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How to Create a Realistic Advertising Budget

Sowing the seeds of growthby Ken Orwig

By building the value of products and brands, the advertising budget represents a long-term investment in a company's future. Every dollar invested in marketing communication is a seed planted for future growth. Although lengthy, this article, which may be the most thorough on this topic available online, will help you achieve the optimal return on your investment.

Advertising budgets are usually determined in one of four ways:
1. By matching the competition. The rationale goes something like this: "We know what Consolidated is spending so we'd better not do any less (lest we lose market share) or more important (lest we eat into profits)."

2. By decree. The president of the company (or its financial management) evaluates available resources, past advertising budgets, very frequently other spending priorities, etc. then allocates an "appropriate" amount.

3. The Percentage of Sales Method, which relates the advertising budget to some arbitrary percentage of revenue.

4. By the Preferred Outcome Method. This approach considers known data and reasonable assumptions tempered by judgment and common sense to reach a realistic budget that will achieve the desired marketing results.

Let's take a brief look at each. The first approach assumes absolute marketing parity with the competition, which rarely exists. It fails to account for fundamental differences such as geography, number of sales reps, dealer relationships, etc.

The Advertising Budget Is A Primary Driver Of Sales

The second method, allocation by decree, should be dismissed for several reasons. Not the least of these is that by relying on prior budgets, it disregards changes in the competitive environment.

Despite the fact that it is likely to offer a much better return on investment, the advertising budget, a primary driver of sales, may have trouble competing with the urgency of a leaky factory roof or the allure of a new computer network unless supported by a well-crafted plan. When the budget is set by decree, the plan follows, rather than precedes, the allocation.

By eliminating feedback from the planning process, the allocation by decree method also reduces the likelihood of sensible budget cuts based on prior successes or new circumstances. Though conventional wisdom presupposes that no one ever asks for less, it is clear that the marketing communication manager is in a better position than anyone else to know his real needs. Efficiency and cost-reduction are well served when senior management promotes a results-driven approach to budgeting. 

Top-down approaches to setting the advertising budget invert the process because financial people make the year's pivotal marketing decision. Then they turn the spending process over to the marketing team. If they guess too low, the entire allocation is wasted on a program with too little impact to be effective. If they guess high, the extra funds may be spent on items of questionable value.


The third approach, percentage of sales, enjoys great currency, primarily because it implies a certain mathematical elegance. My experience is that this method tends to be a favorite among small businessmen because it seems provide a quick answer while circumventing the need for extensive market and situational analysis.

As we will see later, the percentage of sales approach can provide an excellent starting point in setting the marketing communication budget — if those involved in the process clearly understand the underlying assumptions of the formula. Unfortunately, this is often not the case. Much of this article will be devoted to developing a clear understanding of those assumptions.


We strongly believe that the most realistic — and ultimately the most productive — approach is for senior management to request an annual marketing communication plan, which provides a well-documented basis for the funding request. It also provides a structure for sensible control throughout the coming year. Satisfied that a solid case has been made, and that funds are available, management can judiciously weigh the advertising budget request against other spending options.

This approach, the Preferred Outcome Method is the only sensible framework upon which to build an advertising budget.

This Isn't Your Father's Advertising Budget

In order to understand what follows, it will be necessary to consider some definitions. The first of these is the phrase advertising budget, a term that dates back to the early 1900's. At Orwig Marketing Strategies, we strongly believe that the phrase marketing communication budget better reflects the broad scope of strategic messaging options available to the 21st century marketer. Having said that, I will use the terms interchangeably throughout this article.

Next, I would like to differentiate between product advertising and promotional advertising, both of which can be elements of the marketing communication process. In their strictest senses:

Product Advertising influences a prospect's perception of the product or service. It is the type of advertising that makes us want to own a product. While it may very well have an immediate effect on the sales curve, product advertising should always be considered a long-term investment in the brand's future.

Promotional Advertising offers an inducement that prompts an immediate purchase. It offers the prospect a sale price, a cents-off coupon, a free gift or some other incentive. Promotional advertising can be very effective in the near term; however, it has negligible benefit over the long term. Used continually, it has the effect of cheapening the brand.

