View from New York: Is the party over for advertising agencies?

First there was Marlboro Friday, the day Philip Morris, the owner of the world's best-selling brand, announced plans to slash prices to beat back no-name rivals. Then came what should logically be known as Nappy Tuesday, when Procter & Gamble, the world's largest advertiser, said it would start discounting Pampers, its leading line of disposable nappies. Madison Avenue is worried - very, very worried.

For years, America's advertising agencies (few are located on Madison Avenue any more) have spent billions of dollars of clients' money on expensive commercials, based on the notion of 'brand equity'. Advertisers 'invested' in their products over decades, attracting consumers and making them loyal to their brands, which could then command a premium over almost identical items on the supermarket shelf.

The power of brand names was the justification for global mergers and international marketing. Wall Street bought into this idea as well, affording consumer goods companies with durable brands higher share valuations and, in the leveraged takeover frenzy of the 1980s, basing risky buyout deals on the promise that these products would generate reliable cash flow through thick and thin.

But now, suddenly, these household names are losing sales to unknown labels that barely advertise at all. Members of the American Association of Advertising Agencies, or Four As, holding their 75th annual conference last week at a resort in southern California, expressed terror at the prospect that their clients might reach the obvious conclusion: that advertising appears to afford them very little protection from the rigours of price discounting.

Beset by an advertising drought that has now lasted five years, and chilled by developments like Coca-Cola's decision to turn over its television advertising to the Hollywood super- agent Michael Ovitz, the agencies are struggling to redefine their business. 'The party's over,' says Salomon Brothers' foods analyst, Les Pugh.

Brand loyalty

'Is brand loyalty disappearing?' asks Procter & Gamble's chairman, Ed Artzt, in a recent issue of Business Week. 'Hell no. Brand loyalty was always based on value.' Which, as the magazine points out, means that big advertisers like P&G, Philip Morris, Coke and Grand Metropolitan - which in recent years have been spending more money on in-store promotions and coupons - are likely to shift even more of their marketing money out of their accounts with members of the Four As.

To be fair, the big American consumer products companies are themselves partly to blame for the problem, having helped the shopping public to become fixated on price through their aggressive discounting and retail incentives. The industry has also suffered from the belated awakening of supermarket chains and other retailers in the US, who long saw themselves as merely renting shelf space to manufacturers. The emergence of private labels, common in the UK, has been compounded by the rise of powerful discount chains like Wal-Mart.

The owners of big consumer brands are counter-attacking, as evidenced by all the price-cutting this month, both in the stores and in their share prices on the New York Stock Exchange. In most cases, however, the result has not been all-out price wars, but more selective - one might argue predatory - price reductions by the packaged-goods giants, targeted at particular private labels and generic brands.

In a head-to-head struggle between a big brand and an imitator, 'the big name will win any battle' because of the conglomerate's muscle with retailers, capacity to absorb temporary price-cutting and ability to launch new competing product innovations, according to Leonard Teitelbaum, a Merrill Lynch analyst. The big- brand makers are even launching private-label brands; Philip Morris - which said this week it was prepared to go on cutting Marlboro's price to preserve its franchise - already accounts for 27 per cent of the discount cigarette market that has so damaged Marlboro's brand equity.

In the longer term, no one wins at the game of transforming brands into commodities - except of course the consumer. Manufacturers 'won't stay in business very long if consumers continue to buy on price', argues Robert James, chief executive of the McCann-Erickson agency and outgoing Four As chairman.

But some people on Madison Avenue and Wall Street go so far as to accuse the big marketers of 'brand milking' - blaming the current crisis on the financial engineering of the 1980s, which encouraged managers to over-leverage not only companies but also high-profile products.

Spending squeeze

In their zeal to squeeze short-term returns from brand equity, companies stinted on ad spending - capital investment, if you will - in favour of alternating discounts and big price rises, says Larry Light, chairman of the media coalition that calls itself the Coalition for Brand Equity.

Until Marlboro Friday, for example, the big cigarette manufacturers had been exploiting their fame for years by raising prices semi-annually by a combined 10 per cent. While the likes of Philip Morris, RJR Nabisco and BAT came to regard their franchise as a cash cow, smokers began suffering the equivalent of 'sticker shock'. The Marlboro Man's spell was broken; last year shipments of the world's best-selling product fell 7 per cent in the US. Discount brands meanwhile, negligible factors in the market a decade ago, have come to account for 37 per cent of all cigarette sales.

'You can't say 'Because I make a quality product, I can charge anything I want',' Mr Light told the Four As meeting.

Some consumer goods manufacturers, notably HJ Heinz, have been more responsible in pricing their brands, specialists argue, keeping an eye on the gap between their premium products and private-label challengers to make sure consumer attention does not wander from their reassuring label to price sticker.

Thus, some ad experts are insisting that the events of the past month, far from condemning their industry, offer a warning against the consequences of 'brand milking', and underline their owners' obligation to maintain their equity through regular advertising.

A look at a list of the top 20 US brands in 1925 reveals two important things. The most impressive point is that 18 of them are still the best- selling products in their categories. The most cautionary is the fact that only a quarter of their owners are around today to profit from them.