Sarbanes-Oxley Requires Tracking of Marketing Spending

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1 Decision Framework, C. Marcus Research Note 30 May 2003 Sarbanes-Oxley Requires Tracking of Marketing Spending The Sarbanes-Oxley Act will require enterprises to closely monitor and track their marketing expenditures. To do this, the marketing function must be transformed to comply with the new requirements. Core Topic Customer Relationship Management: Business Strategies, Technologies and Applications for Marketing Key Issue How can the marketing function better focus on value creation by leveraging technology in its operations? Note 1 Overview The Sarbanes-Oxley Act of 2002 is a piece of U.S. legislation that was signed into law on 30 July 2002 and was intended to restore confidence in public financial reporting. It represents the most significant reform in U.S. securities laws since they were enacted, as well as a fundamental change in how management carries out its fiduciary responsibilities. Although Sarbanes-Oxley provides specific guidance in some areas, it mostly provides more of a framework and further rule-making will be necessary for clarification. Note 2 Section 404 Section 404 of the Sarbanes-Oxley Act addresses the need for enterprises to establish and maintain adequate, internal control structures and procedures for financial reporting. The new certification requirements may require some enterprises to formalize control structures, enhance controls and establish monitoring programs to enable CEOs and CFOs to make evaluations and report conclusions. The required, annual deliverable is a management and audit firm report that highlights the internal controls that are in place, discloses gaps or weak links in the controls and details plans to remedy outstanding issues. Section 404 is scheduled to take effect with fiscal year reports that are filed on or after 15 September As enterprises begin sorting through the ramifications of the Sarbanes-Oxley Act of 2002 (see Note 1), their examination of financial controls and reporting associated with marketing practices will raise issues that they must address in the next 16 months. Specifically, Section 404 (see Note 2) requires enterprises to establish, maintain and publicly report on the adequacy of internal control structures and processes for financial reporting. Even though Sarbanes-Oxley is a piece of domestic U.S. legislation, not an international agreement, it is likely to have an impact on U.S.-based and non-u.s.-based enterprises (see Note 3). The marketing function is a particularly visible target for efforts associated with the Sarbanes-Oxley Act because it commonly handles material amounts of discretionary spending. Areas of significant spending will be of particular interest in how external audit firms attest to controls related to Section 404. Enterprises should spend time with their external audit firms to understand which areas will be of particular focus, and what the audit firms will be looking for to attest to management's methods and processes in evaluating the effectiveness of the controls. The management and reporting associated with marketing funds will have to adhere to higher standards. They will have to be auditcompliant, and they will require management sign-off so that similar financial reporting adheres to established internal controls and related systems. Marketing Function Must Be Transformed to Comply With Requirements From a conceptual perspective, although specific Sarbanes- Oxley control and reporting requirements remain in a state of flux, some directional expectations have been established. Also, given the current state of the marketing function in most large Gartner Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice.

2 Note 3 Impact on Non-U.S. Enterprises The Sarbanes-Oxley Act demands compliance from enterprises whose securities are listed in U.S. financial markets. The legislation reflects a shift in the philosophy that underlies U.S. securities laws from disclosure to substantive regulation of corporate governance. Also, this shift significantly affects foreign enterprises' costs of complying with U.S. law. In addition, Sarbanes-Oxley requires compliance from all foreign audit firms that deal with U.S.-listed firms. However, the European Union has already raised issues regarding some elements of the legislation that are unnecessary, expensive and, in some cases, contrary to domestic legislation. enterprises, achieving established objectives will require significant transformation. Consider the following: The marketing function often lacks visibility into the current state of marketing activities, as well as the associated financial commitments, actual investments, forecasts or actual results. Most marketers rely on planning and budgeting processes that lack standardization and depend largely on unstructured data. Spreadsheets remain the most-common application for marketing's budget planning and tracking, and they are often used in conjunction with manual input to and from financial systems. Tracking, auditing and reconciling marketing expenditures are, at best, difficult and time-consuming activities. Examination of marketing practices such as purchase volume rebates, cooperative advertising allowances, thirdparty service costs and other marketing practices are likely to reveal significant gaps relative to the higher standards sought by the Sarbanes-Oxley Act (see Note 4). Note 4 SEC Scrutiny on Marketing-Related Reporting The Dutch grocer Ahold is facing Securities and Exchange Commission (SEC) scrutiny, and it has acknowledged revenue overstatements of more than $800 million related to promotional allowance programs at its subsidiary, U.S. Foodservice. At issue are some questionable revenue recognition practices, as well as a lack of control and visibility that enabled such fraud to go undetected for several years. Essentially, most enterprises will need to establish a much higher degree of visibility into the state of marketing activities and associated funds. This can only be accomplished by implementing formal internal controls and processes that effectively track marketing expenditures. Although some enterprises have acknowledged the need for and the benefits of greater visibility and accountability of marketing expenditures, Section 404 of the Sarbanes-Oxley Act raises the level of required attention from a business to a legislative compliance concern. Emerging Compliance Solutions and Their Impact on the Marketing Function Vendors have rapidly lined up to capitalize on the compliance boom associated with the Sarbanes-Oxley Act. Marketing enterprises in particular are presented with two types of solutions: 1. Enterprisewide Compliance-Focused Solutions: These are delivered as a combination of technology and consulting services. They are focused on the documentation and reporting of internal controls within those systems that participate in the processes to which enterprises must attest with less focus on the design, development and implementation of new internal controls and frameworks for enterprisewide compliance. From a 30 May

