Advertising during a Recession

Alex Biel
and
 Stephen King

DEFINING RECESSION

Bernard Baruch said that it�s a recession when your neighbour is out of work (adding that when you�re out of work it�s a depression!).

Although the recessions that make the headlines are generally seen as all-encompassing and national in scope, this definition obscures the fact that �normal� national economic conditions are really an averaging of good times in some industries, bad times in others; growth in some parts of the country and decline in others.

During a national recession everyone gets hurt; but some sectors feel the heat more than others. Conversely, during a period of expansion some markets reap greater benefits.

A more useful, empirically determined definition of recession is one which relates annual growth at one point in time to the longer term growth trend of a specific market. The Center for Research & Development, in collaboration with the Strategic Planning Institute, has used this market-specific concept of recession to analyse consumer businesses in the Profit Impact of Market Strategy (PIMS) database. The PIMS database included, at the time of this analysis, 749 consumer businesses, with a minimum of four years� data covering those businesses and the markets in which they participate.¹

The PIMS database is the only source that contains both marketing data and financial information for the same consumer-based businesses.

A WORKING DEFINITION

For our purposes, a specific market is considered to be in recession when short-term growth lags long-term growth by at least four percentage points. On the other hand, when a market exceeds its long-term growth rate by more than four percentage points, we can say that it is in a period of expansion.² Using this definition, it is possible to describe how consumer businesses fare under different market conditions.

THE RELATIONSHIP OF CHANGING MARKET CONDITIONS

To understand what happens during changing market conditions, it is useful to look at changes in rates of return for those businesses enjoying market expansion compared to those suffering a shrinking market. As Figure 1 shows, there is a substantial market effect that impacts a firm�s return on invested capital.

It is no great surprise to learn that when the market expands, the average consumer business in the PIMS database enjoys an increased return on investment. Indeed, one might expect rates of return to increase even more sharply during a period of market growth; the fact that they do not may be explained to some extent by the difficulty that some businesses face in meeting increased demand.

When a market contracts, on the other hand, the profits of the average business decline. In this study, the average business lost just under two percentage points of profit, dropping from a return on investment of 21.9% to 20.0%.³

CHANGES IN ADVERTISING SPENDING RELATED TO CHANGES IN ROI

What is the relationship of changes in advertising spending to changes in return on investment? To answer this question, we looked at the specific spending policies employed by the businesses in the database.

Of the 339 observations of the businesses that experienced recessionary periods, one-third cut their spending on advertising by an average of 11%, while two-thirds actually spent at a higher rate than before.⁴

Of those businesses raising their advertising investment, the majority � 60% � limited their increase to no more than 20% more than they had previously been spending. The average business in this group increased spending by 10%. However, the other 40% of those businesses that raised their expenditures made substantial increases ranging from 20% to 100%, and averaging 49%.

Table 1 shows how changes in return on investment relate to these changes in spending. Clearly, businesses suffer a reduction in return on investment whether spending is cut or increased during a recession. Indeed, businesses yielding to the natural inclination to cut spending in an effort to increase profits in a recession find that it doesn�t work. These businesses fared no better in terms of return on investment than those which modestly increased their ad spending.

TABLE 1: CHANGES IN ROI RELATED TO CHANGES IN ADVERTISING SPENDING DURING A RECESSION

Those firms that substantially increased their advertising budgets experienced the largest drop in return on investment: a reduction of 2.7 percentage points. However, as we shall see, those advertisers who increase spending � whether modestly or aggressively � achieve greater market share gains than those who cut their advertising investment. This, in turn, puts them in a better position to increase profits after the recession.

THE LINKS BETWEEN MARKET CONDITIONS, MARKET SHARE, AND ADVERTISING

These findings led us to dissect the relationship between changes in return on investment and changes in advertising pressure.

As we showed in an earlier study,⁵ advertising spending and return on investment are linked � but only indirectly. Advertising directly affects brand �salience�: it makes the advertised brand more top-of-mind among prospects. It also tends to amplify the relative perceived quality of the brand, which in turn increases the brand�s perceived value for money. Salience and perceived quality drive buying behaviour, which of course is reflected in sales, and therefore in Share of Market (SOM). But market share is affected by market conditions as well as advertising pressure (Figure 2).

Here we see that the businesses in the PIMS database enjoy a higher rate of share growth during downturns, and a lower rate of share increase during stable periods and periods of growth.

