Benchmarking
Basic Measuring and Benchmarking Techniques Overview
One of the most important tasks for any marketing program is the measurement of
its effectiveness. Whether using a multi-million dollar television campaign or a small,
targeted direct mail solicitation, marketers must ensure that the media mix achieves
its objectives.
In Chang and Kelly's book, Improving Through Benchmarking (1994), the authors
recommend a seven-step model:
1.
2.
3.
4.
5.
6.
7.
Identify what to benchmark.
Determine what to measure.
Identify who to benchmark.
Collect the data.
Analyze the data.
Set goals and develop an action plan.
Monitor the process.
Identify What to Benchmark
Identifying what to benchmark is the critical first step in any measurement program.
Marketers must clarify the objective for the benchmarking activity. Knowing the
objective is key to deciding who to involve in the study, as well as the scope of the
program. By setting parameters for the benchmarking study, marketers can
establish a process to implement the study.
Determine What to Measure
Next, marketers must ascertain what to measure. In this step, marketers should
consider what is important to their customers, suppliers, and partners. The client
requirements—and whether they are being met—are essential to identify and
document.
Identify Who to Benchmark
Marketers, when setting benchmark standards, should research who to benchmark
and how other organizations—industry trade groups, competitors, market research
firms—are making this decision. In addition, this research will reveal what method is
being used to collect the data.
Collect the Data
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Benchmarking
Data collection should use a process, such as a survey or questionnaire that is
detailed by tasks to be completed. In addition, the measurement techniques should
be outlined, assigned, and implemented.
Analyze the Data
Marketers must be prepared to conduct real-time analysis when the data collection
process begins, to assess what changes may be required in any aspect of the
measurement plan, and whether there are any gaps in the data collection process.
Set Goals and Develop an Action Plan
Next, marketers should be ready to set goals for the plan. These goals should be
realistic, measurable, finite, and supported by the data gathered. Marketers should
decide whether the goals must be met by a specific time schedule, in increments or
another factor.
Monitor the Process
The methods to accomplish the goals influence the action plan development. The
tasks, timelines, and responsibilities must be defined and should include a
contingency action plan. Equally important is the action plan monitoring program.
The monitoring frequency (daily, weekly, monthly), short-term and long-term goals,
and the benchmark target are critical elements to the measurement plan.
These basic steps outline critical functions for benchmarking and measuring the
media mix for a marketing program. Mass advertising and direct response
advertising integrate specific techniques into these steps to ensure that the value of
unique marketing initiatives can be evaluated and illustrated. Organizations that
require benchmarking and monitoring for marketing initiatives can be proactive in
adjusting products or services and integrated marketing communications, and giving
them a competitive edge in meeting or exceeding customer needs.
Reference
Chang, R., & Kelly, P. K. (1994). Improving through benchmarking: A practical guide
to achieving peak process performance (Quality improvement series). Irvine,
CA: Richard Chang Associates.
2
Capital Budgeting
Capital budgeting is the process of making decisions about which projects to
adopt and which projects to reject. The cash flows realized from the capital
projects selected fuel corporate growth and drive profitability (Shaeffer, 2002).
The steps in the capital budgeting process include the following (Gitman,
2006):
Proposal generation
Review and analysis
Decision making
Implementation
Follow-up
The actual tools used to pick the individual projects to fund include the
following (Shim & Siegel, 1992; Block, Hirt, & Danielsen, 2009):
Payback method
Internal rate of return
Net present value
Accounting returns
These four types of decision-making tools are divided into those that take into
account the time value of money and those that do not take the time value of
money into consideration. The internal rate of return and net present value
take the time value of money into consideration and are also known as the
discounted cash-flow methods. The other two methods, payback period and
accounting returns, do not take into consideration the time value of money and
are known as the nondiscounted cash-flow methods (Gitman, 2006; Block et
al., 2009).
The payback method looks at one key consideration: how long it will take,
measured in months and years, for the net-after-cash flows generated by the
project to equal the initial investment in that project (Block et al., 2009). This
does not look at the time value of money and, as such, does not give a clear
picture of the project’s worth because the "payback" will be in cheaper dollars
than the initial outlay. Accounting returns can be based on profit derived from
the project, but this method does not take into account the time value of
money either and gives a somewhat distorted view of the project’s true worth
(Gitman, 2006).
The internal rate of return method is a discounted cash-flow technique and
takes into consideration the time value of money. In this method, the yield
from the project is determined by equating the interest rate that equals the
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Capital Budgeting
cash flows both in and out of the company (Block et al., 2009). This value or
internal rate of return (IRR) is arrived at by trial and error until the matching
rate is found. The final method used is the net present value (NPV) method.
