Advertising Sales Up Is a Sign of Good Things to Come

This morning one of the largest advertising firms in the world, WPP PLC, announced its full year 2010 results.  First, profits rose 34% last year.  While this sounds impressive, remember that exiting a recession many companies experience tremendous operating leverage.

Because most businesses have trimmed their expense structures to the bone, any revenue growth has an out sized effect on profits.  That is, incremental revenue dollars have less expense dollars offset against them, so more money falls to the bottom line.

I said in my 2011 Predictions that we would be seeing this phenomenon and that the more important number to focus on was actual revenue growth – something that has been in short supply since the Great Recession ensued three years ago.  WPP’s 2010 revenues were up an impressive 7.5%.  What does this mean and why is it important?

Advertising is a leading indicator of the health of businesses.  The reason is that when there are signs of economic turmoil (think: summer of 2008) businesses look to cut back costs in order to maintain profitability.  One of the easiest and fastest cost cuts to implement is advertising.  In short, aggressive advertising is not a necessity for many businesses.  That’s because most businesses that would advertise at a national or regional level have established businesses with established products.  People buy because they are in the habit of buying those products and not necessarily because they saw an advertisement.

Yet businesses in this situation continue to advertise.  Most often this is because of “impressioning.”  That is, businesses hope that when you go shopping for something that you will remember their brand first when recalling what to buy.  So they are trying to impress your sub-conscious with their brand.  But when times are tough businesses know that you aren’t out there aggressively buying anyway.  Thus, they cut back on their incremental advertising spends because they are, what I will call, a luxury ad spend.

When the economy recovers and businesses are on a more sound footing they tend to once again engage in this type of luxury ad spend.  Evidence that they are doing this is that WPP’s 2010 revenues were up more than U.S. gross domestic product (GDP) was up last year.  In fact, WPP sales up of 7.2% is approximately twice the best quarter of U.S. GDP growth last year.  In other words, businesses are now spending on advertising at a rate that is outstripping overall economic growth.

Businesses would only engage in this sort of activity if they were very confident of two things:

1. That their own financial situation was solid.  If it was not then they wouldn’t engage in unnecessary luxury ad spending.
2. That the U.S. consumer is feeling more confident and thus, is more willing to spend more of their income than in the recent past.

When the economy is recovering the last place that businesses tend to add expenses is in employee headcount.  Hiring people is expensive.  There are all of the costs associated with finding them, training them, dealing with their learning curve, integrating them into established groups of people, benefiting them, and paying them.  For businesses to have increased their ad spends is an indication that they are getting more comfortable with the idea of hiring more people.  In other words, the economy is nearly recovered.  And that’s why WPP’s 2010 results are a sign of good things to come.

Jason