P&G Rewrites Its Definition of 'Ad Spend'

Company Now Includes In-store in Total, Subtracts the Salaries of Marketers

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Procter & Gamble has redefined advertising -- at least in its financial reports.

In an unusual move, P&G is restating 11 years of ad-spending data in its annual report filed Aug. 28. The result largely erases the decline of P&G's ad-spending-as-a-percent-of-sales ratio that in recent years worried some investors, particularly amid declining organic-sales growth. By either the old or new definition, P&G's growth has been closely linked to its ad-to-sales ratio the past decade.

Procter and Gamble's ad spending restatement will include expenditures such as in-store advertisements, but will omit the salaries of ad execs.

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The new math
P&G's yearly ad-to-sales ratio under old and new accounting systems.

The restatement also gives in-store advertising -- everything from promotional display boxes to SmartSource instant-coupon machines and Wal-Mart TV -- a place alongside other media spending in the nearly $8 billion budget of the world's biggest advertiser.

"Over the past few years we've been looking at ways of improving the effectiveness of our marketing spending," a P&G spokeswoman said. "As a result, we've been shifting more of our dollars away from traditional TV and toward other media, including in-store. ... So we thought it was important to include in-store in our disclosed advertising spending."

Subtracting salaries
In-store advertising accounted for "the bulk" but not all of the increases, she said. At the same time, P&G subtracted the pay of many of its own marketing executives from the reported number. That reduced ad spending by as much as $163 million in 1998, when P&G apparently had little in-store advertising to offset the salaries and benefits.

In all, P&G's restatement added $349 million to 2006 ad spending, with much smaller adjustments in other years, though Sanford C. Bernstein analyst Ali Dibadj believes the differences between the old and new definitions could have boosted P&G's reported 2007 outlays by $350 million, too. P&G said it hadn't calculated or disclosed the 2007 impact.

The restatement seems to render moot concerns by some analysts and investors -- and a jibe from a competitor -- about P&G having reined in ad spending.

In an April conference call for Colgate-Palmolive Co., Citigroup analyst Wendy Nicholson noted P&G "is talking more and more about advertising as a percentage of sales as being not necessarily the right metric to look at" because of the impact of efficiency improvements, but that Colgate seemed to be showing a strong link between higher ad spending and faster growth.

To which Colgate Chairman [and then CEO] Reuben Mark replied: "If you are able to increase the advertising effectiveness at the same time you're increasing the absolute amount of advertising, wouldn't that be great?"

Proportional decline
A decline -- or at least what used to look like one -- in P&G's ad-to-sales ratio had corresponded with a decline in P&G's organic-sales growth from 8% in fiscal 2003 through 2005 to 5% in 2007 (ended June 30). P&G's stock has underperformed rivals the past two years largely because of investor concerns over declining top-line growth.
P&G's new advertising definition
What's in:

In-store advertising via displays or third-party vendors, such as News Corp.'s SmartSource and Thomson's Wal-Mart TV (but not trade deals with retailers)
What's out:

Salaries and benefits of P&G marketers
What's always been there:
  • Traditional media
  • Agency fees

Under the old accounting, P&G's ad-to-sales-ratio slipped from 10.7% in 2004 to 9.9% in 2006 (and possibly lower in 2007.) Those seeming declines came as P&G faced growing margin pressure from rising commodity costs.

Under the new accounting, however, it looks like P&G was spending at about the same rate all along -- 10.6% of sales at the peak in 2004 and 10.4% for the past three years.

"I don't think it's a bad thing for P&G," Mr. Dibadj said of the restatement, adding that he believes it brings P&G more in line with how competitors such as Colgate report ad spending. Even after the change, he said about 75% of P&G's ad-spending number is media, compared to about half of Colgate's.

Not total picture
But unlike Colgate, P&G still doesn't count sampling or much of its consumer promotion as part of advertising, so its reported ad spending still doesn't really show whether overall marketing spending is growing or shrinking.

All of which adds to confusion.

"It's not an apples to apples comparison between these companies," Mr. Dibadj said. "The divergence is much bigger than I ever thought."

Another analyst said: "I doubt P&G would have made the change if it didn't make [their numbers] look better," though he said its overall ad ratio has remained fairly constant over the years.

The last time P&G restated its ad spending number in 2001, it also faced investor scrutiny over a declining ad-to-sales ratio amid slowing top-line growth. At the time, P&G explained that restatement as "misclassified brand-equity-building spending," and the restatement boosted its ad ratio from 8.1% to 9.2%.

Looks good on paper
Accounting rules don't dictate how, when or even if companies should break out advertising in reports. And the changes don't affect sales, earnings or margins. But they do affect a line some analysts and investors watch closely as a sign of earnings quality -- either because they see strong ad spending as an investment in growth or a sign that a company is having no trouble meeting its earnings targets.

P&G's figures in the past 11 years show a very high statistical correlation (0.78) between ad spending ratios and organic sales growth under the old advertising definition, and an even higher one (0.87) under the new definition. For the past five years, however, the new ad definition shows a much lower correlation to sales growth than the old one.
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