This is also a discounted cash-flow method that takes into consideration the
time value of money by taking the net-after-tax cash flows expected to be
generated by the project and modifying them by the net present value factor,
summing them, and then subtracting the initial investment outlay. Any
resulting positive answer provides a return that equals or exceeds the
corporation’s cost of capital (Block et al., 2009). If there is any difference in
which a project is favored between the IRR and NPV methods, the NPV method
is considered more accurate.
References
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2009). Foundations of financial
management (13th ed.). New York, NY: McGraw-Hill/Irwin.
Gitman, L. J. (2006). Principles of managerial finance (11th ed.). Boston, MA:
Addison-Wesley.
Shaeffer, H. A. Jr. (2002). Essentials of cash flow. Hoboken, NJ: John Wiley &
Sons.
Shim, J. K., & Siegel, J. G. (1992). The vest-pocket CFO (2nd ed.). Paramus,
NJ: Prentice Hall.
2
Capital Budgeting Evaluation Techniques
This article reviews capital budgeting evaluation techniques for
projects that have revenue and cost streams that occur beyond the
current year.
Management accounting focuses on information gathering and analysis
to make decisions. Some of these decisions such as CVP and pricing
decisions are short term (short term means the benefits and costs are
expected to last one year or less). Other decisions depend on
investments that may occur in a number of years, and return benefits
that also span a number of years. Capital budgeting is a tool that
focuses on projects over their entire lives to consider all cash flows
from a project. For example, a project to consider the purchase or
construction of an expansion on a motorcycle assembly plant in Mexico
would consider costs and revenues from all parts of the project, from
design and engineering to construction and maintenance. During the
financial evaluation phase, a manager chooses those projects with
expected benefits exceeding expected costs by the greatest amounts.
The most common capital budgeting method is called net present
value (NPV). NPV is a discounted cash flow (DCF) technique. DCF
methods incorporate the time value of money. This means $1,000
received today is worth more than $1,000 to be received in 1 year.
The $1,000 to be received in one year is worth less because of the
missed opportunity from not having the money today.
NPV focuses on the CASH inflows and outflows (not on accounting
income). NPV uses a required rate of return (also called the discount
rate, hurdle rate, or cost of capital). The discount rate is the minimal
acceptable rate of return on an investment. Continuing with the
example of the plant expansion, NPV requires the following:
•
•
•
•
1
Identification of the relevant cash inflows and outflows
Estimation of the timing of the cash flows (what year?)
Discounting the cash flows to the current period (so that the
time value of money is equivalent to today’s money)
Summing up the discounted cash flows. Inflows will include
revenues, cash from return of assets, tax benefits, and so on.
Outflows will include expenses and other initial and recurring
costs of the project. Discounting occurs by using a present
value table, a calculator, or plain math, once the timing of each
cash flow is known.
Capital Budgeting Evaluation Techniques
Assume the project has the following cash flows:
$100,000 Investment in year 0
50,000 Additional investment in year2
75,000 Net revenue less costs in year
2
150,000 Net revenue less costs in year
3
50,000 Net revenue less costs in year
4
The discounted cash flows will be computed by dividing by 1 plus the
discount rate to the power of the number of years that need to be
discounted. The discounted cash flows from above are discounted as
follows:
Cash flow
-100,000
-50,000
75,000
150,000
50,000
Year
0
2
2
3
4
Discounted form Discounted $
-100,000
-100,000
-50,000/ (1.10)2
-41,322
75,000/ (1.10)2
61,983
3
150,000/ (1.10)
112,697
50,000/ (1.10)4
34,150
Once discounted, the next step is to sum the discounted cash flows. In
this example, the sum of the inflows and outflows is 67,508. As a
positive amount, this means that the investment has a return of at
least 10% (the discount rate). Remember that the discount rate is the
minimal acceptable rate of return on an investment. Assuming a 10%
return is satisfactory and not competing with other projects, the
business would accept this project.
To determine the exact rate of return earned, a manager would use
the internal rate of return (IRR) method to figure out at what discount
rate, the sum of the discounted cash flows is just zero. This means the
present value of the cash outflows equals the present value of the
cash inflows. The IRR is usually computed using a computer (including
Excel spreadsheets).
2
Capital Budgeting
The two main roles of a firm's CFO or senior financial officer are making
investment decisions for improving the firm's return on equity (ROE) and
finding funds for investment opportunities like new equipment, building
expansions, and new products.
Capital budgeting involves deciding what to invest in. Deciding how to fund
the investment involves an understanding of what is referred to as capital
structure.
There are three primary methods of capital budgeting:
•
•
•
The simple payback method
The net present value method
The internal rate of return (IRR) method
The net present value method involves comparing the present value of the
financial benefits (increased profits, cost reductions, etc.) to the present
value of the investment being considered. If the net present value is greater
than zero, then the project is deemed a good investment; if the net present
value is less than zero, then the project is deemed a bad investment.
