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Attempts to gauge the ROI of advertising hinge on determining a brand's overall value.
Kris Frieswick, CFO.com | US
November 1, 2001
Companies have generally slashed advertising spending when tough times loom, and these tough times are no different: One recent report predicts spending in 2001 will be down 6 percent from 2000 levels. Advertising is a particularly easy target for cost cutting, because few companies have developed reliable ways to track or predict the return on investment (ROI) for such spending. Instead, advertising budgets are often computed strictly as a percentage of revenues, or based on the previous year's budget, with little attempt to determine how much is needed to address market goals.
That is the wrong approach, say those who actively seek the Holy Grail of metrics--an ROI on advertising. Advertising spending does produce measurable returns, they insist. But so far, "most of the effective advertising ROI techniques are based on attitudinal research like field research, and focus groups on consumer perceptions," says Don E. Schultz, professor of integrated marketing communications at the Medill School of Journalism at Northwestern University. "When you try to blend that information with financial metrics, a lot of CFOs don't want to go there."
On the other hand, some CFOs have been there for a while. Businesses that have control over the means of distribution--service firms, restaurants, hotels, grocery stores, and the like--can quite precisely determine the impact of advertising on sales by means of bar code-scanning and other point-of-sale technology. But for firms that lack this direct connection to the consumer, such metrics are hard to come by.
"The finance function has traditionally struggled with advertising investments, because of the difficulty of measuring the impact," says Keith Woodward, vice president of finance at the Big G cereal division of General Mills Inc., in Minneapolis. "We are very analytical people. We want to say, 'I invest here, I see the return there.' That's what we see with most of our capital expenditures. Our return is directly traceable to increased volume or revenue, and you can't do that with advertising."
Woodward thinks that attitude is changing out of necessity. "We have more sophisticated tools to get at the measures, and we're beginning to realize that it's necessary to evaluate new types of metrics," such as brand value. "That's how you differentiate and maintain your position in the marketplace today," he says.
Nonetheless, Woodward says that advertising investments at the cereal division are driven primarily by the market-growth potential of each product line, a traditional revenue metric. "We start with the premise that we will invest most in the highest-return areas," he says. "We look at a total division in terms of brand valuation, but we also look at each specific brand to determine the income for each. There has to be an opportunity for growth, or else we won't invest."
Investment decisions are made by examining the historical performance of the brand as well as market research metrics on previous advertising effectiveness, growth versus competition, and other changes in the marketplace. Using this information, the company determines how much money to spend on advertising each brand, a decision in which Woodward is closely involved. Once the ad campaigns are launched, the company uses revenue and market data, along with some proprietary metrics, to see if they are working.
The company is still far from a metric that directly ties an advertising dollar spent to a revenue amount. "We have good insight," says Woodward, "but as far as an absolute metric for advertising ROI, that's much more challenging."
Quality By DuPont
At the apparel and textile sciences unit of Wilmington, Delaware-based DuPont, advertising budgets are also set the old-fashioned way--as a percentage of product- line revenue--and are currently at 3 percent, according to Carol Gee, global director of brands for the division. The company markets the products from Gee's division (including CoolMax, Cordura, and Lycra) to mills, retailers, and end consumers. It's difficult, she says, to track the effect of its brand communications on the end consumer. "But if we just advertised to our direct [OEM] customers, we'd be a commodity overnight," says Gee, explaining why some of the company's advertising is directed at consumers. "At DuPont, that's how we build the brand."
Gee says measuring ad effectiveness is especially difficult for an ingredient brand, "since we have no way of knowing where that ingredient is going to end up." Gee says her company is working on ways to quantify the bottom-line effect of its advertising spending by coupling a variety of traditional metrics with Six Sigma methodology.
The company has long used Six Sigma to analyze its manufacturing processes, but now it has launched efforts to begin analyzing its brands and advertising activities the same way. (Six Sigma focuses on deconstructing and analyzing processes, then improving process quality, lowering process defects, and optimizing process capacity.) Gee declined to discuss the specific outcome of initial efforts in this area, saying the results are too preliminary. But she has high hopes for this unusual application of Six Sigma. "Once we can start proving, with Six Sigma's help, that advertising is critical in driving price premiums, for example, then we'll know advertising is critical to our whole overall selling strategy."