3 technology perspective, these solutions rely on an enterprisewide content management, business intelligence or corporate performance management platform to document, manage, monitor and report relative to compliance requirements. These solutions primarily aim to coexist with operational processes, and to advocate integration with financial, enterprise resource planning and other established enterprise applications. Examples include announcements of collaboration on compliance-focused solutions between, for example, BearingPoint and Documentum, and IBM Business Consulting Services (formerly PwC Consulting) and Cognos. 2. Marketing-Function Process-Driven Solutions: Their focus includes compliance and extends beyond it, with emphasis on making the marketing function more efficient, effective and accountable with respect to the broad use of financial and marketing resources. Although this approach also involves a combination of technology and consulting services, the emphasis is on re-engineering, standardization and automation of key marketing planning, budgeting, tracking and reporting processes. Marketing-automation vendors such as Aprimo, MarketSoft and SmartPath have taken the lead in emphasizing the broader business benefits associated with this approach. Unlike compliance-focused solutions, however, marketing-function process-driven solutions may lack sufficient breadth and depth of functionality, and expertise, to ensure effective compliance. In particular, these solutions do not address the non-marketingrelated processes to which enterprises must attest. Key Considerations Time is running out for enterprises that are behind in documenting controls for Section 404 of the Sarbanes-Oxley Act. The longer an enterprise waits to begin related documentation and testing, the harder it will be to focus on anything but compliance. However, it is important to note that Sarbanes-Oxley rules are still being developed. Vendors that are pushing to sell compliance-related solutions are leveraging fear, uncertainty and doubt to gain business, and they may be overdocumenting and testing as a precautionary measure and to increase related project revenue. As such, vendors' efforts may exceed the level of effort that is necessary to obtain short-term compliance with regulations. Enterprises must recognize that an enterprisewide compliance approach and a marketing-function process-driven approach are not mutually exclusive. Standardization and automation of marketing planning, budgeting, tracking and reporting capabilities may not satisfy broader compliance requirements, but they are likely to simplify and reduce costs of integration with an 30 May

4 enterprisewide compliance-focused solution. Also, the benefits derived from the more-effective and accountable use of marketing resources are likely to offset related incremental investments (see "Select CRM Applications Carefully to Get Maximum Benefits"). A strict focus on compliance may prove to be effective in minimizing the associated risk and exposure; however, it is less clear that this could have a broader and more-substantial impact on the way the marketing function operates. Much of the research, interviews and analyses that must be done to implement compliance-focused solutions can and should be leveraged in the subsequent design and implementation of a marketing-function process-driven solution. On the other hand, if a compliance-focused solution is deployed ahead of a marketing-function process-driven approach, it may improve marketing visibility and accountability to the point where compliance requirements are addressed but in so doing, it may also reduce the incentive for further transformation of marketing processes. In addition, because an enterprisewide compliance-focused approach seeks to coexist with the marketing function's method of operation, it may be more difficult to promote the broad adoption of a subsequent marketing resource management deployment that is aimed at supporting broader transformation of the marketing function. Recommended Follow-Up for the Marketing Function Locate and consult with the individuals responsible for Sarbanes-Oxley Act compliance within the enterprise, including legal counsel and other internal or external risk management advisors (see Note 5). Note 5 Seek Proper Counsel This Research Note is not intended to provide legal analysis or advice. Enterprises should seek legal counsel and consult appropriate risk advisors regarding specific Sarbanes-Oxley issues and questions, as they relate to enterprises' unique circumstances. Assess the likely impact of Sarbanes-Oxley compliance, relative to the similar processes and capabilities of the marketing function. Undertake a request for information process that includes relevant vendors providing enterprisewide compliance or marketing-function process-driven solutions, to better understand the associated capabilities. Conduct a gap analysis of current capabilities relative to the desired or potential end-state, for the purpose of quantifying the costs and benefits of implementation that are associated with enterprisewide compliance and marketing-function process-driven solutions. Develop a strategy and implementation plan for Sarbanes- Oxley compliance. This should be done in the context of the 30 May

5 enterprise's overall corporate performance management strategy, if it has one. Determine the role (if any) that marketing-function processdriven solutions will play in the compliance process, giving sufficient attention to the broader implications and potential for further transformation of the marketing function. Bottom Line: The Sarbanes-Oxley Act of 2002 is here to stay. It will require significant transformation relative to how most large enterprises manage their marketing expenditures. Enterprises must adhere to the compliance requirements. However, they should also look beyond compliance to assess and take advantage of the larger opportunity of making marketing more efficient, effective and accountable. 30 May