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Why marketers need to understand interest rates

Marketers aren’t innately economists. You’ll be hard-pressed to find any marketing theory book, course, or agency environment that would have given them a passing look, until now, that is. 

For the most part, they never had to care about them. Interest rates have been low globally since the 2008 financial crisis, which has created a state of affairs where innovation has been powered by investment, made possible by low-interest rates. Furthermore, the housing market has benefited, which has enabled lower cost of homeownership and greater consumer spending power.

That’s all changed this year. The whole of Europe and the US has been faced with economic challenges. And although the differences between each country are significant and noticeable, their overall effect on the marketing industry and how marketing operates has been very similar.

To illustrate why, we use behavioural economics to consider their impact on VC investment and consumer spending. There are many more factors that interest rates affect, so if you’re interested in going deeper, then please select a time for a call.

Why do interest rates exist?

To explain this properly, we’d need to cover the financial history of the global economy and the fundamentals of how money works. That would take a little time, so we’ll gladly recommend The Ascent of Money to explain how we got here. To simplify for now, interest rates relate to the creation of credit in society, which is widely thought of as being one of the biggest drivers of economic growth. In short, people with good ideas can borrow credit to get them off the ground, and in doing so, pay an interest rate to a lender for borrowing the money. In doing so, the lender has to take on the risk, and also incur an opportunity cost as they can’t use the money elsewhere.

The relevance of this is that money can be loaned by individuals on this basis, as well as financial institutions, companies, and even the government in the form of debt. And a crucial institution that holds this system together is the central bank. In the UK, this is The Bank of England. In the US, it is The Federal Reserve. The central bank keeps the system in check by ensuring that all banks within a country operate in sync (i.e. they won’t go bust) and the government’s spending plans are feasible in line with global market pressures. In a situation where most global economies are now significantly in debt due to government overspends, this function is critical.

In effect, the central bank pulls a lever on a country’s economic system to ensure that it remains stable. Alongside smaller measures that it can employ, the most visible sign of its influence is the setting of interest rates. These are designed to manage volatility and, importantly, reduce inflation. Inflation is destabilising for an economy because money’s value changes through time. This makes it more difficult for governments to manage society, and very difficult for the majority of individuals that live with little or no salary surplus. In effect, their savings can be quickly wiped out if their salaries don’t rise to compensate.

In today’s environment, multiple economic factors have led to a slowdown in the economy and created inflationary pressures. The result has been a desire for the central banks of Western nations to increase interest rates. However, this has been made more difficult because of the nature of inflation. Price rises have less to do with high demand and more to do with decreasing supply due to disruptions in global supply chains and an energy crisis. 

This is means that the resulting measures won’t curb the over-spending of rich nations and their residents, but instead, show global markets that countries can pay back their GDP deficits to keep their borrowing costs down.

For marketers, these changes couldn’t be more relevant. Since the 2008 financial crisis, digital marketing has dramatically changed the industry, along with budgets to support its growth.

VC investment linked to marketing success

One area where interest rates have a substantial impact is on the viability of venture capital to support entrepreneurial ventures. Although it can be complex to explain all the reasons why, high-interest rates make the return on investment less attractive relative to other, more secure ways of investing. For example, if a bond (e.g. a government debt), has a guaranteed 5% return, then a VC investment will need to return more than if a bond returns 1%. This has very material implications as investors become more risk averse, and entrepreneurs struggle to raise capital.

The fallout is so important for marketers because marketing investment is usually required to establish new companies. Without a legacy to fall back on, startups typically need to shout from the rooftops to establish themselves. We showed previously that startups spend extremely high marketing budgets as a % of revenue compared to established players, powered by investment. This is often a necessity, as startups with an ambition of dominating existing markets will have to have a presence on a par with major players who already have major revenues. 

This drop in marketing budgets cascades into other marketing areas. The largest tech business such as Amazon, Google, Twitter, Meta, LinkedIn and Snapchat all depend on advertising revenues. Furthermore, it is only logical to suggest that established businesses’ no longer have to prioritise marketing so heavily if the threat of new entrants reduces due to a reduction in startup competition.  

Influences on consumer spending

As we covered previously, disposable income is crucial for marketers, as it dictates how much money they have to spend on both essential and discretionary purchases. And this makes interest rates a crucial enabler for disposable income. If interest rates go up, then the government is effectively incentivising saving, as consumers gain more from their savings over time. This reduces the purchase of goods and services, and then, in a perfect world, reduces inflation.

The implication for marketers is that they need to work even harder to gain customers, when as we explained earlier, their budgets are being reduced. A tricky challenge indeed!

In the current economic climate, this is made even more difficult because many of the cost increases have little to do with increased demand and more to do with supply costs going up. For this reason, marketers are caught in an ever-more challenging environment where they have to market inflated prices, with lower demand and lower marketing budgets. 

Economics and marketing so closely linked

This article shows how economic data can have a clear and material impact on how marketing operates. And with interest rates set to rise over the coming years, we are beginning to see many of the second order effects mentioned above.

If you would like to carry on the conversation with us, then please get in touch. Alternatively, we have many more related blogs you can read.

See you next time.

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