But increased awareness that advertising plays a quantifiable role in revenue generation is only a first step. While most companies lack an ROI methodology, a number of consultants and researchers are offering to do the complicated math for a fee.
Northwestern's Schultz, for one, has developed an ROI methodology that uses marketing-mix modeling based on regression analysis techniques--the ultimate combination of art and science. He believes the key to estimating advertising ROI in the short term is to identify incremental financial returns from the ad investment. For the long term, he examines brand equity. In other words, he calculates the percent of total sales attributable just to a brand's existing sales momentum and brand equity.
To determine brand equity, Schultz conducts a statistical analysis that identifies the financial value the brand contributes when compared with product value, distribution, pricing, services, and other factors. To figure out the short-term incremental impact of advertising on sales, Schultz takes 36 months or more of sales data on a particular product or brand. He then uses exponential smoothing to create a sales trend line. From that, using various regression analysis methodologies, he identifies the effects of advertising, promotions, pricing, and other factors in terms of their ability to generate "incremental" sales, or sales over what would be expected.
"What I look for is the difference between what is expected and what occurred," says Schultz. Any incremental revenue spikes that coincide with advertising activity (and exceed the amount spent on the advertising) show an ROI on that advertising spend. Schultz himself notes that this method is flawed, since "I'm only looking back over my shoulder."
To find a predictive model, Schultz says it is crucial to quantify a brand's overall market value. "Once you know how much a brand is worth, you have some basis for knowing what to spend against the brand," he says. To get at that figure, Schultz uses a model developed by London-based Brand Finance. Using product and brand forecasts, historical growth records, costs, and other factors, he determines total sales of the product now and into the future. He then calculates various charges against the brand to cover internal costs, and identifies a brand contribution. This contribution is used in a discounted cash flow model that defines the financial value of the brand.
Brand valuation calculations have been big business for other consulting firms, including Corporate Branding LLC and Interbrand, both of which maintain vast databases of brand value information on thousands of companies. Both firms track these values over time to help their customers make brand investment decisions and to track their success.
James Gregory, CEO of Corporate Branding, in Stamford, Connecticut, says that the return from advertising and brand communications is measured not just by increases in revenue and brand values, but also from boosts to a company's stock price. "Corporate brand plays a real role in stock performance," of about 5 to 7 percent, says Gregory. "While it's not a major driver, it's significant enough that we can actually measure ROI for it."
Ad Agencies Weigh In
Some companies simply look to their ad agencies to prove that advertising works. "We've always had gross measures of effectiveness like awareness," says Austin McGhie, president and CEO of Young & Rubicam San Francisco, a full- service ad agency, "but we've never been able to diagnose what is going on inside a campaign. I wouldn't say our clients are holding our feet to the fire, but that's going to happen soon."
When it does, Y&R says it will be prepared. It has long used a technique called the brand asset valuator, a method similar to those used at Interbrand and Corporate Branding, which is based on field research of consumers on thousands of brands. The results of a Y&R study that quantified the motivators of the buying decision and the role brands play indicated that brands are built when the consumer believes the product is different in a relevant way. Y&R is able to track how well various advertising campaigns have differentiated brands, and the degree to which they have thereby improved brand value.
In addition, ad agencies are increasingly creating ad campaigns that include "response components." Such mechanisms as toll-free numbers or Web addresses incorporated into print, radio, and television advertising enable consumers to get additional product information and advertisers to gauge response to ads. Companies are growing accustomed to this type of data, due largely to the advent of "click-through" ads on Web sites. Soon, says McGhie, interactive technology will expand to television, print ads, radio spots, and other media that currently offer no such insight. These additional sources of data will further bolster a company's ability to create advertising ROI methodologies. "Advertising and direct marketing are all starting to come together," says McGhie. "It's all brand response data now."
The key issue, says DuPont's Gee, was that CFOs saw the brand as "soft." "It's not going to be soft going forward. What we're doing at DuPont is a sign that the softness of a brand is going to turn into hard numbers."