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Evaluating Advertising Return on Investment

Charlie Nelson October 2003 Introduction Quantifying the return on investment in advertising is important for several reasons: Determining the optimal marketing budget; Determining the most profitable allocation of funds between advertising and promotion; In a multi-brand company, determining the share of total advertising investment which should be allocated to each brand so as to maximize overall company profit; Unless marketing managers can demonstrate the financial value of advertising, they risk advertising expenditure being perceived by ceos and boards as discretionary.

There are strategic reasons for advertising in addition to directly boosting sales (for example discouraging the entry of new competitors) but quantifying the relationship between advertising and sales (and hence profits) is fundamental to profit optimization and accountability. This paper reports on some case studies based on research undertaken by foreseechange over the past few years. The aim of the paper is to demonstrate that it is possible to quantify the relationship between advertising and sales and to quantify other benefits of advertising. The case studies are from the packaged food and beverage industries and so are not representative of other industries. 1. Short-term Impact on Brand Sales There are many influences on sales, including: Seasonality; Own and competitive prices; Own and competitive advertising; Economic factors such as interest rates; Changing population growth and demographics; Changing consumer tastes.

The case study I report here is based on weekly sales data over a three year period for a packaged food brand. I have assumed that the impact of changing numbers of consumers and changing consumer tastes has been negligible over the three year period, although changing demographics are known to influence category sales over longer time periods. Also, economic factors have not been included because of the
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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 long lags known to be involved in this category and most others (typically, five to ten years data with quarterly periodicity is needed to quantify economic impacts). Past experience in this category and others has shown that the impact of price discounts, possibly associated with in-store display activity, is restricted to the week(s) of the promotion. Competitive prices are usually included in these models, but in this case the clients priority was initially to quantify their own marketing mix impacts. The short-term sales impact of advertising is expected to be both immediate and extended over a period of many weeks. This expectation is based on modelling survey-based ad recall data. The shape of the response of ad recall to advertising in a single week is as shown in Chart 1. The immediate boost in ad recall is followed by an exponential decay as consumers forget the exposure. The rate of decay varies quite widely but is often at a rate between 5% and 20% per week. Chart 1
Boost in Ad Recall Resulting from Advertising in Week 0
3.5

3.0

2.5 % Boost in Ad Recall

2.0

1.5

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0.5

0.0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Week

The model fit based on seasonality and price only is shown in Chart 2. This models explains 76.9% of variance in sales volume. Seasonality only explains 24.7%, indicating how big an influence price discounting is. The inclusion of advertising, expressed as TARPS, involved quantifying both the initial response and the rate of decay. These effects were estimated solely based on modelling the sales data. Inclusion of advertising increased the proportion of variance explained to 80.3%. At this stage, it was noticed that a competitive promotion which was heavily advertised had negatively impacted sales for several weeks. Accounting for this lifted the proportion of variance explained to 81.2% The final model fit is shown in Chart 3.
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sales volume 100 110

sales volume 100 110 30 40 50 60 70 80 90

Chart 2

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614

Chart 3

30

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90

Sales Model with Price and Seasonality

Sales Model with Price, Advertising, and Seasonality

week

week

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Actual Model Fit

Actual Model Fit

26/03/00 23/04/00 21/05/00 18/06/00 16/07/00 13/08/00 10/09/00 08/10/00 05/11/00 03/12/00 31/12/00 28/01/01 25/02/01 25/03/01 22/04/01 20/05/01 17/06/01 15/07/01 12/08/01 09/09/01 07/10/01 04/11/01 02/12/01 30/12/01 27/01/02 24/02/02 24/03/02 21/04/02 19/05/02 16/06/02 14/07/02 11/08/02 08/09/02 06/10/02 03/11/02 01/12/02 29/12/02 26/01/03 23/02/03

26/03/00 23/04/00 21/05/00 18/06/00 16/07/00 13/08/00 10/09/00 08/10/00 05/11/00 03/12/00 31/12/00 28/01/01 25/02/01 25/03/01 22/04/01 20/05/01 17/06/01 15/07/01 12/08/01 09/09/01 07/10/01 04/11/01 02/12/01 30/12/01 27/01/02 24/02/02 24/03/02 21/04/02 19/05/02 16/06/02 14/07/02 11/08/02 08/09/02 06/10/02 03/11/02 01/12/02 29/12/02 26/01/03 23/02/03

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 The price elasticity is estimated to be -2.7. This means that sales are boosted by 2.7% for each 1% price discount. The profitability of price discounting depends on the price elasticity and the PV ratio - the proportion of sales available to cover fixed costs and profits, after deducting variable costs (Chart 4). Chart 4
Break-even Price Elasticity
(for a 5% discount) 0 -2 Unprofitable region -4 -6 Profitable region -8 -10 -12 -14 -16 PV Ratio PV ratio is the proportion of sales available to cover fixed costs and profits, after deducting variable costs 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5

