Why Now Is Not the Time to Cut Costs

The Problem Isn't High Operating Expenses; It's Low Consumer Demand

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Dr. Ronald Stampfl
Dr. Ronald Stampfl
The deep recession and financial meltdown we are experiencing have put consumer-goods marketers into an enterprise-threatening economic environment. How long it will last, of course, is anyone's guess.

As we well know, a market for a product must meet three conditions before consumer spending occurs. First, there must be a need or want in the consumer's mind. Marketers are trained to stimulate existing wants and create new ones.

Second, consumers must have money or credit to spend, and many American consumers have one or more credit cards that are not maxed out. Credit is tight, but retailers can have their own credit cards, giving them control over credit limits.

Third, credit-worthy consumers must be willing to spend the credit or dollars they have. This is the real constraint facing marketers today. It's a problem of limited demand and can be solved through effective marketing. It's not a problem of high operating costs and cannot be solved by the cost-cutting strategies found among accountants.

What that means is that cost cutting is a worthy goal when it comes to business operating expenses, but cutting the marketing/advertising budget frequently hurts an organization's ability to finance research and development of new products and create or stimulate demand for all products in future fiscal periods.

The experience of General Motors provides an excellent example of the need to match problems to solutions that will work. President Barack Obama was insightful when he insisted that Rick Wagoner be replaced as CEO of General Motors before any bailout funds were offered to GM. Mr. Wagoner had spent several years trying to make GM profitable by reducing costs at every opportunity, including huge cuts in the marketing and advertising budget. That strategy clearly did not work for the following reasons:

  • Lost market share. GM had 52% of the automotive market in the late 1960s but only 24% in 2008. It was profitable when its market share was high but not when its market share was cut by more than half.
  • Costly cost cutting. Closing factories saves operating expenses but still affects the balance sheet: Fewer factories means fewer vehicles manufactured and available to sell, yet the factory remains on the balance sheet. The return on investment on a closed factory is zero, but its liquidation may take years. Closing a factory is expensive. So is restarting one.
  • Ignored product planning and life-cycle timing. If product research and development is cut in difficult economic conditions, the company may not have sufficient new products coming on line to augment the product portfolio. This results in too many mature products subject to high price competition, low profitability and not enough new products in the growth stage of their life cycles.

While reducing costs where possible is good and can lower a company's break-even point, GM simply found that it could not cut fixed operating costs fast enough to outpace the reduction of sales revenue brought on by reducing the marketing and advertising.

But not everyone is getting it wrong. Generating sales revenue to surpass the break-even point requires highly skilled marketing executives with a realistic and sufficient budget despite economic and political difficulties. Cutting the marketing budget by half to meet the forecast level of fewer sales will not work, because a firm's break-even point in sales revenue must still be reached. Some successful organizations are still creating demand-driven solutions to help keep them at the top of the sales game.

Kohl's stores, for example, are highly promotional, with locations away from regional malls, often near big-box retailers such as Staples or Bed Bath & Beyond. Kohl's drives sales by aggressive advertising in Sunday papers -- often a 48-page insert promising special discounts for specific days from 8 a.m. to 1 p.m. It uses direct mail and e-mail to its own credit-card customers and willingly reviews credit limits for strong customers. New credit-card customers are offered 20% off their entire purchase the day they open an account.

Kohl's always places markdown racks at the store's entrance with full-size assortments and name-brand merchandise at 20% to 75% off. Sometimes customers may be given a "scratch-off" card at the checkout counter good for 10% to 15% off that day's purchases. Off-price promotions are always available in cosmetics and jewelry. Kohl's offers a treasure-hunt-type experience and permits multiple discounts at certain times. Shoppers come to Kohl's ready to spend if the incentives are high enough, and Kohl's vendors participate in off-price promotions.

Hyundai Motor, meanwhile, has been successful in increasing potential customers' willingness to spend by augmenting a new-car purchase with a year's supply of gasoline at $1.49 per gallon and an offer to take back a new-car purchase for one year if the customer loses his or her job. Hyundai is clearly lowering the "perceived risk" of its potential customers and absorbing some uncertainty felt by buyers.

Jos. A. Bank Clothiers has buy-one-suit-get-two-more-free promotions. This drives volume in a manner that a half-price single suit cannot.

Carl's Jr. restaurants has recently introduced the "Teriyaki Six Dollar Burger" for $4.88 and provides direct mail or e-mail coupons for a second teriyaki burger free. This promotion gets customers into the store for the new product while up-selling with soft drinks, fries and desserts.

And finally, airlines, supermarkets and even high-end departments stores such as Nordstrom tie customers to their businesses with some variation on patronage incentives, resulting in discounts, savings or rewards for purchases. These programs are open to "double points" awards to drive sales on any given day.

The bottom line is that problems stemming from the big recession of 2009 should remind executives that cost-driven solutions do not solve demand-driven problems. It's critically important to do break-even analysis and fund skilled marketing people, either in-house or through a creative agency, to drive sales revenue beyond the firm's break-even point. The problems caused by the near-meltdown of the American and other economies cause cross-functional problems in any business. Marketers, accountants, finance and human-resource executives are all seriously affected and must understand how these problems can be solved in cooperation with each other.

Although it's counterintuitive, when demand-driven problems become evident, marketing budgets need to be maintained or increased. Demand stimulation and creation in poor economic times that require sufficient funding to redefine and reposition consumer needs and wants (Hyundai); grant or increase credit available to worthy customers through a dedicated credit program controlled by the individual business (Kohl's); or increase the consumer's willingness to spend money or credit with advertising and sales promotion programs designed to drive sales revenue.

Good marketers, through advertising and sales promotion, know how to solve demand-driven problems. That is what marketers do.

ABOUT THE AUTHOR
Ronald Stampfl received his Ph.D. in marketing from the University of Wisconsin at Madison, where he also taught until 1988. Since that time he has been a professor of marketing at San Diego State University's College of Business Administration. His areas of expertise include retail economics, corporate marketing, the study of product life cycles and consumer science.
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