As we approach what is increasingly looking like a recession in the UK, it is timely to review the state of knowledge of how businesses should most profitably approach marketing in a downturn. Peter Field looks at the lessons from previous downturns coming to the conclusion that some large companies have wisely learned to maintain their marketing budgets and are thus in a powerful position to squeeze smaller competitors who have not learned this lesson.
IN AN ARTICLE produced by the Financial Times in June 2008, both Procter & Gamble and Unilever revealed their intentions to maintain marketing spend into the downturn. And although more recently investment analysts have questioned Unilever’s commitment, these companies’ belief, clearly, is that this is an opportunity to gain market share at the expense of weaker businesses that choose, or are forced, to cut marketing expenditure. This intention was echoed by an analyst at Investec, at a recent International Advertising Association conference, who reported that there was no evidence that any of the major fmcg companies that he scrutinised were planning to cut marketing expenditure. But we know from IPA Bellwether data (see Figure 1), as well as anecdotally, that budgets are being cut.
So the suggestion is that it is chiefly the lesser players that are cutting budgets, while major players maintain theirs. The wisdom, or otherwise, behind these strategies was reviewed earlier this year at a conference convened by the IPA. Here, I summarise the Four presentations that were made.
The presentations addressed the likely impact on brands - and their profitability - of reducing marketing communications expenditure during a downturn. Clearly, if all brands in a category were to cut expenditure equally, then apart from some minor effects on the category as a whole (the most important of which might be an increase in price sensitivity) there would be little impact on brands individually. But experience of previous downturns reveals that this is not the general response: some brands maintain or even increase their expenditure, while others cut theirs. And the Bellwether data corroborate this variability in spending intentions. So the question under examination in reality boils down to: what is the impact on those who cut their expenditure vs those who maintain or raise theirs?
Impacts on brand health
Setting the scene for later presentations that examined the impacts on profitability, the first presentation, from Millward Brown, explored the effects of budget cutting on those consumer research metrics that are widely regarded as leading indicators of business performance. As a leading UK provider of consumer research-based brand metrics, Millward Brown has an extensive database to examine the impacts of budget cutting. Its data show a strong correlation between market share and the level of 'bonding’ – an aggregate measure of multiple brand–consumer relationship metrics. The clear implication being that if budget cutting results in a decline in ‘bonding’, then market share can be expected to decline.
Crucially, further data demonstrates that two key constituent brand relationship metrics – brand usage and brand image – suffered considerably (13% and 6% declines respectively) when brands ‘went dark’ (i.e. ceased to spend on communications) for a period of six months or more. More broadly, 60% of brands ‘going dark’ see decline in at least one key relationship metric after just six months.
Moreover, the risk of failure increases when communications expenditure resumes after the end of the downturn. There is a strong relationship between the level of risk of loss of share and the key expenditure metric: share of voice – share of market (SOV–SOM), where share of voice is defined as share of total category communications expenditure (see Figure 2).
Thus brands that cut their budget relative to competitors are at greater risk of share loss.
The level of risk is greater in some categories than others. Brands in categories that are more price-driven and where brands carry less importance to consumer choice (such as motor fuel, mineral water and apparel) are more susceptible to share loss when cutting budgets. Conversely, brands in categories where the reverse is true (such as luxury cars, financial services and fragrances) tend to be more resilient. The average proportion of consumers across all categories who are exclusively motivated by price is around 10% and so even if this increased considerably during a downturn, the proportion would remain small; there is therefore good reason to continue to build brand preference during a downturn.
Millward Brown sounded a final cautionary note concerning the speed with which ‘buzz’ (online and offline word-of-mouth) now spreads consumer views of brands. A brand judged to be on the way down, because it has fallen silent, will very rapidly see this manifested in word-of-mouth, which will accelerate the perception of failure.
Impacts on business performance
The remaining three presentations, examined the effects on the profitability of brands of reducing communications budgets during a downturn.
The first of these, from econometric modelling consultancy Data2Decisions, identified a key factor in determining the business effects of budget cutting: the time lag effect. Although most estimates of short-term payback from advertising (i.e. over small numbers of purchase cycles) is around 50%, the payback over the longer term (one to four years) is usually considerably greater than this.