With a price elasticity of -2.7, the PV ratio must be 0.39 or greater before a 5% discount is profitable. The short-term sales response to advertising is estimated to be a boost of 3.3% per 100 TARPS with a decay rate of 17% per week. In this case, 100 TARPS delivers retail sales revenue of about $115,000. This would not be profitable in its own right, but the advertising objective is to build long-term brand equity. The short-term profit return, in this case about half the cost of the advertising, is a bonus. In effect, this result means that the company can achieve its brand equity objective at half price. 2. Long-term Impact on Brand Sales While it is possible to quantify the short-term influence of advertising on sales, the further ahead we look the weaker the signal to noise ratio. The longer-term influence on sales can be inferred by looking at what happens when advertising ceases. We have data from four brands that ceased advertising and the index of sales over time is shown in Chart 5.

Price Elasticity

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 Chart 5
Volume Index After Advertising Ceases
Based on Four Food & Beverage Brands 1.2 1.00 0.91 0.83 0.8 0.72

1.0

Index

0.6

0.4

0.2

0.0 0 1 Year 2 3

On average, sales volume declined by 9% per year after advertising ceased. The actual loss in a particular case will also depend on pricing and competitive activity. It is only to be expected that brand sales will decline if advertising ceases. Consumers have imperfect memories and forget to consume the brand as frequently. Also, they are tempted by other brands which continue to advertise. In other words, brand equity is eroded without the support of advertising. 3. Impact of Brand Equity Generic brands in Australias supermarkets achieve a value share of 10%, according to ACNielsens Grocery Report 2003. Their share peaked in the early 1990s recession at 11.4% and has fallen to 9.5% when the economy is booming. It is not unusual for a category leading brand to cost over 100% more than a generic brand and yet outsell it by 200% in volume terms. The ability to command a higher margin is one of the primary benefits of building strong brands. According to Kevin Lane Keller, in his book Strategic Brand Management, other advantages include: greater loyalty; increased marketing communication effectiveness; greater trade cooperation; and brand extension opportunities. The value of being able to command a higher premium can be immense. The ability to do so is a function both of product quality and consumer perceptions created by
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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 advertising. This value should be quantified on the basis of the price difference between the brand and a generic brand at which consumers become indifferent, implying equal shares. This can be inferred from historical sales data, although it is unusual to find a category where generic brand sales are equal to manufacturer brand sales. Conjoint analysis can be employed to quantify the margin attributable to brand equity. This is a survey-based multivariate technique that profiles the consumer decision process on the basis of the contribution of brand, price, and other attributes (see www.futuretoolkit.com/conjoint.htm for more information). Using this technique, it is not uncommon to find that manufacturer brands can command a price premium of between 30% and 100% relative to a generic brand. The ability to command a high premium is won on the basis of long-term investment in product quality and brand perceptions. These cannot be taken for granted in a highly competitive environment, and must be defended. Methods for quantifying the other advantages of strong brands are beyond the scope of this article, but can be found in Kellers book amongst others on the subject. Advertising that is intended to gain these advantages through building brand equity should be evaluated on the basis of brand equity. However, as shown above, advertising aimed at building brand equity can also boost short-term sales and any such payoff should be quantified. This is because the residual between the investment in advertising and the short-term profits generated through incremental sales is the amount that an increase in brand equity should be evaluated against. 4. Above-the-line and Below-the-line Impacts on Consumers Marketing investment has been trending from above-the-line to below-the-line over the past decade. In determining the right mix, it is important to know the relative impact on sales volume and profit, as has been illustrated in Section 1 of this paper. It is also important to understand how different consumer segments interact with these marketing investments when considering the brand equity implications. Not all consumers place the same weight on convenience, quality, price, and other attributes. Chart 6 shows the results of a survey of 1,200 consumers, asking them to nominate the first, second, and third most important attributes when they go shopping.

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 Chart 6
Importance of Shopping Attributes
source: foreseechange 2002 convenient location cheap prices easy car parking wide range of merchandise one-stop shopping quality merchandise helpful/friendly service supporting local traders quick service Australian ownership convenient opening times 0 10 20 30 % Top Priority In Top 3 40 50 60 70

Cheap prices is the most important attribute for less than 20% of consumers and is in the top three attributes for less than 50% of consumers. This suggests a consumer segmentation based on price sensitivity. High price sensitivity consumers nominate cheap prices as the most important attribute; Medium price sensitivity consumers nominate cheap prices as the second or third most important attribute; and Low price sensitivity consumers do not mention cheap prices in their top three most important attributes. Chart 7 shows how the sizes of these segments has varied over time. During the 1999 economic boom, price sensitivity dropped and this coincided with a drop in the share of generics in supermarkets (as measured by ACNielsen) from 10.5% in 1997 to 9.5% in 1999. At this time too, the discount chain Franklins suffered a substantial share loss and eventually went out of business.

