How many banking executives
have an accurate idea what return they receive on marketing spend?
According to two leading US-based financial academics, spending on
advertising and promotion really does provide a quantifiable return
and so does expanding the branch network. Charles Davis
reports.
Go deeper with GlobalData
It is a
time-honoured canard that when times get tough, the marketing
budget is the first to go. Academic research from a pair of finance
professors shows that may be precisely the wrong thing to do.
Donald J Mullineaux from the Gatton
College of Business and Economics at the University of Kentucky
told RBI the power of marketing expenditures was largely
unrealised by the financial services industry.
“Banks spend billions of dollars a
year on marketing, but few bank managers can answer this question
with any degree of confidence: what kind of returns are we getting
on our advertising and promotion expenditures? Banks also spend
considerable sums to build new branches, with no idea of the return
on investment from what are pretty significant investments.”
So, Mullineaux and Pyles set out to
quantify the return on investment (ROI) on marketing and branch
building – and found some surprising results.
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By GlobalDataTo isolate the influence of
marketing and branches on ROI, the researchers estimated what
economists call a profit function, using data on advertising,
promotion spending and on the scale of branch network as factors of
production. The results produced an estimate of the quantitative
impact of each type of marketing strategy on bank income after tax,
at the margin. For the typical US bank, spending on advertising and
promotion generates a return – as does building new branches.
Using data from all call reports of
US banks or savings and loans spending more than one percent of
total revenue on advertising as its sample, the study revealed that
advertising spending per bank rose almost five percent per year
from 2002-2006; but the number of branches rose slower and declined
in 2006.
Banks with assets in excess of
$10bn spent an average of $153m a year on advertising over the
sample period, versus $3.6m for institutions in the $1bn-$10bn
group.
Mullineaux said he had expected the
difference between the larger and smaller institutions to be
significant, but had no idea the gap would be so immense. “The
average bank in the largest group spends about 43 times more than
the average institution in the $1bn-to-$10bn class, despite being
‘only’ 22 times as large in terms of assets. That was a surprise,
but there is also considerable variation within the group. The
maximum annual marketing spend by any single institution with over
$10bn in assets was $2.1bn, while the minimum was $4.2m. Bank
executives clearly have strongly divergent views on the power of
marketing.”
When the researchers looked across
the four regulatory asset size classes (assets of less than $100m;
$100m to $1bn; $1bn to $10bn; and over $10bn), the disparity
between the largest and smallest institutions came more starkly
into view.
Banks in the first three groups,
averaged about 0.12% of assets in marketing expenditures.
For the largest banks, that ratio
rose to almost three times as high. Promotion spending averaged
about three percent of total expense for the community bank segment
(assets of less than $1 billion), but rose to almost four percent
for banks in the $1bn-to-$10bn range and to about 6% for banks
with assets of more than $10bn.
“That is a huge difference in
expenditure as a percentage of assets, but these very large
institutions are the ones most likely to hire global advertising
firms, spend in the national media and pursue naming rights for
stadiums,” Mullineaux said.
Addressing the key question of how
investing in advertising and promotion affects profits, the
researchers found that, on average, a 10% increase in such spending
generates about a 2.5% gain in operating income.
The returns to marketing through
advertising increase with bank size, however. The same ten percent
increase in promotion spending yields a three percent increase in
profits at banks with assets of more than $1bn, which economists
call increasing returns to scale.
Building a new branch is also a
form of marketing expenditure. The average number of branches over
the sample period varies from almost two for banks with assets of
less than $100m to just over 200 for those with assets above $10bn.
The authors found that expanding the branch network by ten percent
yields an increase in operating profit of about 2%.
But in the case of branching, the
evidence indicates either constant or decreasing returns to scale.
In other words, the ‘returns’ to branching do not increase with
bank size – and there was evidence to suggests they actually
decline.
The researchers also examined the
impacts of advertising and promotion and branching on bank market
shares of deposits. The results showed that a 10% increase in
promotion yields about a 7% increase over the existing market share
and that a 10% increase in the size of the branch network generates
a 30% rise in deposit market share.
The increasing returns to scale found in marketing expenditures
did not materialise in branch building, though. The returns to
branching do not increase with bank size, and some of the study’s
evidence suggests they actually fall.
