By Gary L. Lilien, Distinguished Research Professor of Management Science, Penn State; and Co-founder/Research Director of Penn State’s Institute for the Study of Business Markets
Firms often ask me, “What is the right marketing budget for me?” Many firms look at their competitors or “industry norms” to get an answer. Patients often do the same thing when they visit a doctor, asking for a treatment or drug that seemed to have worked for a friend or relative. The Lemming effect
But, like a good doctor, I try to get to know the patient and diagnose the disease before prescribing. The answer for firms on the marketing spending question depends on a number of things, but our research has shed some light on how best to answer this question.
As we were about to enter the recession, some research we did in the mid 2000’s[1] on which firms, if any, benefitted from increasing spending during a recession began to get serious attention. Certain firms benefit both during and after the recession by increasing their marking spending when most firms are cutting budgets everywhere. We show that firms with the will (the nerve or culture), the skill (marketing and customer knowledge and the ability to turn that knowledge into strategy) and the till (resources to fund investments in a downturn) are rewarded both during and after the downturn. Why ? Think about cyclists in the Tour de France‐‐the fittest and strongest don’t attack on the flat or early in the race. They attack on the roughest, steepest, most grueling part of the course. Attacking then allows them to separate themselves from the weaker cyclists and provides them a return later on; they will lead or even win the race, having crushed the weaker riders.
Firms pressed me for more specific answers to the question, an answer that would depend on the characteristics of the specific firm and the environment (in or out of the recession). So we followed up that work with a broader and deeper study[2], examining more than 10,000 firm-years of data from publicly listed U.S. firms from 1969 to 2008, a period that included seven recessions. We found that that, during recessions, some firms overspend on R&D and advertising, some under-spend, and others spend about at the right level. The appropriate level depends on the firm’s goal (profit or stock price—the results differ considerably) the market-type (B2B, B2C, products, services), the firm’s market share, its financial leverage and, of course, its current spending level.
The study had many intriguing findings; for example we found that, in recessions, 35% of B2B Goods firms underspend on advertising while 92% of B2C Services firms are overspend on advertising. (Most—98% and 96% respectively—of B2C Good Firms and B2B Services firms spend at about the right level). In non-recessionary times, about 60% of firms spend at the right level, while about 20% underspend and 20% overspend. The most underspending (31% of firms) is amongst B2B Goods firms; the most overspending (29%) is amongst B2B Services firms.
We found that, all else equal, in recessions, the higher the firm’s market share, the more an increase in R&D spending increases its profits while the more an increase in advertising spending decreases its profits. However, the higher the firm’s financial leverage, the more an increase in advertising spending in recessions increases its profits.
We also found that, in many cases, the effects on profits and stock returns differed; for example, while 35% of B2B Goods firms would see higher profits in recessions with an increase in advertising spending, only 2% of those firms would be rewarded by a higher stock price with that same increase in advertising spending. You might ask why; we do too.
So what does this mean for your firm? Plenty. The data we used for these analyses are publically available and the equations to calculate appropriate spending are in the noted paper. That means that these results can be applied to firms outside the sample of firms we studied. So, if you want to analyze and benchmark your own advertising (or R&D) spending—or that of your competitors—you can use the equations and approach to calculate the effects of those expenditures both during recessions and in non-recessionary periods. You don’t need to be a lemming.
FOOTNOTES:
[1] Srinivasan, Raji, Lilien, Gary L. and Arvind Rangaswamy (2005) “Turning Adversity into Advantage: Does Proactive Marketing During a Recession Pay Off??” International Journal of Research in Marketing, June, Vol. 22, Iss. 2; pg. 109-125
[2] Srinivasan, Raji, Gary L. Lilien and Sridhari Sridhar (2011) “Should firms spend more on R&D and Advertising during recessions” (forthcoming in the Journal of Marketing and available at http://isbm.smeal.psu.edu/library/working-paper-articles/2010-working-papers/04-2010.pdf