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 Chart 7
Price Sensitivity Segments
source: foreseechange 100 90 80 70 60 50 40 30 20 10 Sep-1997 Dec-1997 Mar-1998 Jun-1998 Sep-1998 Dec-1998 Mar-1999 Jun-1999 Sep-1999 Dec-1999 Mar-2000 Jun-2000 Sep-2000 Dec-2000 Jun-2001 Dec-2001 Jun-2002 Dec-2002 0 %

Low Medium High

quarter of survey

Analysis of ACNielsen Homescan panel data, which is based on actual purchasing behaviour in supermarkets, shows that in most categories, price sensitivity segmentation comprises: About 20% of households who nearly always buy products on discount; About 30% of households who buy on discount on about half of all purchase occasions; About 50% of households who rarely buy on discount (sometimes they have no choice).

This segmentation suggests that above and below-the-line investments influence consumers in different ways. Advertising that conveys the brands benefits other than price will be of most interest to the least price sensitive consumers, while price focused advertising and price discounts will be of most interest to the most price sensitive consumers. Price discounts apply to both brand switchers and brand loyal consumers, and with the latter group involve an unneeded loss of margin. Many brand loyal customers like to save money so discounting can train them to modify the timing and quantity of their purchases in order to save money. Most people say that they try to save money when shopping for groceries and onethird say that they always do this (Chart 8). However, less than 10% say that they
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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 always switch brand when a brand they dont normally buy is on special and one-third say that they always stock up when their favourite brand is on special. Chart 8
Saving Money and Reaction to Discounts
source: ACNielsen Grocery Report 2003 100 90 80 70 60 50 40 30 20 10 0 Really try to save money when shopping for groceries When on special, I will buy a brand I don't normally buy When my favourite brand is on special, I stock up % Rarely/Never Sometimes Frequently Always

Of course, below-the-line investment involves more than just discounting. A study by GreyGold Research has identified the benefits of in-store taste tests and display activity when launching a new food product. Based on a nationally representative sample of 400 adults surveyed in 2003, respondents were asked to nominate how a manufacturer could most encourage them to try a new food product. The wording of the question implicitly asks respondents to combine both how to reach them and how to have an impact on them (Impactful Reach). Respondents were allowed to nominate more than one media if they wished. The results are shown in Chart 9. A TV ad and an in-store tasting were the most frequently nominated, followed by a supermarket display. Combining TV, radio, newspaper, and magazine together to form above-the-line and combining supermarket tasting and supermarket display together to form below-the-line shows clear consumer segmentation (Chart 10).

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 Chart 9
Most effective way to encourage trial of new food product (multiple mentions allowed)
source: GreyGold Research 2003 60.0

50.0

47.9

47.3

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25.9

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15.7 10.0 10.0

16.6

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0.0 TV ad Radio ad Newspaper ad Magazine ad Letterbox ad Supermarket tasting Supermarket display

Chart 10

Above-the-line and Below-the-line Impactful Reach

Above 35.8

Both 27.0

Below 32.0

New Grocery Product Trial Source: GreyGold Research 2003

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 Above-the-line is the only way to get impactful reach for 36% of adults, while belowthe-line is the only way to get impactful reach for 32% of adults. Either will achieve impactful reach of a further 27% of adults. Either approach alone will miss a significant proportion of the market. This research shows that both above-the-line and below-the-line investments can be valuable. But it is important to quantify the value of each. 5. Impact on Category Sales Advertising can do more than boost brand sales and build brand equity. Growing category volume is also an important function of advertising, especially for category leaders. In a packaged food category we analysed recently, the effect of advertising on category sales was statistically significant. The additional retail sales value per $1,000 of advertising was $1,100, distributed over several months. This is not profitable in its own right, either at the category or brand level. But it is additional profit for the retailers, a fact that should be used in negotiations with them. Building category sales is typically not the objective of advertising, but it is a valuable bonus both in the sense of short-term sales and longer-term category health. 6. Summary and Strategic Implications The short-term return on investment of advertising and promotions can be reasonably easily quantified by regression analysis of historical sales data. It is usually found that: Price discounting has an immediate sales effect only and the profitability depends on the price elasticity and margin; Advertising has an immediate and ongoing sales effect and when the advertising objective is to develop brand equity, this is something of a bonus.

The longer-term impacts of advertising include developing and defending brand equity and these impacts can be quantified in various ways including: Measuring the margin that can be commanded relative to other brands, especially generics; Observing the long-term sales decline of brands that are not supported by advertising .

Above-the-line and below-the-line investment impacts different consumers in different ways and this, in addition to profitability, is an important strategic consideration in determining the optimum mix.

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forecasting and futures consultants foreseechange pty ltd acn 094 521 614 Advertising can boost category sales, an important objective for category leaders and an important message to communicate to retailers. Advertising can have other important strategic objectives than boosting sales and building brand equity, such as deterring potential new competitors, and these need to be taken into account when evaluating the return on investment.

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