Colgate Should Embrace Social Media and Innovation in Place of Ad Spending

In the personal care consumer goods industry where advertising is crucial for driving business and constitutes a significant share of operating costs, Colgate-Palmolive (NYSE:CP) has traditionally been conservative in its media spending compared to the other big players such as L’Oreal (PINK:LRLCY) and Procter & Gamble (NYSE:PG).

P&G has long dominated the personal care industry in terms of advertising and competing with the likes of P&G solely on advertising would unnecessarily strain Colgate’s operating margins. The recent drop in Colgate’s market shares across all major product segments – toothpastes and toothbrushes, deodorants, dish soaps, body washes and pet foods has incited speculation of a probable rise in media spending.

However given that Colgate has historically underspent in media and not competed with the other global players in advertising spending and so we do not see the company launching into a massive ad campaign which might not bear fruit. While we maintain our bullish stance on Colgate-Palmolive with our $85 Trefis price estimate at close to a 9% premium over its current market price, the recent drop in market shares leads us to explore Colgate’s options with its limited advertising budget and their impact on Colgate’s stock price.

What Are Colgate’s Options?

Colgate’s current dilemma is that while increasing advertising is bound to have a positive impact on sales, would the incremental sales increase justify the jump in expenses incurred on media and advertising?

We think there might be two other areas where Colgate could focus:

1) Leveraging Social Networking

Going the social networking way by leveraging Facebook, Twitter, Google, Youtube etc, presents Colgate an excellent opportunity of connecting with consumers at costs significantly lower than traditional mass marketing. We estimate that redirecting advertising spending to social media and Internet has the potential of not only arresting the decline in market shares but also increasing the market share gradually while maintaining current EBITDA margins.

We forecast a potential 3% upside to our current Trefis price estimate of Colgate Palmolive’s stock for every a 1% incremental growth in market share by 2012 over our current estimates.

2) Focusing on Innovation

A second alternative could be focusing on product innovation by heightened research & development spending. While this does pressure operating margins in the short-term, it doesn’t bind Colgate to heightened levels of media spending where the effects of the ad campaign could taper off once Colgate reduces spending. By investing in the development of new and improved products, Colgate could sow the seeds for future profits that would have a more lasting impact to its business.

We expect a 4% downside to our current Trefis price estimate of Colgate Palmolive’s stock for a 1% increase in R&D spending (i.e. 1 % decline in EBITDA margins) over the short-term (2011-13) in Oral Care, the largest product segments within Colgate Palmolive.

Given the slow pace of the economic recovery, communicating effectively (via new media touch points such as websites etc) and focusing on offering new, innovative products to consumers holds the key to maintaining market shares even at relatively low advertising spends.

You can see our detailed analysis of $85 Trefis price estimate for Colgate Palmolive’s stock here.

Visit our home page at trefis.com for details on how to win a free iPad.