Why Marketing (Research) Is Important

Yes, I admit it. This is a self-serving post. But when compelling research crosses one’s eyes, one is forced to write a blog post. In this case the compelling research comes from Natalie Mizik under the intriguing title of “The Theory and Practice of Myopic Management”. How can I pass that up? In this research Natalie sets out to show that myopic management (i.e. cutting marketing and R&D expenditure for short term gain) is financially bad for the firm in the long run. She proves her main point but also makes a couple more so let’s take a look at what she has cooked up.

Incentives and Disincentive

The basic setup is this. Managers at firms have all sorts of incentives and disincentives. Rarely are they aligned perfectly to benefit the shareholders long term as they should be. The big bully in the neighborhood everyone wants to please (periodically) is the stock market. Too often managers may be incentivized to avoid ticking off the bully. So they may engage in activities that have unintended consequences. We are not talking about illegal activities, just your garden variety adjustments. Such activities fall into at least two categories. One is accounting adjustments (such as recognizing revenue in an earlier quarter) and the other is myopic management (i.e. reducing expenditures in marketing and R&D) to make the quarterly numbers look better. In one survey, 80% of CFOs report they would reduce discretionary spending such as advertising and R&D when faced with the possibility of falling below their desired quarterly earnings. Yikes!

The question then is, are there any consequences for such cutting of corners? Is one kind of corner cutting (accounting-based versus myopic) worse than the other? Appropriate data (and some strong quantitative modeling skills) would be needed to tackle these questions. I know she has the skills. For the data, she actually has two sources. One is the Compustat database providing accounting information and the other is the CRSP data providing monthly stock return information. Combining the two she gets a database of more than 6600 firms over a twenty-year span and everything she needs for the analysis. Given the time series nature of the data (rather than the one shot cross-sectional data typically seen in market research studies) she uses a complex variation of regression analysis called autoregressive modeling.

Findings of the Study

What did she find? Let’s take a look at one of her charts that very nicely shows a lot of the basic results. She had to run a lot of models to validate this raw data but the picture holds up.

Here’s what we see:

· In the short term, the market can’t tell the difference between cheaters and others (hence the incentive to cheat)

· In the short term, the honest under-performers take a hit (hence the incentive to cheat)

· In the long term, cheaters do worse than everyone else (so cheating doesn’t pay)

· Best of all, those who took their lumps early beat the cheaters in the long run

So the lesson here is, don’t be afraid of the bully. You may lose your lunch money but you will prevail over time.

Talking about cheating, is there a difference between the two kinds (accounting-based and myopic management)? It turns out there is. Myopic management (cutting marketing and R&D expenditure to boost performance) is significantly worse over time compared to an accounting based manipulation. In fact she provides a delicious little nugget from the data. Remember the corporate good governance legislation that was passed in the wake of scandals such as Enron and Worldcom? It was called Sarbanes-Oxley (SOX for short). Supporters said it would reduce corporate wrongdoing while opponents said it was unneeded additional regulation. Turns out both may have been right in a way. After SOX accounting-based manipulation significantly declined, so hooray for the law. But following the dictates of the law of unintended consequences, myopic management decisions went up making matters even worse!

To be clear, her research is addressing firms that showed above-normal levels of profit and still proceeded to cut expenses. They don’t apply to firms that are cutting expenses because they are struggling.

So where does that leave the market research worker bees? Undoubtedly research expenses get cut along with or ahead of marketing expenses when someone higher up decides they don’t want to take on the bully. This research shows that’s a bad idea and the result will be lower company performance in the long term (in this case just a couple of years). Market researchers would be well advised to show the value of the research they do. Perhaps even better they should showcase the results of this study as it talks directly to those who make the decisions on what to cut.

Resist the bully!

About the Author of the Study 

Natalie Mizik is the Gantcher Associate Professor of Marketing at Columbia University. She is currently a Visiting Associate Professor at MIT. Her research was published in the August 2010 issue of the Journal of Marketing Research. A related article was also published in the Harvard Business Review in 2007.