Balancing Ad Spending and Revenue

STUDY OF DOT-COM MARKETING FINDS MAJOR IMPROVEMENTS

Online Companies Evolve Into Disciplined Businesses

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NEW YORK (AdAge.com) -- Stamps.com topped the list of dot-com irrational exuberance in 1999 by plowing $98 into marketing for each dollar of revenue. Last year, it
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spent 15 cents on marketing for each dollar of revenue -- leaving enough money to pay for postage.

Disciplined marketing
After slashing expenses and learning to live on a budget, dot-coms have evolved from virtual jokes to real businesses backed by disciplined marketing. That should translate into increased consumer advertising.

As a new study conducted for Advertising Age by Pegasus Research International proves, dot-com is no longer a pejorative. The average dot-com spent a realistic 26% of revenue in 2002 on expenses related to sales and marketing. That's down from the high point (or low point) for dot-com mania in 1999, when the average dot-com spent $1.01 on marketing for every dollar of revenue.

Spending is still above sales-and-marketing rates typical elsewhere in the marketing world. Those rates vary across industries and companies. Retailers, for example, tend to spend from 5 cents to 15 cents; Net-savvy JetBlue Airways invests 7 cents; consultant Accenture puts in 12 cents and Microsoft Corp. spends 19 cents.

Grounded in reality
Online companies don't necessarily have to match offline counterparts since Web companies avoid other expenses, such as store rent and store employees' pay. Regardless, there is no doubt that dot-com spending rates have come down to reality.

Stamps.com's entire budget for traditional advertising -- and slick TV campaign from Wieden & Kennedy, Portland, Ore., and director Joe Pytka -- are long gone. Stamps.com's losses have shrunk, it has money in the bank and it's focused marketing on alternatives, such as direct mail and partnerships with companies serving its small-business target, to deliver new customers.

"We have a real business model," said President-CEO Ken McBride. "Our name happens to be dot-com."

Stamps.com still must prove long term it can grow the company after slashing marketing; revenue fell for six consecutive quarters before picking up in the second half of last year, when it launched new products.

The Ad Age study
But at least in the short term, Stamps.com ranks as one of the most efficient dot-com marketers, as seen in Ad Age's study. The new study analyzes sales-and-marketing expense rates -- ad spending, promotion and pay for marketing and sales people -- for 107 current and defunct publicly traded dot-coms and other Net-centric companies, such as online brokerages. It updates an analysis first done for Ad Age by Pegasus in 2000 when the stock market and dot-com bubbles burst. Breakout data on 35 companies that survived the dot-com bust are included in this report.

Greg Kyle, president of Pegasus, an independent investment research firm known for its early warnings about dot-com excesses, predicted in the 2000 analysis that sales-and-marketing expense rates for some dot-com sectors would fall to a range of 25% to 40% by second quarter 2002. Spending actually fell further; the share of revenue that went into marketing across dot-com sectors in 2002 ranged from 14% to 37%. That's down from 90% to 133% in 1999, when the dot-com fad took off, and 62% to 95% in 2000, when dot-com advertising peaked.

Marketing spending is down "to a rational realm," said Mr. Kyle, who predicts the average marketing spending rate for dot-coms will stabilize in the next few years in the range of 20% to 25%.

Mr. Kyle notes many dot-coms have the infrastructure in place to handle more volume without a corresponding increase in costs, putting survivor dot-coms in a strong position to prosper when the economy recovers.

Connecting the dots
That's not to say companies have connected all the dots.

Among the group of 35 dot-coms in the study, just eight made money last year. While the biggest wave of consolidation is over, some dot-coms continue to struggle. Auditors, for example, have raised "substantial doubt" about the future of Audible, a provider of Web audio programs. Audible, the sole company on the accompanying chart whose marketing expenses last year were still higher than revenue, said in its 10-K annual report last month it had enough cash to go through June. It's trying to raise money and may sell assets.

Overall prospects for dot-coms look good. Costs are under control (average marketing spending rates for the 35 companies are down 58% from 1999). Revenues are growing (up 75% since 1999 for this group). Web usage is expanding (the number of U.S. PCs connected to the Internet has risen 25% and PC users are spending 16% more time online since the bubble burst in 2000, according to comScore Media Metrix).