This difference between product advertising and promotional advertising will be explored in more detail in a future article on this website.

The importance of the distinction here is that almost all discussions about advertising budgets advance a formula that relates the budget to some percentage of sales. One must apply these formulas with care because they are very specific mathematical models. What is seldom made clear is that in almost every application of these formulas, the resulting advertising budget is intended for brand building - not promotional advertising.

Some Special Considerations For Retailers

The distinction between product advertising and promotional advertising is particularly important for retail advertisers. The percentage figure cited for many retail categories is very low. That's because the budget figure that results from the calculation is intended to fund only the portion of advertising that builds the store's brand image. It might be used for advertising that is purely image building or it might pay for the portion of a "price and product" ad that contributes to store image.

"Aha!" you say. "Some retail categories spend vast amounts on advertising and it's all price and product." You are absolutely correct. Most supermarket advertising is price-oriented. Aside from the fact that a substantial amount of that advertising is paid by vendor money, most national supermarket chains have built their brand image around "low, low prices." If you're a discounter, by all means focus your branding message on prices. However, if you sell luxury products to the carriage trade, you'd be better served by spending your branding budget to create a more refined image.

By understanding that percentage formulas are intended to develop a brand-building budget, the importance of vendor "co-op" becomes clearer. Co-op lets the retailer enjoy a much larger presence because his small budget is applied only to the portion of the ad that promotes the store - for example, the 10-second dealer tag at the end of a vendor's 30-second TV commercial.

It is also easier to see why co-op money generally should be allocated to a separate advertising account. If you budget using a formula based on the percentages typical in your retail category then consider co-op to be part of it, you will drastically under-fund the portion of your advertising intended to differentiate your store from its competitors.

Before we leave the specialized area of retail advertising, I would be remiss if I didn't point out that some percentage budgeting formulas for retail stores relate the percentage to the store's profit. Then they subtract the cost of rent, which may represent an important part of the store image. The remainder is the advertising budget. For example, If your jewelry store is located on Rodeo Drive in Beverly Hills, the high rent might result in an advertising budget of zero. This, however, would be appropriate because in this case location is everything!

How Does Advertising Fit Into The Overall Marketing Budget?

Let's consider the difference between the advertising (or marketing communication) budget and the marketing budget, of which it is a component. Most companies divide the marketing budget into three categories. The best way to decide which expenses belong in each is to have a clear understanding of their roles.

  • The Advertising Budget - Advertising or marketing communication sets the stage for sales by making us feel that we want or need the product. It sometimes offers an incentive to "buy now." However; its primary mission is to create strong, positive feelings about the product. The next section contains an in-depth discussion about what is usually included in this budget.

  • The Direct Sales Budget - This includes all the costs associated with placing a team of company salespeople or independent representatives in front of prospects. In business-to-business marketing, the prospect is often an end-user. In many consumer categories, the sales department's prospect is a proxy for the end-user, such as a retail buyer. Items in the direct sales budget typically consist of compensation for the sales force, travel, sales manuals, sales conferences, and incentives as well as other direct and indirect selling expense.

  • The Sales Promotion Budget - Sales promotion is, in effect, a bridge between advertising and direct sales. The sales promotion budget funds all the initiatives that move a prospect who is predisposed to want the product down the road toward an actual sale (or repeat sale). Some offer inducements. Others "just keep our name out there." Items that belong in the sales promotion budget are many and diverse: in-store displays, sweepstakes, premiums ("two box tops and a quarter get you a decoder ring"), imprinted merchandise or apparel, trade-show giveaways, etc. All items that are not primarily aimed at improving attitudes about the product itself go into the sales promotion budget.

What Should Be Included In The Advertising Budget?

Unless we clearly define which expenses to charge to advertising or marketing communication, the entire budgeting process becomes an academic exercise. The "marcom" budget is a frequent dumping ground for all kinds of unrelated (or supposedly related) expense. Like weeds in a garden, these expenses choke the life out of the marketing communication process.

