Case Study On Advertising Budget Method

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The advertising budget of a business is typically a subset of the larger sales budget and, within that, the marketing budget. Advertising is a part of the sales and marketing effort. Money spent on advertising can also be seen as an investment in building up the business.

In order to keep the advertising budget in line with promotional and marketing goals, a business owner should start by answering several important questions:

  1. Who is the target consumer? Who is interested in purchasing the product or service, and what are the specific demographics of this consumer (age, employment, sex, attitudes, etc.)? Often it is useful to compose a consumer profile to give the abstract idea of a "target consumer" a face and a personality that can then be used to shape the advertising message.
  2. What media type will be most useful in reaching the target consumer?
  3. What is required to get the target consumer to purchase the product? Does the product lend itself to rational or emotional appeals? Which appeals are most likely to persuade the target consumer?
  4. What is the relationship between advertising expenditures and the impact of advertising campaigns on product or service purchases? In other words, how much profit is likely to be earned for each dollar spent on advertising?

Answering these questions will help to define the market conditions that are anticipated and identify specific goals the company wishes to reach with an advertising campaign. Once this analysis of the market situation is complete, a business must decide how best to budget for the task and how best to allocate budgeted funds.

BUDGETING METHODS

There are several allocation methods used in developing a budget. The most common are listed below:

  • Percentage of Sales method
  • Objective and Task method
  • Competitive Parity method
  • Market Share method
  • Unit Sales method
  • All Available Funds method
  • Affordable method

It is important to notice that most of these methods are often combined in any number of ways, depending on the situation. Because of this, these methods should not be seen as rigid but as building blocks that can be combined, modified, or discarded as necessary. Remember, a business must be flexible—ready to change course, goals, and philosophy when the market and the consumer demand such a change.

Percentage of Sales Method

Due to its simplicity, the percentage of sales method is the most commonly used by small businesses. When using this method an advertiser takes a percentage of either past or anticipated sales and allocates that percentage of the overall budget to advertising. But critics of this method charge that using past sales for figuring the advertising budget is too conservative, that it can stunt growth. However, it might be safer for a small business to use this method if the ownership feels that future returns cannot be safely anticipated. On the other hand, an established business, with well-established profit trends, will tend to use anticipated sales when figuring advertising expenditures. This method can be especially effective if the business compares its sales with those of the competition (if available) when figuring its budget.

Objective and Task Method

Because of the importance of objectives in business, the task and objective method is considered by many to make the most sense and is therefore used by most large businesses. The benefit of this method is that it allows the advertiser to correlate advertising expenditures with overall marketing objectives. This correlation is important because it keeps spending focused on primary business goals.

With this method, a business needs to first establish concrete marketing objectives, often articulated in the "selling proposal," and then develop complementary advertising objectives articulated in the "positioning statement." After these objectives have been established, the advertiser determines how much it will cost to meet them. Of course, fiscal realities need to be figured into this methodology as well. Some objectives (expansion of area market share by 15 percent within a year, for instance) may only be reachable through advertising expenditures beyond the capacity of a small business. In such cases, small business owners must scale down their objectives so that they reflect the financial situation under which they are operating.

Competitive Parity Method

While keeping one's own objectives in mind, it is often useful for a business to compare its advertising spending with that of its competitors. The theory here is that if a business is aware of how much its competitors are spending to advertise their products and services, the business may wish to budget a similar amount on its own advertising by way of staying competitive. Doing as one's competitor does is not, of course, always the wisest course. And matching another's advertising budget dollar for dollar does not necessarily buy one the same marketing outcome. Much depends on how that money is spent. However, gauging one's advertising budget on other participants' in the same market is a reasonable starting point.

Market Share Method

Similar to competitive parity, the market share method bases its budgeting strategy on external market trends. With this method a business equates its market share with its advertising expenditures. Critics of this method contend that companies that use market share numbers to arrive at an advertising budget are ultimately predicating their advertising on an arbitrary guideline that does not adequately reflect future goals.

Unit Sales Method

This method takes the cost of advertising an individual item and multiplies it by the number of units the business wishes to sell. This method is only effective, of course, when the cost of advertising a single unit can be reasonably determined.

