Working out an effective marketing budget
“How much should I spend on marketing?” Most small business people ask me this question at some stage. Many small business people find working out how much to spend on marketing a tricky exercise to calculate.
Generally there are five ways to work out a marketing budget for the year. Remember that these are marketing budgets, not advertising budgets. Marketing covers everything you do in your business that creates awareness, including such activities as advertising, brochures, competitions, free tastings, demonstrations, trade shows, travel, personal selling, direct mail, sponsorships, etc.
1. No idea at all method
Some businesses don’t have any budgets, and just advertise either when they feel that sales have slipped and they need extra business, or when they get duped into advertising by some advertising salesperson (“Buy now and we will give you 50% extra free!”). Ever wondered why they offer you the freebies? Usually because it’s such a dumb time to advertise that all their regular clients are holding back and the sales rep is desperate.
I see many businesses that are just too busy during certain times of the year to think of advertising, and if they did, it would be a waste as they would not be able to handle the work anyway. Suddenly, however, sales fall (perhaps due to seasonality) and then the business starts advertising. However, this could be a waste of money as often you’re advertising at the wrong time, or advertising to get instant sales, which is unlikely to happen. So the problem is that the advertising money is spent during slow times (this hurts), and that it is spent to fix a problem instead of to create new opportunities.
2. Whatever you can afford method
Here you just spend spare cash (yes, spare cash may exist!) on advertising. So the advertising is dependent on cash flow. During the good times you advertise more, during the bad times you cut the advertising. The danger here is that if business falls, and you cut advertising, then the situation is likely to spiral out of control. How can you climb out of the situation when there is no money for marketing?
3. The percentage of sales method
This is a popular method. Typically, you work out at the start of the year what percentage of sales you want to spend on advertising. For example, if sales last year were $200,000 and you decided to spend 5% of sales on advertising, then you’d have a budget of $10,000 ($200,000 x 5%).
The problem with this method is you may not actually need $10,000 worth of advertising to achieve your sales target. What if you can only do so much? If $4,000 spent on marketing creates enough work for you to be flat out, then the other $6,000 is just being wasted. And what percentage should you use? I’ve learned that 3 – 6% of sales is an average, but the figure obviously depends on what industry you are in. For example, here are some advertising-to-sales percentages researched in the USA for marketing budgets:
- Couriers 2.1%
- Rental car companies 2.9%
- Computers 5.1%
- Games and toys 18.4%
- Cafes 5.6%
- Hotels/motels 3.8%
- Sporting goods 5.0%
So what percentage you use all depends on your activity. If you are a retailer, then you will spend more on advertising than a manufacturer who concentrates on personal selling to suppliers.
4. The ‘whatever the competition are doing’ method
This is the cheat’s way. Find out what the competition is doing and then spend a similar amount on similar promotions. This approach has an obvious problem: what if the competition has been using method number one—the ‘no idea’ method? For example, a well-known retailer went into receivership after spending large amounts of money on TV and radio advertising. Now if you had copied that business, you might have found yourself down the gurgler as well.
Never think that the competition or the larger businesses know what they are doing, as often they do not. I know of many large companies that spend thousands of dollars on wasted promotions. Just watch TV adverts every night to spot the ads that really represent a waste of money. Then again, copying the competition is basically a poor strategy anyway. You should always strive to be one jump ahead of the opposition.
5. The objective and task method
Now this is the one I recommend—I had to like one of them! At the start of the year select the targets you’ll be aiming at over the next 12 months. Work out what you want from each of these targets (such as 100 new customers, or each existing customer to spend another $100, or an increase in the average sale, or whatever). Then specifically state what you want to do to achieve this, estimating how much it will cost (common sense will give you guidelines, for example, a small business will not be spending $100,000 on TV advertising).
Complete this exercise for each of your targets, then add up all the costs, and this will be your marketing budget for the year. Points to note include:
- Always have a cash reserve for marketing, so you can take advantage of any opportunities that may arise during the year. Remember, not only can you not predict what may happen (for example, some action by your competitors), but the whole point of being in a small business is having the flexibility to adapt to market forces.
- Your objectives must be specific, so that when you’ve reached them, you can choose to stop any further marketing expenditure if you wish to remove any wastage. Of course, you could continue and look for more growth. The point is, you—not someone else—make that conscious decision to spend your whole budget.
- Conduct a break-even analysis. For example, if you’re spending $1,000 to get 50 new customers to spend on average $50, then sales will be $2,500. Will $2,500 in sales generate enough profit to cover the $1,000 spent on marketing?
- You may have a number of methods that you have used in the past, which you know work. Fine, just include them in your plan.
- You may have to spend a certain amount of money just to keep your existing customers and maintain market share. Fine, but again make sure this is in your plan, and you review the effectiveness of what you’ve always done.
Remember to monitor results
Finally, always have a method of monitoring if your marketing is working or not—otherwise you’ll fall into the ‘no idea’ category that far too many small business owners belong to. You can’t refine and improve your marketing spend unless you measure the results
As always, it is important to keep your accounts up to date at all times. Using Xero will help to speed up the flow of accounting information in your business.
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