The internal rate of return (IRR) method asks this question: At what discount
rate will the present value of the project's financial benefits equal the present
value of the investment being made? This IRR percentage can then be
compared to the firm’s cost of capital or benchmark hurdle rate. If the IRR is
greater than the hurdle rate, then the project should move forward; if the
IRR is less than the hurdle rate, then the project should not be approved.
The simple payback method determines the amount of time in years or
months it will take for the project to recoup its own cost in financial benefits.
Each method has its pros and cons. Most small businesses, run in many cases
by owner-managers, prefer the simple payback method. The calculations are
very fast and easy. Corporations and privately owned firms use one or more
of the NPV and IRR methods in addition to the simple payback method.
To use the NPV or IRR methods, the firm’s cost of capital must be
determined. Determining the cost of capital has many components, among
them the expected return of each of the firm's contributors of capital
(common and preferred stockholders as well as creditors, like bondholders).
Asset valuation is a method to determine these various asset values,
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Capital Budgeting
which can be used to determine what the contributors of capital expect as a
return.
Asset values are predicated on expected future cash flows. In other words,
the real value of an asset depends upon its ability to generate cash flows into
the future, and the value of that asset is represented by the present value of
those cash flows. For example, a preferred stockholder would value a share of
preferred stock as the periodic dividend divided by the expected return, which
is the basic perpetuity formula.
If the face value of the preferred stock were $100 paying an 8% dividend,
and the investor's expected return was 5%, the value of this share would be
$100 multiplied by 0.08 and divided by 0.05 for a value of $160.
This can be used to determine the preferred stockholders' expected return.
The expected return equals the dividend divided by the price paid. If the
stockholder paid $160 for the share, the expected return equals $100
multiplied by 0.08 and divided by $150, equaling 5%.
If the investor only paid $120, the expected return when he or she made the
purchase would be 6.7%.
An identical calculation can be made for the expected return of common
shareholders and bondholders using the dividend discount formula.
This can be used to determine the discount rate to the shareholder.
The formula to determine the value of a bond given a face value, a stated
interest rate, and a maturity date when purchased with a stated number of
years until maturity is as shown:
PVbond = PV of face value upon maturity + PV of the annuity
represented by its interest playments
In turn, this formula can be used to get the expected return, or what is
referred to as the bond's yield to maturity (YTM).
2
Investing to Meet Financial Goals
Financial Goals
The comprehensive financial planning process considers goals for investing
planning, income tax planning, insurance planning, retirement planning, and
estate planning. The financial planning curriculum includes courses that cover
each of these items in greater depth, but it is important to remember the
interrelated nature of the financial planning process.
Some of the typical financial goals would include building an emergency fund,
saving for a home, building a college fund for your children, building a
retirement fund, insuring for catastrophic losses, minimizing taxes and creating
an estate plan.
One thing to consider in investment planning is your stage of life cycle. Your
financial goals will differ based on your circumstances throughout your life. For
example, some of the life circumstances may include the following:
Single-adult
Married
Divorced
Remarriage
Domestic partners
Parenthood
Single parenthood
Divorced parenthood
Empty nesters
Retirement
In addition, your age life stage plays a major role in determining investment
goals. Your goals change as you age because your needs and life situation
changes. Some examples are noted below:
Age and life stage Financial Goals
20s single
Buy new car
Create good credit rating
Begin savings and investment program
20s–30s married
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Purchase house
Meet insurance needs
Create wills
Investing to Meet Financial Goals
Save for children's education
40s
Continued children's education fund
Increase saving and investing
Establish estate plan
50s
Increase saving and investing
Focus on more conservative investment strategies
Increase focus on retirement and estate plans
60s
Update retirement and estate plans
Continual move toward more conservative
investment strategies
Investment Planning
Investing includes forgoing immediate consumption to accumulate funds for
future consumption. Thus, an investor saves or invests funds in an investment
vehicle such as savings certificates, bonds, stocks and real estate to earn
income and or capital appreciation. But the investment planning process will
consider many factors besides growth, such as inflation, taxes, and the risks of
the investment alternatives.
Wealth accumulation is really about achieving goals. This includes accumulating
and preserving capital while maximizing return and minimizing risk. Investing is
not the same as speculating. Speculation is similar to gambling in terms of
taking extreme risk to maximize returns. You can classify speculation as a highrisk investment strategy. Speculation strategies are generally short term and
may include high leverage and do not attempt to preserve capital. The goal of
speculation is to seek high price fluctuations over a short period of time to
maximize profit. These high price fluctuations are considered very risky and are
not for the average investor.
In any event, investment planning strategies that build wealth must consider
the following:
Short- and long-term investment goals
Rate of return
Time horizon
Risk tolerance
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Investing to Meet Financial Goals
Taxes
Diversification
Passive versus active management
Regular investment
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