risk – did you want to say what those are?
Malcolm
McDonald
Yes, there are three areas. Before I go on to that what I
will say is that as we are sitting here now in July 2009, if
you wanted one word that was at the top of every
government and every chairman’s agenda, the word
would be risk, because we have all suffered a global
crisis where risk wasn’t managed properly. So it’s a
very exciting area, and any work that is done in this area
is going to be well received.
Now the three areas in marketing; every organisation in
the world says three things – all plans say three things.
They say this market that we are going in looks like this,
it’s this big and it’s going to grow by this much. It says
in this market these are the strategies we are going to
employ to get this many sales and this much market
share. And these are the margins that we are going to
market – the profit pool we call it – these are the margins
we are going to make.
Now all plans say that. What we say is that those three
major areas should be formally and systematically
subjected to risk assessment so that the net free forecast
cash flows are reduced probabilistically by your risk
assessment in those three areas. And that is what the
book explains, that is what the book does.
Steve Macaulay
So what are the implications of this for managers?
Malcolm
McDonald
The implications are very serious because in capital
markets, Steve, success is measured today in terms of
shareholder value added, having taken account of the
risks associated with your future strategies; that is the
one that I have just outlined; the time value of money
and the cost of capital. Whether we like it or not that is
how major organisations are judged. So it is
shareholder value added.
Now the bottom line on the book is that having taken
your strategies and subjected them to that rigorous
probabilistic risk assessment, and having either reduced
or not – depending on how good they are – the net free
cash flows; having then gone to the finance director and
found out how much capital is employed in the business
unit – and they all know because it is not just tangibles.
They all know what the capital is. What you then do is
you do a simple calculation with a finance director to say
whether those net free risk adjusted cash flows are going
to create or destroy shareholder value. If they are not,
© Cranfield University
Knowledge Interchange Podcast
Page 2
Professor Malcolm McDonald
that should be reported to the board and you should be
putting your strategies right before you implement them.
That is a major, major implication and of course, if you
have done it, then clever companies – and the big
companies, the clever companies like the Procter and
Gambles already do this anyway – they actually report to
the investment community what their strategies are going
to be and they have already subjected them to this risk
assessment. Which is why the capital value of the
shares of those companies always goes up; and
whereas the capital value of other shares that haven’t
done that go down.
Steve Macaulay
Now we may be dealing in stereotypes, but it feels like
the average marketing person might well run a mile at
this kind of analysis, of looking at share price and so on
and these numbers. Am I right in this?
Malcolm
McDonald
I am very sad after a lifetime in marketing, Steve, to say
that you are right. The majority of the marketing
community – fortunately there is a minority in the
marketing community – and they are gainfully employed
in these world class companies already, who do these
kinds of things, but the vast majority of the marketing
community, I am afraid to say, they don’t understand
finance, they don’t know how to address their board, they
don’t understand the concept of shareholder value
added, they don’t subject their own strategies to this kind
of formalised risk assessment process.
And I suppose the most insulting term I could use is that
turkeys don’t vote for Christmas. So the book that was
voted Britain’s Best Marketing Book in 2006 by the
Chartered Institute of Marketing, is in the main bought by
finance directors and they are beginning to ask their
marketing colleagues some very awkward questions.
So my plea is that the marketing community should pick
this book up, read it and do it.
Steve Macaulay
So what are the first steps to do that? They have picked
the book and maybe they feel a bit daunted by this
process, but they have picked it up and they have read it;
and then they would say well now what? Where do I go
from here?
Malcolm
McDonald
Well one of the most frequent outcomes from
implementing the marketing due diligence process in
organisations, and if you picked the book up and did it
yourself you would come to the same conclusion, is that
your strategy isn’t a robust strategy. So the first thing
© Cranfield University
Knowledge Interchange Podcast
Page 3
Professor Malcolm McDonald
you have got to do when you discover that on route to
working out the shareholder value added bit, or
shareholder value lost, the first thing you have to do is go
back and reformulate your strategy. That is the whole
purpose of it, so you have got robust value creating
strategies as opposed to the vapid forecasting and
budgeting kind of stuff; the vague hopes of doing better
that you get in most plans.
So that is the major, major outcome when somebody
picks the book up. They have either got a robust
strategy and they can prove it to the board, or they
discover that they haven’t and they have to go back to
basics and reformulate their strategy.
Steve Macaulay
In these straightened times in particular, Malcolm, thank
you very much for this very useful advice and
recommendations.
Malcolm
McDonald
My pleasure.
© Cranfield University
Knowledge Interchange Podcast
Page 4