Here's a common example. Stationery often is included in the advertising budget. After all, it's a printed material and the marcom department buys most of the printing. Stationery should be considered an office expense. Only the portion used for purposes such as direct mail marketing should be charged to the marketing communication budget.

 
How Much Should I
Budget For Ad Production?

A rule of thumb among national advertisers is that production should cost about 10% of the amount spent for the associated paid media advertising. Of course, there are exceptions. Production expense may be higher for smaller advertisers who routinely demand very high production values. And, there are times when the occasion just seems to demand something special. When an ad will only appear one time, it may require a very elaborate concept and execution.

For example, remember the famous commercial that introduced Apple's Macintosh computer? It aired a single time on the 1984 Super Bowl at a cost of one million dollars. It also cost a million dollars to produce!

If your total production budget represents much more than 20% of your total media budget, you are probably spending too much. Consider repeating the same ad or commercial more often.

As a rule of thumb, legitimate expenses deal with brand and product building. Sales expenses should not be charged to marketing communication. Here is a list of expenses that should typically be included - along with cautionary notes:

  • All paid media advertising - Magazine, TV, radio, newspaper, etc. that contributes to the marketing function. As an example, Help Wanted advertising would not be included.


  • Production expense - Art, photography, talent fees, ad preparation charges, agency fees and miscellaneous expenses related to preparing the paid advertising.


  • Collateral material - Brochures, mailing pieces, catalogs, etc. intended to associate positive feelings with the company's products, brands or services.


  • Internet expense - Website design, maintenance and hosting expense are included to the extent that they are incurred for marketing communication. Add in Internet marketing expense (banner ads, etc.) and e-mail marketing, too.

    The mission of online marketing communication is to bring eager customers to the website where they can learn more about your products or purchase them. As the Internet continues to evolve, marketing communication represents a single aspect of a much larger presence on many company websites. The cost of modules like customer relation management (CRM) and inventory management should typically be charged to the appropriate departments.

    E-commerce presents further issues. An e-store replaces or supplements the company's conventional "bricks and mortar" outlets. Perhaps the associated expense should be placed in an account similar to rent & utilities!

  • Public relations - that advances the marketing process is included. Preparation of an investor relations newsletter, for example, should not be.

  • Trade show display and booth expense - Although many displays perform more of a sales promotion function, a well-designed exhibit enhances the product story. To the extent that this is so, the cost to create a display and the cost of booth rental are reasonably charged to the marketing communication budget. The sales staff's travel and entertainment expense, however, should be charged to the sales department. Charging these items to the marketing communication budget creates a huge aberration, particularly for a company with a small advertising budget. I will expand on this in the next section.

Step 1 In Creating The Budget: Percentage Of Sales Is The First Cut

A good marketing communication plan doesn't flow from the budget. The budget evolves as the plan takes shape. Having said that, creating a budget that the company cannot (or will not) implement is a monumental waste of time. There must be a starting point.

Determining a reasonable level of expenditure is relatively easy if there is a track record. You start with last year's budget, perhaps adjusted for inflation. But what do you do when:

  • You're preparing to take the company into a new and unknown market category?
  • You are planning a marketing budget for a startup company?
  • You are guiding a small business that is trying aggressive marketing communication for the first time?

In situations like this, the percent of sales technique can provide a reliable launch pad. The method works like this. A ratio of advertising to sales, expressed as a percentage, is determined based on industry norms. This number is often available from trade associations. The percentage is then multiplied by company sales to determine a reasonable budget figure.

The process can be further refined by applying the fixed percentage to the sales of various products or service groups. This provides an indication of how much should be allocated to each line. The technique can be further distilled. Some planners go so far as to apply a different percentage to each line or market.

The choice of sales data that will be used is more speculative. Options include:

1. Current year sales. In a growing market or economy, this is the conservative approach. Obviously, it is not suited to startups.

2. Forecast sales. This relates the budget to where the company reasonably projects its revenues will be in the coming year. It's conservative in a growing economy; a little more risky in a shrinking one.

3. Moving average of sales. By averaging the current year's sales results with forecast sales, this approach tempers optimism with caution.

4. Desired sales. The most aggressive option, this one is based on the sales target that the company hopes to achieve by the end of the accounting period.