All Available Funds Method

This aggressive method involves the allocation of all available profits to advertising purposes. This can be risky for a business of any size it means that no money is being used to help the business grow in other ways (purchasing new technologies, expanding the work force, etc.). Yet this aggressive approach is sometimes useful when a start-up business is trying to increase consumer awareness of its products or services. However, a business using this approach needs to make sure that its advertising strategy is an effective one and that funds which could help the business expand are not being wasted.

Affordable Method

With this method, advertisers base their budgets on what they can afford. Of course, arriving at a conclusion about what a small business can afford in the realm of advertising is often a difficult task, one that needs to incorporate overall objectives and goals, competition, presence in the market, unit sales, sales trends, operating costs, and other factors.

MEDIA SCHEDULING

Once a business decides how much money it can allocate for advertising, it must then decide where it should spend that money. Certainly the options are many, including print media (newspapers, magazines, direct mail), radio, television (ranging from 30-second ads to 30-minute infomercials), and the Internet. The mix of media that is eventually chosen to carry the business's message is really the heart of the advertising strategy.

Selecting Media

The target consumer, the product or service being advertised, and cost are the three main factors that dictate what media vehicles are selected. Additional factors may include overall business objectives, desired geographic coverage, and availability (or lack thereof) of media options.

Kim T. Gordon, author, marketing coach and media spokesperson offers three general rules to follow when trying to select a media vehicle for advertising in an article entitled "Selecting the Best Media for Your Ad."

Rule number 1: eliminate waste. The key to selecting the right media source is to choose the source "that reaches the largest percentage of your particular target audience with the least amount of waste." Paying to reach a larger number of people may not serve well if the audience reached has only a small percentage of likely customers of your product. It may be preferable to advertise in a paper or magazine with a smaller distribution if the readers of that paper or magazine are more likely to be in the market for your product or service.

Rule number 2: follow your customer. Here again, the objective is to go to the sources used most by your target market, especially a source that that audience looks to for information about your type of product or service. Gordon explains that advertising "in search corridors—such as the Yellow Pages and other directories—is often a cost-efficient solutions. They're the media customers turn to when they've made a decision to buy something."

Rule number 3: buy enough frequency. We are constantly bombarded with advertisements and images and in order to penetrate the consciousness it is important to be seen with some frequency. Gordon emphasizes that it is "essential to advertise consistently over a protracted period of time to achieve enough frequency to drive your message home."

Scheduling Criteria

The timing of advertisements and the duration of an advertising campaign are two crucial factors in designing a successful campaign. There are three methods generally used by advertisers in scheduling advertising. Each is listed below with a brief explanation.

  • Continuity—This type of scheduling spreads advertising at a steady level over the entire planning period (often month or year, rarely week), and is most often used when demand for a product is relatively even.
  • Flighting—This type of scheduling is used when there are peaks and valleys in product demand. To match this uneven demand a stop-and-go advertising pace is used. Notice that, unlike "massed" scheduling, "flighting" continues to advertise over the entire planning period, but at different levels. Another kind of flighting is the pulse method, which is essentially tied to the pulse or quick spurts experienced in otherwise consistent purchasing trends.
  • Massed—This type of scheduling places advertising only during specific periods, and is most often used when demand is seasonal, such as at Christmas or Halloween.

ADVERTISING NEGOTIATIONS AND DISCOUNTS

No matter what allocation method, media, and campaign strategy that advertisers choose, there are still ways small businesses can make their advertising as cost effective as possible. Writing in The Entrepreneur and Small Business Problem Solver, author William Cohen put together a list of "special negotiation possibilities and discounts" that can be helpful to small businesses in maximizing their advertising dollar:

  • Mail order discounts—Many magazines will offer significant discounts to businesses that use mail order advertising.
  • Per Inquiry deals—Television, radio, and magazines sometimes only charge advertisers for advertisements that actually lead to a response or sale.
  • Frequency discounts—Some media may offer lower rates to businesses that commit to a certain amount of advertising with them.
  • Stand-by rates—Some businesses will buy the right to wait for an opening in a vehicle's broadcasting schedule; this is an option that carries considerable uncertainty, for one never knows when a cancellation or other event will provide them with an opening, but this option often allows advertisers to save between 40 and 50 percent on usual rates.
  • Help if necessary—Under this agreement, a mail order outfit will run an advertiser's ad until that advertiser breaks even.
  • Remnants and regional editions—Regional advertising space in magazines is often unsold and can, therefore, be purchased at a reduced rate.
  • Barter—Some businesses may be able to offer products and services in return for reduced advertising rates.
  • Seasonal discounts—Many media reduce the cost of advertising with them during certain parts of the year.
  • Spread discounts—Some magazines or newspapers may be willing to offer lower rates to advertisers who regularly purchase space for large (two to three page) advertisements.
  • An in-house agency—If a business has the expertise, it can develop its own advertising agency and enjoy the discounts that other agencies receive.
  • Cost discounts—Some media, especially smaller outfits, are willing to offer discounts to those businesses that pay for their advertising in cash.

