Money well spent?

When a company’s debt shoots up, its customer satisfaction is likely to go down, which can make running a business as difficult as balancing a teeter-totter.

Examples range from debt-heavy American Airlines, which cut costs while trying to increase revenues by putting a price on everything from peanuts to legroom, to the pharmacy chain Rite Aid, which borrowed a lot of money, then cut corners and reduced staff.

“Now they have long lines, have lost customers and it’s directly linked to increased debt,” says Ashwin Malshe, PhD ’11, currently an assistant professor of marketing at University of Texas at San Antonio. “Debt reduces satisfaction and makes the customer assets less valuable.”

So who’s the heavy when the bottom line bottoms out?

It’s not uncommon for marketing to bear the blame when customer loyalty cannot be maintained after a highly leveraged company increases prices and decreases services in an attempt to shore up revenue. But Malshe and Manoj Agarwal, associate dean and professor of marketing in Binghamton University’s School of Management, say their research shows that responsibility lies with a corporate culture in which managers in marketing and finance work independently without fully understanding how their actions impact each other.

Finance vs. marketing

Agarwal recruited Malshe to the School of Management from India in 2006. The two shared an interest in the marketing/finance interface and began collaborating on research.

Malshe received a PhD in marketing with a minor in econometrics from Binghamton University in 2011, but he also completed coursework for a minor in finance. “The finance faculty said he was one of their best finance students,” Agarwal says, and Malshe developed two essays for his dissertation — one that looked at the impact of finance on marketing, and one that did the opposite.

“My principle interest was to understand how financial markets respond to what marketers do,” Malshe says. “What intrigues me is that a lot of financial policies have an impact on marketing, but marketing is self-contained. Marketers look externally at competition, consumer behavior and regulations for impact, but seldom something within the firm.”

In 2011, Malshe and Agarwal presented their research at the Marketing Meets Wall Street conference then submitted their paper to the Journal of Marketing, the top journal in the marketing field. Timing and substance was key, Agarwal says, because an almost identical paper from other researchers was also under review.

“Ashwin’s understanding of the finance literature was very thorough, and we felt there wasn’t as much theory from the finance side in the other paper,” Agarwal says. “Ultimately our paper, ‘From Finance to Marketing: The Impact of Financial Leverage on Customer Satisfaction,’ was accepted and published in September 2015.”

“Essentially, in most firms, finance and marketing work separately. They don’t interact as much as they should,” Agarwal says. “What our paper basically says is the chief financial officer (CFO) and chief marketing officer (CMO) need to really understand how their actions affect the other.”

The paper does an excellent job of bridging marketing and finance, says Sundar Bharadwaj, Coca-Cola Company chair of marketing at the University of Georgia’s Terry College of Busi-ness. “Customer satisfaction is a key outcome variable for marketers, as the financial returns of satisfied customers are very significant. Capital-structure decisions that constrain a firm’s ability to invest in and maximize the benefits from customer satisfaction is value destroying.”

Malshe and Agarwal were among the first to show the impact of financial decisions on marketing actions, Agarwal says. “Everybody has been publishing about how marketing impacts finance, rather than the other way around, so we had something in a different vein.”

“This is a very important issue,” says Vikas Mittal, J. Hugh Liedtke Professor of Marketing at the Jones Graduate School of Business at Rice University. “For the past decade or so, there seems to have been an untested assumption that marketing impacts firms’ financial outcomes. It is important to look at the converse and examine how a firm’s financials can impact its marketing decisions.”

In fact, Agarwal says, bringing some aspect of finance into the marketing literature and practice has now become “the in thing.”

This research is critical in identifying and documenting the dysfunctional consequences of firm leverage, Bharadwaj says. “Research done with such rigor, while having managerial relevance is important both for knowledge development and for training the next generation of smart managers in the classroom.”

Answering skeptics

Results of Malshe and Agarwal’s study indicate that a firm’s increased debt may lead to low customer satisfaction, and customer satisfaction’s impact on a firm’s value is moderated by the level of debt the firm has.

“Some people are skeptical about our claims,” Malshe says. “If our results are true, why would any company take on debt, they ask.”

When firms need funds, they prefer debt over equity because of its tax benefits. “However, when firms take on a lot of debt, they’re worrying about paying it back, so are more conservative in their actions,” Agarwal says. “As a result, they make investments that give them short-term cash flow rather than long-term benefits. Thus they might cut expenses on customer-support staff, reduce new-product introductions, etc. — in turn reducing customer satisfaction.”

“What we have shown is two-pronged,” Agarwal adds. “When a firm takes on debt, it affects the thinking of the manager, who makes more short-term decisions. The other prong is that the investors value the firm’s satisfied customers less, as they feel that the debt might constrain the firm from taking full advantage of their customer assets in the future. It’s a double whammy.”

“To academicians, the focus is to maximize marketing metrics such as brand equity, customer satisfaction or market share,” Malshe says. “They often don’t take an organization’s dynamics into account, such as how stock analysts can impact a firm’s strategy.

“If marketing academics don’t take into account the cross effects from other divisions in a company, they might make incorrect blanket inferences such as ‘delighting all the customers is the best policy,’ when our research shows that it will be true only under certain conditions,” Malshe says. One reason, he says, is because — at some point — customer satisfaction will stabilize, and the cost of maintaining that satisfaction will not be offset by an increase in revenue.

“At a very high level of debt, customer satisfaction can even have a negative impact on a firm’s value. Our research can help put things into perspective,” Malshe says.

The clear message of Agarwal and Malshe’s research is the need for strong communication, especially between a firm’s CMO and CFO.

“Say marketing wants money to run a campaign and asks for $5 million, but the CFO will only give them $1 million because the CFO may be under pressure to make interest payments on large sums of borrowed money. The CFO needs to take into account marketing and customer satisfaction instead of just capital structure, and the CMO needs to understand the financial side of the equation,” Malshe says.

“The reality is you can’t work in a bubble,” he says. “Better communication is how to make the best decisions.”