How to invest & dis-invest in advertising

Investing in Advertising

In terms of profitability, investing in advertising is justified only if the incremental revenue generated from the advertising exceeds the advertising expense. In other words, if the advertising expense is $X, then over the long term (i.e., not necessarily immediately) revenue attributable to the advertising must be more than $X to justify the investment. decision-making-street-signs-f_10740635On what grounds might one expect that the revenue will exceed the advertising expense? In terms of Volume= Trial + repeat, it might be expected that effective advertising will attract new triers to a brand and encourage repeat purchasing. Hence, effective advertising should build sales volume by enhancing brand equity—both by increasing brand awareness and by enhancing brand image.

 

Other determinant of revenue besides sales volume is the unit price at which a brand is sold. Advertising has the power to enhance a brand’s perceived quality and thus the ability of brand managers to charge higher prices; that is, consumers are willing to pay more for brands they perceive as higher quality. Taken together, then, the case for investing in advertising is based on the belief that it can increase profitability by increasing sales volume, enabling higher selling prices, and thus increasing revenue beyond the incremental advertising expense.

Dis-investing from Advertising

Firms often choose to reduce advertising expenditures either when a brand is performing well or during periods of economic recession. This is a seductive strategy because a reduction in expenses, everything else held constant, leads to increased profits.   The implicit assumption is that revenue (and revenue’s constituent elements, volume and price) will not be affected adversely when ad budgets are diminished. However, such an assumption is based on Pollyanna-like thinking that past advertising will continue to affect sales volume positively, even when advertising in the current period is curtailed or reduced. The assumption also is somewhat illogical. On the one hand, it presumes that past advertising will carry over into the future to maintain revenue; on the other hand, it neglects to acknowledge that the absence of advertising in the present period will have an adverse effect on revenues in subsequent periods.

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