Of course, small business owners must resist the temptation to choose an advertising medium only because it is cost effective. In addition to providing a good value, the medium must be able to deliver the advertiser's message to present and potential customers.

RELATIONSHIP OF ADVERTISING TO OTHER PROMOTIONAL TOOLS

Advertising is only part of a larger promotional mix that also includes publicity, sales promotion, and personal selling. When developing an advertising budget, the amount spent on these other tools needs to be considered. A promotional mix, like a media mix, is necessary to reach as much of the target audience as possible.

The choice of promotional tools depends on what the business owner is attempting to communicate to the target audience. Public relations-oriented promotions, for instance, may be more effective at building credibility within a community or market than advertising, which many people see as inherently deceptive. Sales promotion allows the business owner to target both the consumer as well as the retailer, which is often necessary for the business to get its products stocked. Personal selling allows the business owner to get immediate feedback regarding the reception of the business' product. And as Hills pointed out, personal selling allows the business owner "to collect information on competitive products, prices, and service and delivery problems."

BIBLIOGRAPHY

Advertising Your Business. Small Business Administration, n.a.

Clark, Scott. "Do the Two-Step with Advertising Budget." Memphis Business Journal. March 3, 2000.

Gordon, Kim T. "Call in the Pros." Entrepreneur. December 2000.

Gordon, Kim T. "Selecting the Best Media for Your Ad." Entrepreneur. September 2003.

Pinson, Linda and Jerry Jinnett Steps to Small Business Start-Up. October 2003.

Rasmussen, Erika. "Big Advertising, Small Budget." Sales and Marketing Management. December 1999.

Silver, Jonathan. "Advertising Doesn't Have to Break Your Budget." Washington Business Journal. May 1, 1998.

New and better budgeting processes are a near-universal pursuit among businesses, particularly in advertising divisions. In an era of big data and powerful computing, the end of this pursuit is often assumed to include some type of algorithmic method — a mathematical technique that, once and for all, will identify the optimal amount to spend on advertising.

But what if there isn’t a single optimal tool? And what if experience and intuition can be as useful as data and algorithms in making budgetary decisions?

Generations of marketers and advertisers have been taught to view algorithmic budgeting techniques as more rational and therefore superior to heuristics — problem-solving mental shortcuts like rules of thumb, educated guesses or even intuition, which often lead to faster, more customizable decision-making. Consequently, managers have been reluctant to even admit to using heuristics in their budgeting decisions.

Our research addressed the question “What usefulness, if any, do heuristics have in determining advertising and promotion budgets?” In addition, we examined how prevalent these methods actually are — something few researchers have explored to date.

Prevalence of Heuristics in Advertising Budgeting

In our study, we sent a questionnaire to 1,000 advertising and promotion managers nationwide. We then evaluated the responses (125 total) with respect to four categories of information — principally, budgeting techniques used in their advertising budgeting process. Respondents chose one or more of 11 options, seven heuristic (e.g., advertising-to-sales ratios) and four algorithmic (e.g., ROI).

            Budgeting Method: Heuristic

  • Arbitrary: Solely determined on the basis of what is “felt” to be necessary
  • Affordable: Determine how much can be afforded
  • Competitive Absolute: Set in line with the closest rival
  • Competitive Relative: Set in line with market share
  • Percentage of Last Year’s Sales: Might also be a fixed rate per case or non-dollar measure of sales
  • Percentage of Anticipated Sales Next Year: Same as above, except uses forecast of sales to set budget
  • Unit Sales: The company allocates a fixed percent of unit price for advertising and promotions and then multiplies this amount by projected sales volume (e.g., 5 percent unit price x 200,000 units sold)

            Budgeting Method: Algorithmic

  • Incremental Testing: The budget is allocated in an incremental series of market tests. Spending is increased or decreased in line with results.
  • Objective Task: We start by setting particular advertising and promotions objectives and then derive a budget that will enable us to achieve these.
  • Quantitative Models: Computer simulation models are used involving statistical techniques such as multiple regression analysis.
  • Return on Investment (ROI): Advertising and promotions are considered investments and monies are spent to maximize ROI.