The choice of which sales figure you will choose to apply will depend on corporate philosophy, market growth, and business conditions, among other factors. Clearly, you'll be more inclined to choose Desired Sales if you're launching a hot, new, high-tech product with the potential to be a runaway success.

What Percentage Of Sales
Should We Budget?

The range usually cited is 2% to 5% of sales. Rather than using the numbers shown here, you should seek the correct percentage for your industry or retail category. This information is usually available from trade associations. The list below illustrates the wide variation in percentages used:

Auto Manufacturer — Less than 1%
Makes sense when you consider the revenue generated by each sale.

Typical Retail Store — 2.5%
This is the amount for advertising that builds the store's brand image.

Typical Service Business — 3.5%
Spend this amount on brand building. Awareness building items like logoed pens and refrigerator magnets belong in the sales promotion budget.

New Business Startup — 5% - 7%
However, take the comments about Share of Voice into account.

Fast Moving Consumer Goods — 
8% - 10%
There's no salesman at the point of purchase. These items must be pre-sold and resold by advertising.


Pharmaceutical Companies — 20%
A great deal of this is spent on conventional advertising; however, in drug marketing - legal or illicit - brand preference is often built upon a trial dose. This is one of the unusual cases where sampling - usually considered a sales promotion technique - is a legitimate advertising strategy.

Please do not apply these numbers blindly. This article offers important guidelines for using the percentages correctly.

 

As elegant as this exercise seems, in the final analysis it is only an estimate - a mathematical projection of reality based on a model. Now we can see more clearly, why we have to be careful about what to include in the advertising budget. Looking back to the discussion of trade show expense, I said that the display and booth rental might be charged to the marketing communication budget, while the sales staff's T&E, should be charged to the sales department.

You're welcome to define your budgets any way you'd like. Obviously, T&E expense could be booked to the marketing communication budget. However, if you do so, apply the percent of sales technique at your own peril. The mathematical model is quite specific. If you load in expenses that aren't built into the model, you will shortchange necessary brand building.

Assuming that the model is accurate and that we have applied the formula properly, we're done. Right?

Not so fast.

Top marketers employ many complex tools to plan their marketing communication budgets. However, far too many businesses simply apply the projections derived from this simple model.

It represents much better practice to use the percent of sales method to generate your "first cut" number. Think of your percent of sales number this way: "This is where a company with sales like ours might be." "This is a number our management can believe." The percent of sales tool is a great starting point. It can take you to the right neighborhood, but it won't guide you through the door of success.

Step 2: Now Let's Consider The Real World

As compelling as it might be, the percent of sales technique inverts causality. Rather than recognizing that sales are the logical result of marketing communication, it implies that advertising is the consequence of sales - whether based on results, forecasts (or dreams).

Modeling methods don't address the essential issue - reality. Next we'll consider the way products and services are pre-sold by advertising. We'll also look at your competition. What's their market share. Most importantly, what share of the prospects' perception do they own?

Whether we are selling into consumer or business-to-business markets, the buying process has four stages. They are:

1. Product awareness - By noting an advertising message, we learn that the product exists. At this stage, mass marketing communication is, by far, the most economical way to get the message out.

2. Attitude change - Subsequent marketing communication messages result in an attitudinal change toward the product, which leads us to a trial. For some products, particularly business-to-business products or services, direct selling may also have a significant effect on our perceptions.

3. Product trial - We purchase the item or service, then evaluate it. At this point, the product must survive based on its own merit.

4. Repeat purchase - Follow-on advertising reinforces our trial experience with the hope of inducing a subsequent repurchase of the product.

At this point, let's review our definitions:

Product Advertising influences a prospect's perception of the product or service. It is extremely effective in stages 1, 2 and 3.

Promotional Advertising offers an inducement that prompts an immediate purchase. Promotional advertising can have a beneficial short-term impact in stages 2, 3 and 4, but is unlikely to be effective at all in stage 1.

