I have sort of explained this very briefly in my opening post. I’d like to use the opportunity now to explain how this works.
Companies in general try to make a 60% Gross Profit. Out of this they pay salaries, rent and other operational cost. Included in their operational cost is advertising, and this seems to be about 12-15% of their turnover. What is left after this is their profits, which they try to keep at about 12-15%.
Advertising is a grudge expense to most companies, especially the people who are not in the marketing department. All companies know that if they can stop advertising they immediately double their profits (from 12-15% to 24-30%).
The question is: Why don’t they all do it?
All research over many years and many studies in many markets show that advertising works at a brand level.
Except for new markets the total market size is not really influenced by the amount of advertising by all the brands in the market. However, advertising for a brand (mostly) has an effect on the market share of the brand.
So, if a company wants to maintain, or grow, the market share of its brands it HAS to advertise – as long as the competitors advertise.
Here is the rub: As long as all brands do not advertise, none have to advertise. However, if only one starts to advertise then everyone has to advertise!
There are a few markets where traditionally there is no advertising. My advise to them is to not start advertising.
So what do you do if you are in a market where the brands are very similar (homogenous) and mostly very sensitive to advertising and you want to increase (double) your profitability?
An alternative is to get all the companies together and all agree to stop advertising. Firstly you need a situation where a few companies totally dominate the market. If there are too many companies then you can be sure that someone will use the opportunity to advertise and gain market share.
However, even if you do manage to get the few companies to agree and all stop advertising you can be sure that the Government is not going to like it. You will be seen to have colluded, and there is no better way to attract the unwelcome attention of the legislators. This is why it is not done, even if the competitors in the market know they can do this.
So, if this alternative is not open to you, what is the alternative?
Well, why don’t you get the Government to tell you all to stop advertising?
This way you achieve two very desirable objectives: The Government cannot accuse your industry of colluding; and no-one can try to steal some market share by advertising.
The third benefit is that if there is no advertising to influence brand shares the share of a specific brand will remain stable over much longer periods. This is of course why you want to follow this strategy of non-advertising when you are close to a monopoly with several brands. Not only do you maintain your brand shares, but even if there is a shift in brand preferences then it is likely that it will be to one of your other brands.
This is especially desirable if the production process from planting the crop up to packaging the final brand is so homogeneous over all your brands that you merely change the packages that the end product is put in if there is a shift in demand.
This is the simplest of business strategies.
The problem is to get the government to ban advertising for your whole industry.
This was not a problem for Philip Morris and BAT. People did it for them. All they had to do was to sit back and allow the anti-smoking lobby to do their work for them.
What did the Minister of Finance think about this? They loved it.
They balance their books based on the taxes they receive, especially corporate tax on profits. If the cigarette companies double their profits then the taxman gets twice as much money from them!
You might argue that the taxman would have got the same money if the money went to media and advertising agencies. This is not so. In the first instance it is more costly to collect the money from many organisations than what it is to collect the money from one. Beside this: if each of these companies were running at a 10% profitability then the taxman would only get his cut on 12% of the money.
This brings me back to the French report I based my second post on: “Improving Public Health Prevention with Behavioural, Cognitive and Neuroscience“. This report was prepared for Nathalie Kosciusko-Morizet, France’s Secretary of State for Strategic Planning and the Development of the Digital Economy.
I asked myself: Why the Ministry of Strategic Planning and not the Ministry of Health?
As you will see this leads to the next question: What does the International Monetary Fund (IMF) have to do with all of this? Why do they insist on countries having a health bill regard cigarette advertising before they grant loans? This is like your bank asking whether you are a smoker before they give you a bond.
This will lead us to some more quirky economics and unintended consequences:
- Why did some countries introduce draconian anti-smoking laws when they did. Ireland was first in UK to ban smoking in pubs, and their economy had big problems well before the current European economic woes. England’s sudden ban of smoking in pubs and hotels and about everywhere just before their economic problems.
- So, if the profitability of Philip Morris and BAT increase so dramatically, who gets the money? The first and obvious answer is that it went to the shareholders. But who are the shareholders: ‘The 1% of the world population that owns 40% of the world wealth!’ against whom Wall Street is being occupied.
- Who are the main shareholders in all stock-exchanges? The insurance companies. This is how they make their money. You give them your contribution and they buy shares in companies like Philip Morris and BAT. They are not stupid either. They got onto the anti-smoking bandwagon and increased the levies of smokers – so they get a double cut of the cherry.
Hold on the sums get very interesting as we continue untangling this web of unintended economic consequences.