Even in the current dismal economy, the profit picture is improving; 41% of dot-coms tracked by Mr. Kyle made money in the fourth quarter, vs. 17% a year earlier.

Investors take notice
Investors are taking notice. A few dot-com stocks this month hit their highest prices since falling from grace in 2000, including Drugstore.com and United Online.

United, notably, has turned a money-losing idea -- giving away online service -- into a moneymaking strategy of selling low-priced Internet access ($9.95 a month vs. $23.90 for AOL Time Warner's America Online).

Companies have cut marketing costs by slashing advertising. For the 35 companies analyzed here, U.S. measured traditional media advertising as a share of marketing spending fell to 18.5% last year from 28.2% in 1999, according to data from Taylor Nelson Sofres' CMR. Measured spending for the group last year was down 21% from 1999 and down 48% from 2000.

As a result of tightened advertising spending, dot-coms such as Amazon.com and Yahoo! compare more favorably with traditional retailers and media companies in ad spending as a percentage of revenue.

Yahoo!'s spending
Yahoo! compares unfavorably with other dot-coms on one score: Its spending rate on sales and marketing in 2002 actually was higher than in 1999 and 2000.

In its 10-K annual report, Yahoo! attributed last year's increase to costs related to the purchase of HotJobs and to compensation expenses but noted it cut discretionary expenses such as ad spending.

Measured offline ad spending for the 35 companies was flat last year after factoring out a big dollar increase at a large Net-centric brokerage, Charles Schwab Corp. The most profitable consumer dot-com, eBay, tripled measured ad spending last year, though such an increase is as exceptional as eBay's profits. EBay's advertising agency is San Francisco-based Goodby, Silverstein & Partners, part of Omnicom Group.

United vs. AOL
United Online is among those that intend to spend. Pushing a price message with simple spots for its Juno and NetZero services, in 2002 it boosted ad spending, grew revenue and at mid-year moved into the black. In the fourth quarter, United Online had offline spending measured by CMR at $11.6 million and added 154,000 paid subscribers; AOL had measured spending of $31.1 million-and lost 176,000 U.S. subscribers in the quarter.

Brian Woods, executive vice president and chief marketing officer, said United Online tries to produce TV spots for less than $100,000 and limit other marketing expenses, all to free money to buy media. It creates ads in-house; Bernstein-Rein, Kansas City, Mo., plans media, and Interpublic Group of Cos.' Initiative Media, New York, buys the time.

"You cannot cost cut your way to success," Mr. Woods said. "If you have a consumer proposition, you have to get that message to people."

Some others are returning to advertising. Drugstore.com, founded by an ex-Microsoft Corp. executive with backing from Amazon.com, this quarter will start its first offline ads since 2000. The limited magazine campaign, created in-house, will promote new store sections focused on women's health, natural goods and sex products such as condoms.

Improving metrics first
Since Drugstore.com halted offline advertising, it has increased revenue and cut losses while improving key metrics such as increasing average size of purchase, reducing cost of customer acquisition and lowering cost of fulfilling orders.

"We got smarter at growing our revenue by retaining our customers" so as not to have to spend more to reacquire them, said VP-Marketing Niti Badarinath. He stresses the new ads will be "very targeted and very measurable."

The dot-com ad boom was a bust for most advertisers -- though a nice if short-lived transfer of wealth to media and agencies. Nearly half -- 17 -- of the 35 companies in the survey had no measured offline spending last year. But many survior dot-coms will return to old media.

Online is a smart place to promote online. And some dot-coms, such as Stamps.com, may efficiently get their product into the hands of business users through direct mail.

"For us, traditional ads -- magazines, TV, radio -- just don't work," said Kyle Huebner, Stamps.com's vice president of marketing and strategy. Yet for many dot-coms it makes sense to invest in traditional media.

Even as Mr. Kyle, the Pegasus researcher, expects the share of revenue dot-coms spend on marketing to decrease a bit, he said marketing dollars will increase because of higher revenue. "As they start to scale up and see more revenue," he said, "then they will start to return to traditional advertising."

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