On an annual basis, firms are confronted with multiple decisions. One of them is regarding their marketing budgets. Here are three scenarios: 1) Increase the marketing budget as a percentage of overall sales (Pushers); 2) Keep the marketing budget constant as a percentage of sales (Plodders); 3) Decrease the marketing budget as a percentage of overall sales (Pioneers). Which scenario is most effective?
Knowledge at Wharton examines a book written by J.C. Larreche, called “The Momentum Effect,” that examines these scenarios. According to Mr. Larreche, the third scenario is most effective. It seems counterintuitive doesn’t?
From the second scenario, where the company keeps its marketing to sales ration constant. It does not differentiate itself from its competitors with respect to its spending, it is akin to being on cruise control. This is the least effective method to increase sales for sustaining profits. In fact, these firms underperformed vis-a-vis the Dow Jones index by 28%.
The first scenario, by increasing its marketing budget, both sales and profitability increase moderately. Their shareholder value performance mirrored the Dow Jones index. These companies typically cut back on other expenses such as Manufacturing and R&D in order for them to increase their marketing to sales ratio.
Surprisingly, the third scenario by decreasing its marketing budget as a percentage of overall sales is most effective because the company allocates its resources to other areas of the business that can help contribute to the overall sustainability of profits in areas such as R&D. Overall, the marketing budget increases in real terms, but decreases as a percentage. These companies outperformed the Dow Jones index by 80%.
Companies need to understand that merely increasing the marketing expenditures is not nearly enough for sustainable and profitable growth, it needs to focus on other areas of its business that maintains current customers and eventually attract new ones such as logistics, product/service R&D and after sales.
I think that companies that understand and identify with current and prospective customers needs and wants in their advertising, product/service design, and after sales is prescient on future successes. Merely focusing on one area (perhaps the business’s core competency) is not enough.
An example of this can be found in the auto industry. After 9/11, GM introduced an incentive called “Keep America Rolling,” this was to generate sales and to clear up built-up inventory. Ever since that campaign, the Big 3 (GM, Ford and Chrysler) have constantly relied on expensive advertising campaigns, as well deep discounts and incentives. This was an example of a Pusher. The Japanese manufacturers were examples of the Pioneer, they relied less on incentives and were able to be more in tune with the customers needs and wants.