WASHINGTON, March 17, 2017 — If you’re feeling less content about the businesses that you invest in, it could be because many businesses today are sinking further into debt without a commensurate effect on the bottom-line to justify the borrowing. New studies have shown that a business with high financial leverage—defined as the ratio of business debt to overall business value—tends to spend much less on marketing and advertising, which may reduce consumer satisfaction in the brand.
- Consumer satisfaction drives business value in a healthy borrowing environment
According to this study, not many people have been interested in investigating the possible effects of business borrowing on marketing. This is surprising for many reasons, not least because businesses with high financial leverage will gradually reduce their investments in intangible and long-term assets, most of which tend to have a direct bearing on maintenance of consumer satisfaction levels.
The authors of the study carried out a 17-year long analysis of 171 sample businesses that were investigated in the American Customer Satisfaction Index. They established that high financial leverage can result in less advertising over time and in turn reduce consumer satisfaction in the brand.
This is a significant study, given that marginal rises in leverage and the corresponding reduction in consumer satisfaction can eventually result in significant reduction in revenues and hence operating cash flows.
In addition, high leverage has a negative effect on the relationship between business value and consumer satisfaction. When your business is highly leveraged, greater consumer satisfaction, which should have a positive effect on business value, can have the exact opposite effect. This is because of the increased risk of insolvency, which makes it more difficult for the business to maintain such levels of customer satisfaction.
One way to reduce exposure might be to explore the possibilities of actual debt consolidation, meaning that the business will reduce interests payable and possibly the overall debt burden.
So, what can business owners and managers learn from this? There are strategic opportunities that come as customer satisfaction levels rise. High financial leverage can make it more difficult for your marketing teams to effectively pursue such opportunities. This may happen because of the overestimation of the value of marketing efforts and failure to realize these estimates because of over-leveraging.
- Customer satisfaction is achieved when marketing and finance teams work together
The delicate relationship between business debt and customer satisfaction makes running a stable business more difficult. Think any highly leveraged businesses you know and how their efforts to reduce the financial burden interfered with customer satisfaction.
Take, for example, American Airlines, which began to sell everything from airplane snacks to extra leg-space. There’s also the case of Rite Aid, a pharmacy chain that overleveraged itself and then had to downsize its staff. As a result, they had fewer assistants, longer queues and angrier customers unlikely to return.
Many people blindly attribute all customer satisfaction decline incidents to marketing goofs. While this is often true, highly leveraged businesses play a different game altogether. It is likely that the business will try to increase its prices and reduce value addition services to raise revenue, and we know that these directly lower customer satisfaction. The real problem, however, is that senior level managers operate the marketing and finance divisions as two separate entities, not pausing to consider how one’s actions may affect the other.
In truth, financial markets are directly affected by the action of businesses’ marketing teams as research shows. The reverse is also true. However, marketers tend to only look outside; examining competition, regulations and consumer behavior for impacts rather than looking inwards for possible counterproductive strategies.
In many businesses, the finance and marketing teams operate completely autonomously. In reality, the heads of both teams must consider the effects of their decisions on each other to maintain the delicate balance between financial leverage and consumer satisfaction. Consumer satisfaction is an important deliverable for the marketing team, while financial results from said satisfaction forms the financial team’s deliverable.
As a result, any decisions to change the business’s capital structure without considering how such decisions will benefit customers will slowly erode a business’s intrinsic value. There have been many studies explaining the impact of marketing on finance, but few people actually consider the converse hypothesis.
Most often, businesses choose to change their capital structure in favor of increased borrowing when they need money, mostly because of the tax benefits that debt has over equity. But then, increasing the level of debt increases the debt repayment burden, which in turn makes managers more conservative in their actions to ensure the business remains solvent in light of the new debt taken on.
Such businesses tend to choose short-term cash-giving investments rather than long-term intangible benefits. For instance, they may reduce the money spent on customer support or research and development of new product lines since they don’t directly increase the bottom-line, especially in the shorter term.
As the businesses’ finance managers become more risk-averse, more short-term decisions are made. In addition, investors and lenders such as online consolidating companies may begin to lose confidence in the customer asset base since customers are less satisfied and therefore no longer dependable as a business asset for the future.
On the other hand, without considering financial impacts, marketing teams are likely to make all-encompassing and sometimes wrong hypotheses, such as “Making customers happy is the most important thing.”
In reality, customer satisfaction achieves its equilibrium at some point, after which increasing satisfaction will not result in a corresponding increase in revenue. As a result, the business will be spending/foregoing revenues in order to increase satisfaction yet they stand to gain nothing by way of returns. And as mentioned before, beyond a certain point of financial leverage, chasing after customer satisfaction can actually negatively affect the business value.
The reality of running businesses today is that nothing can exist or should be considered in a vacuum. The most successful businesses have a bird’s eye view of organizational strategies, looking at how a possible change in one area can improve or negatively affect another area. Understanding the role of financial leverage in the race for customer satisfaction will help you make better borrowing decisions. The thing to remember is that nothing exists in a bubble. Improving communication is the best way ensure you’re making the right decisions for your business.