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Now, to be clear, I don't think the intention of the ad creators was to make something that mocked homosexuals. But that's what they ended up with. It's a classic example of heterosexism in action; the failure to realize that the statements and images you're promoting mean something entirely different when taken out of a heterosexual context. Of course, Dodge's attitude about the whole thing is another story entirely. In a classic defensive move, Dodge has chosen to deflect criticism of the spot back on those finding fault with it. In the Detroit News, a spokesperson said: "We were pretty surprised that there are individuals that are making the conclusion that sexual orientation can be determined by the type of clothes you wear and the type of dog that you're walking." That's a great bit of double-speak right there. Dodge is basically saying "we're not homophobic because we made fun of gay people in our commercial, gay people are homophobic for spotting that we were making fun of gay people."
Though, for the record, Dodge missed the mark because the transformed look isn't really a "gay" look anymore. It's really more of an 80s preppy/yuppie look. The guy actually looked gayer originally.
It's really two places where the ad becomes problematic and skirts with homophobia. First, it's in the symbolic emasculation of the man. He has a big, butch, macho dog, which is changed into a bunch of frilly, yappy little sissy dogs. The root of much homophobic humor is a mocking of the supposed femininity of gay men. It's the area in which homophobia and misogyny converge. Gay men are worthy of derision because they are like women, and being a woman is the greatest sin of all. Just ask Eve.
The other, and much more prominent aspect, is the emphasis on the word "fairy." Had any other word been used, such as pixie, sprite or nymph, the tone would have been much different. But instead the man uses the word "fairy" mockinginly and has his word turned back on him, as the fairy returns his insult in kind. Any other word would have helped Dodge avoid criticism. But they used a word that's used as an anti-gay epithet. Intentional or no, the symbolism of that word, in this context, cannot help but be offensive.
(As always, a good resource for discussion of gay and lesbian images in commercials is The Commercial Closet. Their take on the ad is here.)