A typical brand case study shows that the long-term element of payback can be over four times greater than the short term. The importance of this is considerable. Following a budget cut, a brand will continue to benefit from the marketing investment made over the previous few years. This will mitigate any short-term business effects, and will result in a dangerously misleading increase in short-term profitability. The longer-term business harm will be more considerable, but will not be noticed at first. To illustrate this, the long-term effects of two different budget-cutting scenarios are modelled for the brand. In the first scenario the budget is cut to zero for just one year and then returns to usual levels. In the second scenario the budget is halved for one year and then returns to usual levels. Sales recovery to pre-cut levels takes five and three years respectively, with cumulative negative impacts on the bottom line of £1.7m and £0.8m.
However, there are other dangers of common downturn behaviours. The diversion of communications expenditure into price promotions is a common response to downturn. The experience of widespread use of price promotions in the US automotive category illustrates how consumers quickly come to expect ‘incentives’. They therefore lose their efficiency as a generator of incremental sales and end up as a loss of profitability.
Another widely overlooked impact of reduced brand communications expenditure is on price elasticity. Analysis of a brand’s pricing data across a campaign shows that it reduced the price elasticity of the brand (i.e. the percentage change in volume for a 1% change in price) from -2.2 to -1.5. Such improvements often account for the majority of the profit impact of a successful campaign. By extension, the abandonment of communications is likely to result in the gradual increase in price elasticity and the growing need to reduce pricing to maintain volume. This may have a very damaging effect on profitability, but again one that is deceptively time-lagged.
Finally, the Data2Decisions presentation raised an unfortunate side effect of markets in downturn: greater unpredictability and hence risk. In particular, increased volatility in the response curve to marketing results in radically different optimum levels of expenditure for maximum profitability. This risk can deter expenditure, but the solution is to use modelling to determine the optimum expenditure and to maintain brand support.
The second business effects paper is by Malik PIMS (Profit Impact of Market Strategy). PIMS has analysed data collected from around 1,000 business units in developed economies during periods of market downturn and subsequent market recovery. The data are extremely robust and highly respected, and enable a comparison of downturns pre-2000 with more recent ones. Three performance metrics are examined: inflation-corrected ROCE during downturn, inflation corrected ROCE during the first two years of market recovery, and market share change during the first two years of recovery.
A previous (2001) analysis of the winning business strategies deployed during earlier downturns demonstrated the importance of increased commitment to marketing during a downturn.
That analysis showed that while maintaining or reducing fixed costs was desirable, the opposite was true of marketing costs. Communications, R&D and new product development were all areas where increased expenditure was associated with business success during downturns. Improving customer preference while enabling maintained relative price were the means by which increased marketing expenditure drove success.
More recent data bring the analysis of the effect of increased spend on marketing and R&D, and more active NPD, up to date.
Looking first at marketing spend, the recent data show that ROCE and market share after a downturn are considerably enhanced by increased marketing expenditure during the downturn. ROCE during the downturn is perhaps mildly adversely affected by increased marketing spend, but not significantly, and the longer-term upside greatly exceeds any short-term downside. By contrast, cutting marketing expenditure results in less ROCE recovery and reduced market share post-downturn. This pattern of more recent findings is therefore broadly the same as was found with the earlier data.
Turning next to the effects of increased R&D expenditure during the downturn, the recent data reveal that some developments in the pattern have occurred since the earlier analysis. While the effect on market share post-downturn of increased R&D spend during it remains very positive, the effect on ROCE recovery post-downturn is now more muted. There is little or no observed adverse effect on ROCE during the downturn caused by increased R&D spend. Cutting R&D expenditure appears on balance the least successful approach.
And turning lastly to the effects of increased new product development activity (expressed as percentage of sales derived from new products) during the downturn, the recent data again reveal that patterns have evolved slightly from the earlier analysis, but the central conclusion remains the same: NPD has a strongly beneficial effect on ROCE during the downturn, but rather less so post-downturn. This is explained by the observation that increased NPD brings less lasting effect on market share postdownturn. Competitor response to NPD has become swifter since the earlier analysis, resulting largely in only short-term benefits to the first mover.
So the Malik PIMS analysis provides clear evidence that increasing marketing communications expenditure in a downturn is a profitable strategy for recovery because media costs and competitor activity tend to fall. Essentially downturns provide a window for cheaper market share gain to brands that increase investment. Increased expenditure on R&D brings similar benefits, while increased NPD is the best strategy for enhancing short-term ROCE during the downturn, but brings little benefit thereafter.
