How much money should you spend on marketing? How do you decide? The questions is a common one and any method you use to choose the best marketing budget for your company has an “it depends” aspect to it (of course).
One thing is sure: in order to gain market share, you need to outspend your competitors on effective marketing methods.
3 Ways to Set Your Marketing Budget
There are 3 methods we recommend for setting a marketing budget. They are listed here from easiest to most complex (depending on how you look at it). One thing you have to consider regardless of the method you use is: How aggressively do you want to grow? If you are trying to double sales, your marketing budget needs to be significantly different than if your goal is to maintain your existing sales levels. Another thing to keep in mind is that we are talking about marketing here (including advertising), not sales.
Set the Marketing Budget as a Percentage of Sales
This is the easiest — or maybe, the laziest — way to set your marketing budget. A lot of companies like to pick a number somewhere in the 1.5 to 3% range. The benefit to using the percentage-of-sales method is that you need little or no metrics to make this decision (although it’s better to have them). With that, owners and managers to tend choose the percentage-based budget based on what they “feel” seems right or affordable instead of basing it on what level of budget they need in order to make an impact on sales through marketing.
One instance in which the number is actually meaningful is if you are highly focused on beating a specific competitor and you know what their marketing budget is as a percentage of sales (or you can use an industry benchmark). In this specific case, you can simply budget to spend more than they do as a percentage of sales. In this case, the method should actually achieve the objective of helping you grow faster than your competitor (gain market share).
If you want to use a percentage of sales as your budgeting metric, I recommend selecting the percentage based on your goals versus past performance. If you’ve been using 2% per year and you are not happy with the sales growth (or lack of it) you’ve been experiencing, it is probably time to spend more. If your marketing works — which you know if you use tracking — then you should be able to increase sales by either spending more money on the same marketing, by applying the proven methods you’ve been using to other markets, or by expanding your marketing system in to other marketing methods.
Base Your Marketing Budget on the Value of the Investment (or, the Value of Lead)
Here’s another way to set your marketing budget with minimal effort or historical data but you do need to have an idea about what a realistic ROI would be along with some idea of your conversion and/or close rate. Base your marketing budget on the Target Gross Profit (GP) ROI of the investment in your marketing — the value of the investment in terms of the expected profit from it. You can also use this to determine what you want to pay for a lead. Obviously, there are a lot of variables that could come into play but this is great method for those that like to add solid to budget numbers. Plus, by applying additional metrics and tracking to the various components, you can improve and optimize your budget utilization and conversion rate over time.
Note: ROI is usually used as a tracking metric — a “how did we do?” metric. The equation to find the ROI of a campaign is exceptionally simple:
[pmath size=16](GP – Investment)/Investment = ROI[/pmath]
When using this ROI calculation as usual, you already know Gross Profit and the Marketing Investment and are solving for ROI. To set your budget using targeted ROI, you have to work backwards, using Marketing Investment as the variable (aka “x”).
Working backwards to find your target marketing investment (now the “X”) requires a little Algebra which not everyone is comfortable with (don’t worry, there’s a cheat; keep reading) . Either way, the equation looks like:
[pmath size=16](GP – x)/x = eROI[/pmath]
AND, here’s the cheat for the equation:
[pmath size=16]GP/(1 + eROI)=Marketing Investment[/pmath]
To find the target cost per lead, you simply apply your conversion rate (or sales close rate) to that number to estimate how much you should be willing to pay for a lead. That equation is simple:
[pmath size=16]Target Marketing Investment x Conversion Rate[/pmath]
It gets more complicated if you really drill down into it by product line and/or market segment of course, but the extra effort is worth it so you can better allocate marketing investment dollars more effectively.
Here’s an example of finding your target investment per sale and your target cost per lead. Let’s assume your gross profit per sale of a new product is $120 and, based on past results of similar products, you believe an ROI of 50% (.5) is reasonable. Let’s say your conversion, or close, rate is 25%.
[pmath size=16](120 – x)/x = .5[/pmath] boils down to [pmath size=16]120 = 1.5x[/pmath] so [pmath size=16]80 = x[/pmath]
AND, here’s the cheat for the equation:
[pmath size=16]120/(1+.5)=80[/pmath] 0r [pmath size=16]120/1.5=80[/pmath]
Next, let’s find the cost per lead…
[pmath size=16]80x.25 = $20[/pmath]
The numbers above apply to a single sale so to get the aggregate marketing investment, simply multiple the marketing investment by the number of sales you would like to close. The cost per lead stays the same, of course. My favorite part about this method is that the exercise of going through the math brings sheds light directly on the various components of your marketing system and sales closing efforts. It may seem complicated but it’s worth the effort to gain the visibility.
Important Note: If the real value of your marketing comes from acquiring repeat business, you probably want to use the Customer Lifetime Value (CLV) number in place of GP above. It is a simplified version of the lifetime value of a customer (no time value of money taken into account). The equation typically yields much higher ROI’s than a simple GP equation.
Set Marketing Budget Based on Cost Per Customer Acquisition
In an ideal world, we could use this number to budget every time. It assumes you know how much it costs to acquire a new customer — to close a new sale. The math is easy, really; totally based on historical info. You simply multiple the average cost per new customer in the past by how many new customers you want in the next year and voila! There’s your marketing budget. This can also be done by product line and market segment, of course.
Example: If it cost you on average $122 to acquire each new customer last year and you want 3000 new customers this year, your budget would be set to $366,000 this year. Easy.
It might be easy for you to figure this out if you have a very simple service offering or only sell one product (some companies do). How much did you spend on marketing last year? Let’s say $100,000. How many new customers did you get last year? Let’s say 378. With those numbers, your average cost per new customer acquisition was $264.55. So, if you want 500 new customers this year, you need a marketing budget of $132,275.
Once you do the math, you might be surprised how high or low the number. It varies by industry, supply, demand, seasonality, and often more.
Setting Your Marketing Budget Helps Drive Sales
Taking the time to set your marketing budget will make a noticeable difference in your marketing. Take a look at your competition, get some industry benchmark numbers, and apply some logic and math to finding out what your ideal marketing budget should be.
Contact Us About Your Marketing
If you are interested in discussing the best ways to allocate your marketing and creating the idea marketing for your company, please call us as 832-900-2000 or contact us online.