One explanation for this is that weaker businesses � businesses with lower market shares � may be less able to defend themselves during downturns, while their larger competitors become more aggressive in order to partially make up sales that are threatened due to a lower growth rate of the total category. The PIMS database includes a broad range of consumer businesses; while some are strong and even market-dominating, others are less successful and weaker. However, on average, the businesses contributing data to PIMS are somewhat more likely to be the stronger players in their markets.⁶

THE RELATIONSHIP OF ADVERTISING SPENDING TO MARKET SHARE

To identify the relationship of changes in spending to changes in share of market, we again analysed the data in terms of the spending strategies of the various businesses. As Figure 3 shows, those who reduced their budgets during recession attained much lower share gains than their more aggressive counterparts. On the other hand, marketers which increased spending were able to realise significant market share gains.

It is worth noting that, while there appear to be opportunities to win share by becoming increasingly competitive during a recession, when markets expand, share gains are harder to come by. This is demonstrated in Figure 4, which reveals the link between changing advertising investments and share as markets expand.

Marketers that decrease their spending during an expansion of the market lose share, albeit slightly; on average, they drop one-tenth of a share point. Those who increase their spending by upwards of 20% as their market expands increase average share, but by only half a percentage point. In other words, the possibility of gaining share through increasing advertising appears to be greater when the total market is soft.

It is important to remember that the changes in both share of market and return on investment reported were achieved during the recession itself. Other research indicates that much � but by no means all � of the impact of advertising on sales is achieved in the year the budget is spent.⁷ However, the main impact of share gains is translated into gains in profitability in subsequent periods.

While the data reported here are of course correlational, and do not necessarily prove causality, they none the less suggest that there may be some attractive share-building opportunities during periods when business contracts. Indeed, the data suggest that aggressive marketers may well find that recessionary periods offer a unique opportunity to build share and position themselves advantageously for the market’s recovery.

THE RELATIONSHIP OF MARKET SHARE AND PROFITABILITY

In our earlier study of consumer businesses, we found a clear relationship between share of market and return on investment.⁸ In fact, this general relationship is not limited to firms marketing to the consumer; it is a robust, well-documented general principle that seems to occur in all markets.

The specific relationship for the average consumer business is shown in Figure 5. These data suggest that the advertiser who is able to build market share is likely to enjoy a better return on invested capital than is the marketer with a lower market share.

IMPLICATIONS

In general, businesses earn reduced profits when their markets are in recession. But those that cut their advertising expenditures in a recession lose no less in terms of profitability than those who actually increase spending by an average of 10%. In other words, cutting advertising spend to increase short-term profits doesn’t seem to work.

More importantly, the data also reveal that a moderate increase in advertising in a soft market can improve share. There is a substantial body of evidence to show that a larger share of the market generally leads to higher return on investment.⁹

For the aggressive marketer, the data suggest that a more ambitious increase in expenditure, although reducing short-term profit, can take advantage of the opportunity afforded by a recession to increase market share even further.

The PIMS data indicate that consumer marketers increasing their spending by an average of 48% during a recession win virtually double the share gains of those who increase their expenditures more modestly. While this aggressive increase in advertising is associated with a drop in return on investment of 2.7% in the short term, it may nevertheless be acceptable to the marketer looking ahead to post-recession growth.

1. Since each business unit contributed a minimum of four years of data, and since recessions and expansions were defined as deviations from the normal growth trend of the industry, a given business unit provided at least one, and often more than one observation. Thus the sample of 749 business units provided a total of 1,639 observations.

2. For the purposes of this analysis, we define short-term periods as one year. Long-term trends of a market are defined as a minimum of four years.

3. Return on investment is calculated before taxes and interest charges for the purpose of this analysis.

4. Some businesses doubtless did take a clearly aggressive stance in light of the softness of the market. But it is probable that for other businesses in the sample spending was committed prior to the receipt of sales or market data. This helps explain why more businesses increased spending than curtailed their efforts.

5. ‘The impact of advertising expenditures on profits for consumer businesses’ (The Ogilvy Center for Research & Development, 1987)

6. Since the concept of share of market is a zero sum notion, it is important to note that the share of market averages described here relate to the businesses studied rather than shares of all the entrants in each of the specific markets involved.

7. See ‘Long-term Profitability Advertising versus sales Promotion’ Alex Biel. (Table 2 and Note 2)

8. See Note 5

9. Robert D. Buzzell and Bradley M. Gale, The PIMS Principles, The Free Press, 1987.

From Options and Opportunities for Consumer Businesses: Advertising During a Recession, Alexander L. Biel and Stephen King.

© The WPP Center for Research & Development, October 1990

http://www.warc.com

(c) Center for Marketing, London Business School