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FMCG: The cost of growth

Jan 14, 2010

Advertising is an integral part of any organisation as it helps spread awareness about its products. This in turn helps in generating sales. This would especially hold true for companies directly catering to the end customers. What better than FMCG companies to use as an example. In this article, we shall take a look at how India’s largest FMCG companies have changed their advertisement and marketing (A&M) spending over the years, and how the same has impacted their revenues. Usually, companies budget their A&M expenses depending on the revenues they generate. As such, companies tend to maintain a certain ratio between the A&M costs and revenues. As and when companies go for aggressive marketing campaigns, the ratio tends to rise. And the ratio falls when they go easy on their marketing activity.

Going by historical data, average A&M costs (as a percentage of sales) have increased significantly over the past few years. The chart below shows the average of this ratio (A&M costs divided by revenues) of select FMCG companies forming part of the BSE-FMCG Index. These include Britannia, Colgate-Palmolive (CPIL), Dabur India, HUL, Marico, Nestle and Tata Tea.

*Average marketing costs of selected FMCG companies.
These include - Britannia, Colgate-Palmolive, Dabur India, HUL, Marico, Nestle and Tata Tea;
Marketing includes commissions, rebates, discounts, sales promotional,
expenses on direct selling agents & entertainment expenses;
Data Source: CMIE Prowess

In absolute terms, A&M expenses of FMCG companies have increased tremendously over the past many years. But at the same time so have their revenues. Just to give you a rough idea, the average standalone A&M expenses have (of this lot) has increased at an average annual rate of about 15% over the past 15 years. During the same period, standalone revenues of these companies have increased at a slower rate of 12%.

The reasons for A&M expenses to increase at a faster pace than revenues are various. However, the key reasons would be the increasing competition in the FMCG space and a relatively slower growth in revenues. The latter is also known as the diminishing rate of return on investments. Investments in this case would be the costs for brand building.

However, one of the simple ways to gauge the impact of A&M expenditure would be by calculating the ratio of sales by the A&M expenses for a particular year. However, as it is possible that the A&M expenses can be quite different in to consecutive years, we have done this exercise by taking the average A&M costs. Average A&M cost in this case is the average of A&M costs of the year in focus and the preceding year. For example, to calculate this ratio for 2009, we would have taken the revenues of the year, and divided the same by the average A&M costs of 2009 and 2008.

Below is the chart showing how this ratio has changed over the years for the FMCG companies taken under consideration. In simple terms, this chart depicts what kind of revenues a company generates on spending Re 1 on advertising. As it is quite evident, a lot has changed over the past 15 years.

The ratio for almost all these companies has come down over the past 15 years. Let’s take up HUL's example. The company was able to generate revenues of about Rs 28 for every rupee spent on advertising back in 1995. The same ratio stood at about Rs 12 in 2009. With competition heating in up many of its segments, HUL has felt the need of protecting its market share. This has led to higher A&M expenses.

In its simplest form, the rule of diminishing returns states that beyond a certain level of investment, returns increase at a decreasing rate. As the market share of companies climb it becomes more and more expensive for companies to achieve incremental growth. This means a market leader will have to spend more to grow its market share than a new entrant in the market.

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