RETURN ON ADVERTISING INVESTMENT

RETURN ON ADVERTISING INVESTMENT [i]

In preparation for a call on a leading supermarket chain in a large Midwestern city, the top sales executives of the leading television station in the market read the company’s Annual Report and gathered as much information from local market sources they could. At the beginning of the initial meeting with CEO of the supermarket chain, the station told the client that it was not there to talk about the station but to learn about his business and then determine whether the station could help improve profitability. “No media peddler has ever said that to me,” the CEO stated. “Ask your questions.”

First, the station learned that the company owned eleven supermarkets in the market which generated $200 million in sales and that its market share was 25 percent. Total sales annually in the market were therefore $800 million. The company’s CEO also said that their market share rank was thirdamong the six competing supermarkets. Its operating or pre-tax profit margin was three percent (about average for the supermarket industry) which meant that after paying all operating expenses—cost of goods sold, salaries and benefits, rent, and marketing costs—the company had three percent of revenues remaining before paying taxes. Also, the station learned that the lifetime of a customer was a little over three years. This meant that the supermarket chain’s customers remained loyal customers for about three years. Finally, and importantly, the station learned that the shares of the company’s stock were selling for 12 times the company’s pre-tax profits.

The sales management team that made the call thanked the supermarket chain’s CEO for the information; assured him that they would use it in confidence; and, that they would return with a recommendation to invest in advertising on their station only if they believed they could increase the chain’s profits and shareholders’ value. Note the words “invest,” “increase,” and “profits.”

Back at the station, the sales management team asked the sales staff the key question: did they believe that with a substantial expenditure of advertising on the station over a sustained period—at least a year—that the supermarket chain could increase its share of market? The salespeople, citing several success stories of how several advertisers had experienced solid market share increases, stated strongly their belief that with an expenditure of $1 million over the course of the year and with maximizing the commercial placement of the client’s schedule, and with a solid creative approach, the supermarket chain could attain a two percent market share increase. With each market share point worth $8 million in total sales in the market (one percent of $800 million total market supermarket sales) and with the client’s 25 percent market share, that meant each share point increase was worth $2 million in sales. The sales management team believed it could make a strong case that the supermarket chain could likely receive a compelling ROI with an investment on the station.

The station decided to build an ROI model based on the client gaining a one percent market share increase—not the two percent the sales team felt was achievable—because it would obviously be more believable to the client. With the one percent of market sales worth $2 million annually for the client, the station now had to estimate what the incremental costs associated with their recommended program would be. First, there was the $1 million in additional advertising invested by the client on the station. It was then assumed for the eleven stores to generate $2 million in additional sales, it would not require much additional operating expense. It seemed unlikely that the stores would have to stay open more hours a day. Therefore, essential non-personnel costs such as rent, lighting, and heating expenses would not increase. Built into the model was $200,000 for several new checkout counter personnel and another $300,000 in miscellaneous expenses since the sales management team did not know as much about the supermarket business as the client did and because they wanted as few assumptions challenged by the client as possible.

Here is the way the economics of the station’s ROI proposal looked:

Advertising Return-on-Investment Analysis

A. Investment in TV advertising	$1,000,000

B. Investment in 8 check-out personnel	$200,000

C. Miscellaneous expenses	$300,000

D. Total investment	$1,500,000	D = A+B+C

E. 1% market share increase realized from TV advertising	$2,000,000

F. Increased pre-tax income	$500,000	F = E-D

G. ROI	50%	G = F/A

A 50 percent return on investment was almost 17 times the three percent ROI the supermarket chain was currently receiving on its shareholders’ investment. Therefore, the station knew the client—if the assumptions in the ROI model were accepted—would acknowledge that the ROI was substantial. However, the sales management team knew that there was one more vital piece of missing information that the client would find even more appealing.

Because the station had learned that the equity value of the supermarket chain’s parent company was currently based upon a multiple of 12 times the company’s pre-tax profits, the station could now provide a believable estimate for the increase in the enterprise value of the supermarket chain company. This information is readily available for all publicly traded companies and can be determined for private companies relatively easily by any financially trained person. Therefore multiplying $500,000, the incremental pre-tax profit the investment in advertising with the station produced by 12, the pre-tax multiplier the stock market had placed on the company’s share price resulted in an increase of $6 million in the market value of the supermarket chain. Assuming—and the station did not look into this—that there were 50 million shares outstanding, the price per share of the company’s stock would increase about 12 cents. This is this kind of information that CEOs like to hear. See below for the potential affect of the advertising investment on share price.

ROI Impact on Share Price Analysis

A. Return on $1,000,000 advertising investment	$ 500,000

B. Equity value of company multiple	12

C. Increase in company market value	$ 6,000,000	C = A*B

D. Outstanding shares of stock	50,000,000

E. Increase in value per share	$.12	E = D/C

The station added one more assumption to its ROI model that gained the attention and approval of the client’s CEO and management team. The station assumed that half of the incremental sales revenue, or $250,000, generated by the advertising on the station would come from current customers spending more money per shopping visit. The station assumed the other half would come from new customers. Since the client had told the station before that new customers remain with stores on average three years, the station then estimated that the advertising program would also add $250,000 more in profits during the two years following the advertising campaign even if the $1 million advertising investment was discontinued after a year. This additional pre-tax profit also increased the already high ROI on the $1 million investment and it would positively impact the share price in the following two years as well.

It is important to note here that the station did not attempt to persuade the supermarket chain to allocate any of its current advertising budget to the $1million investment in the ROI proposal. The station believed that if it proposed that any of the dollars that the client was currently spending on media in the market, including investment on the station, were re-allocated, the CEO might well argue that his current share of market sales could be offset to some degree. The station knew that its ROI proposal had to be judged on its own merits as a new and incremental investment opportunity, and to suggest switching any of its current advertising investment to the proposal would lead to a debate on existing market share and possibly upon existing relationships the client might value.