Charting the Course of Advertising

Half the money I spend on advertising is wasted; the trouble is, I don’t know which half.

–  John Wanamaker, A pioneer in advertising and marketing 

Is advertising truly effective? If so, does it yield a positive or negative return on investment? Does advertising significantly impact a company’s value growth? What crucial factors should advertisement producers and managers consider to optimize ROI?

The famous quote by advertising pioneer John Wanamaker suggests that half of advertising expenditure might go to waste, but it’s worth considering that this statement may have been made during a time when advertising’s impact differed considerably from today’s context.

Extensive scientific research reveals that, on average, advertising’s effectiveness is relatively limited. Nonetheless, these research findings offer valuable insights that can pave the way for improvement.

The primary goal of this review is to bravely face the truth, no matter how uncomfortable, and to identify practical solutions to the issue at hand.

We sincerely hope that this review inspires you to adopt a fresh perspective on advertising, embracing new possibilities and opportunities.

Markus Kivikangas,
CEO & Founder, Steinheide Oy
markus.kivikangas@steinheide.com

Background

When investigating the effectiveness of advertising through Google, one encounters a multitude of conflicting results. Some studies advocate for its effectiveness, while others present opposing views. Interestingly, specific brands, like Zara, outperform H&M in terms of value and revenue. Likewise, grocery retailer Costco achieves a remarkable annual growth rate exceeding 20%, in stark contrast to the industry’s average of 3.1%. Additionally, Spanx propelled its founder, Sara Blakely, to the distinction of becoming the first female billionaire to amass her wealth. A common thread among these successful companies is their profitable growth and market leadership, achieved without allocating any funds to advertising.

However, delving into market studies on advertising’s efficacy further complicates matters. According to an Accenture-based research group, 82% of television advertising yields negative ROI, while DMA suggests 48%, and Accenture reports that approximately 59% of marketing decision-makers feel their social media investments have been wasted. Moreover, Accenture indicates negative expected returns on print advertising (-48%), and Nielsen supports radio advertising with an ROI of 0.85.

Conversely, Accenture’s findings highlight television’s superior ROI, standing at 83% compared to all other media. Nielsen reveals that investments in digital media generate 2.3 times ROI, while GfK identifies magazines and newspapers as the most effective media, surpassing radio and television advertising.

These conflicting outcomes leave one puzzled about which advertising media is genuinely effective and why varying research institutions claim contradictory views. Such uncertainties prompt the question: Is advertising effective at all? This query gains significance when considering examples like Zara, Costco, and Spanx, thriving in fiercely competitive industries without resorting to any advertising efforts. This raises further contemplation: Could similar achievements be attained in other industries?

To derive the most objective answer, we turn to scientific studies, bypassing commercial research influenced by financial motives and resources.

GOOD NEWS AND BAD NEWS

Let’s begin with the positive aspect. By synthesizing findings from over 1,100 research outcomes spanning 94 scientific studies focused on the economic impact (elasticity) of advertising, we can assert with high statistical confidence (>95%) that advertising consistently enhances sales, both in the immediate and prolonged durations. Similarly, through a comprehensive analysis of nearly 500 research outcomes derived from 83 scientific studies probing the influence of advertising on corporate value growth, we can confidently affirm that, on average, advertising contributes to an increase in company value.

Now, let’s move on to the less favorable news, which is quite concerning. Although there is an effect, it is minimal, almost trivial. Moreover, this effect diminishes each year, making it even weaker over time. The 2021 elasticity estimates for the short-term impact of advertising are 0.03 (median) and 0.08 (average). In practical terms, this means that by increasing the advertising budget by one percentage point (1%), the company’s sales will only increase by 0.03% to 0.08%. Similarly, a tenfold increase in the advertising budget will lead to a mere 0.3% to 0.8% rise in sales.

On the other hand, if a company intends to boost its revenue through tactical advertising, it must be prepared to amplify the advertising budget by 13 to 33 times, depending on whether the average or median figures are considered.

Several factors contribute to the loss of elasticity, including increased competition and advertising over time, the emergence of new advertising channels facilitated by the Internet, and the ability of digital tools for consumers to bypass television advertisements. Regardless of the reasons, the impact of advertising on sales weakens, necessitating a higher budget for tactical advertising every year just to maintain the previous level of sales.

The effect of advertising on a company’s value is indeed positive but remains very close to zero. A total of 83 scientific studies and their 488 research results underlines this outcome [Figure 2].

Based on these discoveries, it becomes evident that within the spectrum of marketing tools employed, brand equity exhibits a staggering 725% higher effectiveness in shaping a company’s value growth when juxtaposed with advertising. In contrast, the commonly employed pricing strategy showcases a negative impact, suggesting that a competitive pricing approach essentially undermines the company’s overall value.

Now, let’s consider the interaction between advertising and pricing. While the elasticity of advertising decreases annually, the elasticity of price increases, though, regrettably, from the seller’s perspective, it is headed in the wrong direction. Based on 81 scientific studies and over 1800 research results, the elasticity of price was -1.76 in the 80s, but by 2005, it had already risen to -2.62. Correspondingly, the elasticity estimates for 2021 is -3.4, meaning that a one percent price increase this year will reduce sales by an average of 3.4%, while a one percent price reduction will increase sales by an average of 3.4% [Figure 3]. Consequently, the impact of price on people’s purchasing decisions intensifies each year, leading customers to make more frequent purchases based on the reduced prices.

If the decrease in advertising elasticity noted in the previous chapter is combined with the increase in price elasticity noted in Figure 3, a completely unsustainable equation is obtained. While back in the 1980s, a mere five percentage point rise in the advertising budget sufficed to counterbalance the adverse effects of each percentage point increase in prices, the dynamics have significantly evolved over the past two decades. By the turn of the century, this ratio had surged to 30, and now, in the present year, it surpasses 40. Thus, in 2021, a mere one percent increase in prices would necessitate an advertising budget augmentation of more than 40% to effectively counteract the dip in demand arising from the price escalation (Figure 4).