Long-term Profitability: Advertising versus Sales Promotion

Alex Biel

This study examines the allocation of funds between advertising and sales promotion. In recent years, marketers have been increasingly turning to sales promotion as a seemingly attractive strategy.

Although many marketers agree that resource allocated to advertising is an investment in long-term brand building, there is far less confidence that advertising is an effective tool in the short or intermediate term. While it is generally accepted that promotions generate short-term sales, some of those sales are simply ‘stolen’ from future purchases by the same consumer.

I am concerned that this short-term orientation has destructive longer term effects. A major question which marketers must confront is whether excessive emphasis on promotion actually erodes perceived brand value.

If a brand is on ‘special’ price too frequently, consumers are likely to start to think of the ‘special’ price as the normal price for the brand – and learn never to buy the brand unless it is discounted. Clearly, we need to pin down the benefits of sales promotion: Does it really build profits for a marketer, as conventional wisdom suggests? Or does it have a negative impact on earnings?

THE LONG-TERM PROFIT EFFECTS OF SALES PROMOTION

Those questions led to the second collaborative study between the Center for Research & Development and SPI.¹ This time the SPI investigative team was headed by Robert D. Buzzell, Professor of Marketing at Harvard Business School. Again, the PIMS database was used.

For this second study, we further refined the database of 749 consumer businesses to examine businesses with basically similar promotional mechanisms. This led us to examine a group of 314 consumer non-durable businesses – the fast-moving consumer goods (fmcg) businesses included in PIMS, and on which we had both advertising and promotion spending data. Sales promotion, as defined in PIMS, includes both trade and consumer activities (the average US package goods marketer spends 60% of his below-the-line money on trade promotions, and 40% on consumer promotions); most consumer promotions relate to price: temporary cut-price offers, premiums, direct couponing and money-back deals. Contests, games and sweepstakes are also included in this category.

To examine the relationship between various strategies on the one hand and payout on the other, the sample of business units was divided into three approximately equal parts, based on a frequency distribution of their allocation patterns:

• businesses using sales promotion as their dominant strategy,
• businesses using a mixed strategy,
• businesses using advertising as their major marketing investment vehicle.

Businesses using promotion as the dominant strategy were defined as all businesses spending less than 36% of their marketing funds in advertising. The average business in this group spent only 23% of their marketing money on advertising and 77% on sales promotion.

The group using the ‘mixed strategy’ actually skewed slightly towards promotions. This segment of PIMS fmcg businesses spent between 36% and 50% of their marketing money on advertising. On average, they placed about 44% of their marketing expenditures in advertising, and 56% in promotions.

The final group comprised that set of businesses which used advertising as their dominant spending strategy. To be included in this group, businesses had to place over 50% of marketing investment in advertising. The average business in this group allocated two-thirds of its marketing funds to media advertising, and the rest to promotion. Table 1 gives the performance of each group.

TABLE 1: RELATIONSHIP OF ADVERTISING/PROMOTION MIX TO RETURN ON INVESTMENT

Those companies spending the bulk of their funds – 76% – on promotion, achieved an average return of 18.1% (pre-tax and pre-interest charges).

Those employing the mixed strategy, where on average 44% went to advertising and 56% went to promotions, earned a considerably more respectable average return on investment of 27.3%.

The group of marketers using advertising as their dominant strategy – that is, businesses investing more than 50% of their marketing resources in advertising – registered the healthiest return on investments of all, averaging 30.5%.

The other measures of performance included in the analysis, such as return on sales and share of market, all showed similar patterns; but as might be expected, the magnitude of the differences varied. It is clear that there is a positive relationship between the emphasis on investment in advertising and profitability. Conversely, those businesses that allocate most of their marketing budgets to promotion tend to have lower profit margins and rates of return on investment.

THE EFFECT OF EXTRA AD EXPENDITURE

One final piece of evidence comes from another source. These other data were developed by Information Resources Incorporated, a leading US research firm. They studied the impact of extra advertising spending on sales for 15 fmcg brands in a highly controlled experiment. The average brand they studied increased its advertising spending by 70% during the one-year test.²

The IRI measurement system, ‘BehaviorScan’, is state-of-the-art, and quite high tech. It controls the advertising reaching test homes and measures what members of these households purchase through scanners at the checkout counters of stores in the market. This makes it possible to compare households receiving the extra advertising with a matched control group receiving only the normal advertising spend.

As Table 2 shows, the average increase in sales among those receiving the additional advertising pressure during the year of the test was 22%. Not bad, but the story does not end there.

TABLE 2: ADVERTISING-INDUCED SALES INCREASE FOR THREE YEARS

At the end of the one-year test, the extra advertising completely stopped. Both groups of households – the test group that had previously received the higher level of advertising, and the control group – received exactly the same level of advertising pressure over the next year for the test brands.

One year after the test, there continued to be higher sales among those households which had received the heavier advertising weight. These on average bought 17% more than those receiving the base level advertising. In year three – two years after the heavy spending test – those who had received the higher weight during the test continued to purchase 6% more of the average test brand than those in the control group. So it seems that additional advertising pressure has an enduring effect in addition to its immediate effect.

In another analysis of the profitability of more than 60 trade promotions using the same technology for data collection, IRI found that overall only 16% of the promotions paid out. In addition, for established brands, the long-term effects were likely to be negative due to stockpiling by loyal buyers on the one hand and ‘training’ buyers to wait for deals on the other.

CONCLUSIONS

I will summarise what these various PIMS and IRI studies are telling us.

First, when we look at advertising alone, it makes a measurable direct contribution to perceived quality, and share of market, which leads to profitability.

Second, advertising appears to have a carry-over sales effect that extends beyond the period during which it is actually running.

Third, when we separately examine the way in which businesses allocate their expenditures to sales promotion and to advertising, we see that those businesses emphasising advertising enjoy a higher return on invested capital.

Finally, we see a significant relationship between changes in market share and changes in advertising spending, but not between share changes and promotional changes. Clearly, money invested in advertising not only drives profits on a yearly basis, but also builds strong brands.

Design, packaging, public relations, sales promotion, experience with the brand and word-of-mouth all contribute to – or, in some cases, detract from – these values. But advertising has traditionally played the leading role in shaping and defining the image of strong brands.

In this reading I have presented evidence from PIMS showing that advertising makes a measurable, significant contribution to brand profitability. It does this in the year in which the advertising budget is spent, so there is an attractive short-term payout.

Data from IRI were also presented, however, illustrating that the carry-over effect of advertising continues to produce higher sales in the years immediately following the expenditure: a longer term payout, and a welcome additional benefit.

Advertising produces these results by adding value to products and services. It produces these results by turning products and services into strong brands that have more leverage with middlemen; brands that can credibly pre-empt the truth; brands that enjoy higher loyalty; brands that are more forgiving of owners who occasionally stumble; brands that command better margins and are more resistant to price competition; brands that can be extended.

Advertising builds brands that mean more to the consumer. These brands can, in principle, live forever. In other words, advertising works by building strong brands.

1. ‘Advertising, sales promotion and the bottom line’ (The Ogilvy Center for Research and Development, 1989)
2. Magid Abraham, ‘fact base design to improve advertising and promotion productivity’, Proceedings, 2^nd Annual ARF Advertising and Promotion Workshop, 1990.

From ‘Strong brand, high spend. tracking relationships between the marketing mix and brand values’, Alexander L. Biel, Admap, November 1990.

© NTC Publications Ltd, 1990

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(c) Center for Marketing, London Business School