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Aug. 24, 2010, 12:16 p.m. EDT

Ad Cuts Can Cause More Pain Than Gain

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By Renée Schultes

Cutting advertising and promotion spending to protect margins is a natural reaction in tough times. But consumer-staples groups should think twice: Regaining sales momentum can take many years to correct.

Low commodity prices in the first half gave more flexibility for food, drink and other consumer-staples companies to spend on advertising and promotion without crimping operating margins. WPP, the world's largest advertising agency by revenue, said Tuesday that estimated net new business billings in the first half were almost twice last year's levels, noting a particularly strong recovery in the U.S.

But a return to price inflation in some commodities, coupled with a more difficult consumer environment in developed markets, means even maintaining advertising and promotion spending could mean pressure on margins. WPP's chief executive, Sir Martin Sorrell , noted most clients are doing their budgets for 2011 at a time when there is considerable uncertainty. That could make them more conservative.

Some already have pulled back. Danone, which raised advertising and promotion spending in 2009 to 12.6% of sales to expand market share, returned to its annual run rate of 12% in the first half. German skin-care company Beiersdorf /zigman2/quotes/210479173/delayed DE:BEI -0.52% , which makes Nivea creams, cut advertising spending in 2009, and in the first half said that it was maintaining those levels. Analysts at Sanford C. Bernstein said L'Oréal, which reports first-half results after the market's close Wednesday, may have sacrificed advertising spending to overdeliver on margin growth.

But sales momentum is costly to rebuild. Spirits companies, including Pernod Ricard and Diageo /zigman2/quotes/208129584/composite DEO +0.60% , which cut spending heavily in the downturn, will increase advertising spending significantly more quickly than sales for the next six to 12 months, said Barclays Capital analysts.

Deutsche Bank's analysis of 30 large U.S. and European groups over 15 years suggests consumer-staples companies that increase advertising spending deliver sales growth 30% faster than peers.

In a weak consumer environment, where the fight for market share will be intense, companies should resist the temptation of going for the easy option of sharp cuts to advertising budgets.

DE : Germany: Frankfurt
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