How to set an advertising budget
One of the most common questions we are asked is one that has no absolute answer: “How do I set an advertising budget”? The funds designated for marketing and advertising comprise a key factor affecting your marketing strategy, but most marketers struggle with the “right” way to set a budget. Here I will suggest that the only “right” way is the way that works for you within your unique parameters of revenue generation, market share, profit margin and cash flow.
Many smaller companies find spending of any kind to be constraining. In this situation, advertising may be just one of several tightly allocated spending areas and, thus, the level spent on advertising will naturally vary over time. If that’s your situation, don’t resist the economic realities, but formulate a strategy around them. This may mean a short term, “project-based” approach that takes advantage of funds when they are available to promote a specific product or service when your potential ROI is highest. It’s a reactive way to market, but it also provides a nimble and fluid way to take the highest advantage of marketing opportunities as they present themselves, free from the constraints of a pre-allocated budget.
For companies who can and want to formulate a fixed annual budget, the most common method is Percentage of Sales. Under this approach, ad spending is set based on either a percentage of previous sales or a percentage of projected sales. Both of these come with pitfalls if some degree of flexibility isn’t built into your budgeting process. For example, if you base your budget on what has already happened rather than what is expected to occur, and the overall market grows rapidly, you may lose an opportunity to gain market share with under-funded advertising. Conversely, if your budget is based on future sales and your forecast is over-optimistic, the percentage of revenues allocated may turn out to be considerably higher than expected. In both cases, build in a range of flexibility that allows you to decrease or increase your budget in short-term reaction to actual marketing conditions.
So what percentage of previous or projected revenues should you allocate? Again, there is no absolute formula, but a good rule of thumb is to tie that percentage to your margins. The higher your mark-up (for retail businesses), the higher the percentage of revenues allocated to advertising should be. Here is a suggested approach:
If your mark-up is: Allocate to advertising:
50% or less 2% – 3%
75% – 100% 4% – 5%
100% + 6% – 7%
200%+ 7% – 10%
For service businesses, the above approach can be used, based on profit margins. For example, if your margin is less than 5%, a 3% – 5% allocation of revenues to advertising is reasonable. If your margins are up in the 7% – 10% range, you should expect to allocate anywhere from 6% – 10% to advertising.
Setting an advertising budget is more art than science. The formulas above can provide a guideline, but ultimately the process comes down to three questions: 1. What resources are available to devote to advertising? 2. Are those resources adequate to meet the marketing objectives? 3. How stable are those resources?
More than any rigid formula, how honestly you answer those questions will determine the “right” way to set your advertising budget.