For years, agency types like me having been referring to an old study about the deleterious long term effects of short term spending cuts. Until yesterday, I’d never seen a stock analyst frame his/her recommendations based on increases/decreases in A&P (advertising and promotion) budgets. It took me a day to realize how significant this really was and why I needed to share the whole story which ran in Wine & Spirits Daily yesterday:
Spirits Make Biggest Cuts in A&P Spending
A new report from Deutsche Bank’s Jamie Isenwater says that the spirits sector has taken a short-term approach by cutting their marketing budgets during the downturn, which almost guarantees it will be expensive to rebuild once the environment improves. In the last 6 months, Pernod Ricard (Sell), Diageo (Hold), AB Inbev (Hold) and Campari (Hold) cut A&P the furthest out of 30 European and US consumer staples companies, while Beiersdorf (Buy), Unilever (Buy), Henkel (Buy) and L’Oreal (upgraded to Buy) invested the most aggressively.
Jamie says that Pernod and Diageo cut their organic marketing spend by -24% and -18% respectively in the first half of calendar 2009. “We remain underweight Beverages with a particular caution on Spirits given the aggressive cutting of A&P spend seen on the back of the downturn,” said Jamie. “We see little earnings rebound for the Spirits sector as a result and struggle to see where earnings upgrades are likely to come from. Pernod Ricard remains a key Sell recommendation and we see little upside to Diageo at current levels.”
LOWER A&P EQUALS LOWER MARGINS. “When we analyze our entire consumer staples dataset we find a similar result – companies that cut A&P see their operating margins fall over time,” said Jamie.
The note points to a McGraw-Hill study of the early 1980s recession that says “companies that maintained or increased their advertising spend in 1980-81 grew over 50% faster in 1982 than those who cut spend and grew over three times faster by 1985. Whilst it may not be entirely surprising that increasing A&P, increases sales growth…a study of the PIMS (Profit Impact of Market Strategy) database shows that those companies who increased marketing spend also increased profits and returns post-recession.”
Deutsche Bank realizes that “in a difficult environment it can be very tempting for companies to cut marketing spend to protect profitability,” but that “the benefits of the cost savings are short-lived with profits dipping in the following year and again the year after as marketing spend needs to be rebuilt.”
Why is A&P spending so important? Deutsche believes it’s because “consumers are prepared to pay higher prices for brands they like and trust.”
Bottom line–spending cuts may help not help bottom line after all!