The following discussion, based on a substantial body of research, deals with product advertising rather than promotional ads - the kind that offer discount pricing or other incentives. Two issues determine the success of product advertising: creative approach and media intensity. At Orwig Marketing Strategies, we describe that intensity as media mass - the size of the media portion of the advertising budget leveraged by the choice of media and timing.

The percentage of an advertiser's media budget compared to the expenditures by all advertisers in a product category is referred to as share of voice." A substantial body of ongoing research has shown several long-term relationships between share of voice and share of market:

1. A product's share of market will tend to equal its share of voice.

2. Advertisers whose products enjoy a larger share of market can safely make slight reductions in their share of voice. Conversely, products with a smaller share of market must be supported with a larger share of voice to avoid losing ground.

3. To increase market share, an advertiser must commit to a share of voice that is somewhat higher than the share of market he intends to achieve.

4. New products typically need to be launched with a share of voice that is double the share of market sought.

Although this research has been conducted on consumer package goods, it has strong implications, particularly for first time advertisers and for marketers launching a new product or entering a new market. The share of voice comparison can be especially useful in clarifying what can realistically be accomplished with the financial resources available.

Information about total spending in major consumer product categories are tabulated and available from several sources. Companies marketing in narrow business-to-business channels can often obtain a reasonable approximation of total spending by tallying the costs of their competitors' ads in magazines and trade show programs then adding an allowance for direct mail, online activity, etc.

3. Now, We Can Build a Realistic, Objective-based Budget

Now that we have a feel for what needs to be done, we can formulate a budget that is based on actual costs. Here's the procedure:

1. Clearly define your marketing objectives. They should be measurable. For example, "By year-end, we intend to control 27% of the oatmeal market in Pakistan."

2. List the best marketing communication options for each objective - In the above illustration, we might consider:

a. Paid advertising

b. Unpaid advertising in Pakistani media -  (Public Relations)

c. Messaging from the outside the country - (Internet, Satellite TV)

d. Distribute printed flyers

Compare the advantages and pitfalls of each. If dial up and DSL access in Pakistan are unreliable and satellite downlinks are frequently blocked by mountains, messaging from the outside may not be effective. Pick the best option(s), then,

3. List the possible delivery media for each communication option. For example, suppose you decide paid media and printed flyers are your best bet. Your delivery media options might be:

Paid Advertising

• Newspapers
• Radio
• Billboards

Printed Flyers

• Direct mail
• Hire young men to pass them out at soccer matches
• Drop them from airplanes

4. Consider the pros and cons of each medium - Take everything into account. What's the likelihood of achieving effective reach and frequency. How well suited is a particular medium to telling the "product story." Looking at our example, what percentage of the population owns a radio? How many people read the paper?

5. Add up the media and production costs - Gather the costs for planning, research, creative work, production, media, printing, lead processing, follow-up, etc. This is where the process can become difficult. In order to project expense, you must have a very clear understanding of everything that might affect your overall plan. Unless you're an expert in each area, you'll probably want to seek assistance from outside professionals.

6. Make the final cut - Pick the best delivery medium (or media) for each option. Then compare the communication options themselves. If an item makes sense, add it to the budget. Keep adding until:

a. You reach your reasonable budget ceiling, or

b. You are satisfied that you don't have to add any more options to achieve your objectives. Needless to say, in the real world this seldom happens.

Creating the objective-based budget is often iterative. That is, you may find that "you just can't get there from here" considering the funds available. If so, you should either cut the number of objectives or prioritize them; then, if necessary, reduce expectations to a reasonable level. This is more sensible than funding too many objectives with too few dollars, which almost invariably leads to failure.

 
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About:


Advertising Budgets

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Subliminal Advertising

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Conclusion

As we have seen, the procedure for creating a realistic advertising budget from scratch is complex. The budgeter begins by determining a reasonable approximation based on assumptions about spending norms within the industry. Next, he determines the level of communication activity that will be necessary to achieve success in influencing the marketplace. Then a list of marketing communication options is created and compared. Finally, as financial resources allow, the options are assembled into a plan from which the budget flows.

In addition to creating an objective-oriented, real world advertising budget, the Preferred Outcome Method also helps management obtain a much clearer picture of what really is possible given available resources.
 


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