The final presentation was based on an analysis of 880 IPA case studies submitted to the IPA Effectiveness Awards since 1980.
Share of voice (SOV) and share of market (SOM) data from the case studies have been collected and used to examine the relationship between SOV and SOM and by extension the effect of cutting SOV.
The theoretical relationship between equilibrium SOV and SOM, is shown in Figure 3. Brands spending above equilibrium SOV will grow, whereas those spending below equilibrium will shrink.
The dataBANK data validate this theoretical relationship closely.
Brands lying above the curve tend to grow market share in proportion to their distance from it, while brands below tend to lose market share commensurately. Thus ‘excess share of voice’ (SOV–SOM) is the most critical factor in explaining subsequent SOM changes. This relationship holds during buoyant times and downturns.
The actual relationship between market share growth (or decline) and the level of excess share of voice (SOV–SOM) recorded in the case studies is shown in Figure 4. It is statistically very reliable and closely mirrors findings from other databases.
The rule-of-thumb finding from this analysis is that for every ten points that SOV exceeds SOM a brand can expect to gain one point of market share per annum. The corollary of this is that a brand can expect to lose one point of market share for every ten points it allows its SOV to fall below its SOM. This is an average finding across all categories and ideally the relationship for any given category should be derived from econometric modelling. Nevertheless this rule of thumb can be used as a forecasting tool for the effects of different marketing communications expenditure strategies during a downturn. An important facet of this relationship is that there is an inherent time-lag between relative marketing expenditure (SOV–SOM) and market share growth. Table 1 shows the share resulting (in the following year) from expenditure in the previous. It is this lag that causes deceptive short-term profitability effects during periods of sudden marketing expenditure change.
Table 1 applies the forecasting rule of thumb to a hypothetical brand in a fairly common scenario. The brand operates in a previously buoyant category, and prior to the downturn mildly under-spent its SOM. A ‘panic’ scenario is modelled in which budget was cut to zero for two years (while competitors maintained real spend). The forecast market share in the third year falls to 5.7% from 7.1%.
The likely impact of this decline on the profitability of the brand is modelled in Table 2, assuming a fairly typical cost structure for a packaged goods brand. Other assumptions made are that category growth ceased for two years and resumed 5% growth in the third year; that marketing communications expenditure for the brand is restored in the third year; and that fixed costs for the brand rise with RPI across the downturn. The result: a short-term improvement in profitability is rapidly overtaken by a severe decline, becoming acute in the third year when the marketing budget is restored.
It is important to note the deceptive shortterm profit improvement due to the lagged effects of marketing on sales (recent authoritative PricewaterhouseCoopers research suggests that 45% of the return on TV expenditure comes through more than one year later). This short-term improvement provides the stimulus for budget cutting and briefly masks the considerable damage inflicted on longer-term profitability.
Applying this modelling to a less severe but more common budget cut of 20% for two years (with other assumptions remaining the same) reveals a similar but less severe pattern. However, the brand still emerges from the downturn in a considerably weaker profitability position, as shown in the top row of Table 3. Table 3 compares this scenario with the forecast profit pattern for the minimum recommended expenditure level (where SOV equals SOM). This comparison reveals the wisdom of maintaining marketing budgets during a downturn: cumulative profits generated in the SOV=SOM scenario over the three-year period greatly exceed the mild cut scenario, despite a disadvantage in the first year. Though it should be noted that no DCF analysis has been applied, which would tend to lessen the overall advantage.
The key conclusions from the four presentations can be summarised as follows:
- Cutting budget in a downturn will help defend profits only in the very short term.
- Ultimately the brand will emerge from the downturn weaker and much less profitable.
- It is better to maintain SOV at or above SOM during a downturn: the longer-term improvement in profitability is likely to greatly outweigh the short-term reduction.
- If other brands are cutting budgets the longer-term benefit of maintaining expenditure will be even greater.
So it appears that the major players are the wise ones - they have learned to take advantage of downturns to grow. Perhaps they are encouraged by the investment community, which has also clearly learned the lessons of previous downturns: on the day analysts questioned Unilever’s commitment to maintaining marketing expenditure, the company’s share price fell 8%, despite better than expected short term results. Budget-cutters take note. ❦
Peter Field has been a marketing consultant for the last ten years and set up the IPA dataBANK in 1996.