The results indicated heuristics are used surprisingly often in the advertising budget process. Nearly three-fourths (72 percent) of respondents said they rely on heuristics — 41 percent solely, 31 percent in combination with algorithmic methods. Furthermore, most companies use two or three methods, not just one.

Thus, although market data may be increasingly available, and sophisticated methods are placed regularly on the budgetary pedestal, our study shows most companies are not using these more analytical methods — at least not exclusively.

Budgetary Categories and Methods

No. Methods  Percent
1  45.0
2  34.1
3  17.1
4  12.7
5  0
6  0.9
TOTAL:  100

 

Corporate Culture and Other Influences

In addition to reporting their budgeting techniques, respondents characterized their companies according to three “antecedents” that we suspected may drive the nature of the budgeting process — rooted in a theory about cognitive styles and their influence on decision making.

  1. Corporate culture. We suspected some business environments would favor algorithmic budgetary methods, while others would tend toward heuristics. Our study confirmed that nearly all corporate cultures favor the use of a combination of heuristic and algorithmic budgeting techniques, except one — an adhocracy — which relied on algorithmic techniques alone. An adhocratic organization is marked by entrepreneurial spirit, emphasizing creativity and innovation. In these environments, power may be decentralized and corporate memory limited. Thus, these companies likely use more analytical methods to cross the “sufficiency threshold” in the budgeting process.
  2. Risk-taking propensity. We hypothesized that a high-risk-taking company would use heuristic methods more often. This proved false; a company’s propensity to take risks did not seem related to its advertising budget techniques. Rather, an array of tools in budgeting seemed useful regardless of risk level.
  3. Knowledge and experience. We looked at the relationship between the use of heuristics and an organization’s collective marketing knowledge and experience. As predicted, greater experience and knowledge is associated with greater use of heuristic techniques. In other words, over time, advertising personnel gain in confidence and experience, and are more likely to rely on intuition and good sense rather than solely on analysis and logic.

What the Findings Mean for You: Taking a Balanced Approach

In a classic 1951 Harvard Business Review article, Joel Dean noted that the fixed-percentage of sales method, a common budgeting heuristic, “gets the cart before the horse.” In his words, “Advertising outlays should cause sales, not be determined by them.” We contend that, although he may have been correct from a purely logical standpoint, this heuristic — and others — can be valuable nevertheless.

Specifically, our research concluded that heuristics used sensibly — in conjunction with algorithmic techniques — can serve as a vital check against data-intensive methods, plus save time and resources. Heuristics, by their very nature, are easy to use and adapt quickly, and are therefore appealing for very complex situations or when time pressure is high.

Consider the analogy to catching fly balls, from German psychologist Gerd Gigerenzer’s work on “fast and frugal” heuristics. A coach often instructs a baseball outfielder to “run to where the fly ball will land.” Yet, to catch the ball, fielders need not calculate the exact ball speed and trajectory. They simply begin running toward the ball, constantly adjusting their speed to maintain as constant an angle as possible.

Companies can think of heuristics in a similar way. For example, in contexts where advertising managers have accumulated good intuition and sense over time, heuristics may prove not only expedient but also often arrive at the same or similar outcome as algorithmic methods.

By the same token, formal analytics can serve as a valuable check, helping to ensure heuristics are used but not abused. In certain contexts, algorithmic techniques should be relied upon more — for instance, where company memory or managerial experience are lacking, such as a startup environment.

Transparency in the Process

A key conclusion of our research is that there exists a need for companies to be more open about their advertising and promotion budgeting techniques. Just as improvement in manufacturing processes began with articulation of those processes, advertising budget processes will only improve if managers become more willing to document them. Our research gives managers confidence that they can do so without fearing that they will appear irrational or lazy. Just because a technique is not scientifically rigorous does not mean it’s not sensible. In fact, data-intensive techniques can be as misleading and wrong as heuristic ones. Irrelevant data may be used naively when it should be forgotten, and the external environment may change so quickly so as to render past data impertinent. Furthermore, sometimes a manager may wisely apply a heuristic when cash flow or other pressing concerns clearly take precedence.

In summary, we suggest advertising managers proceed through the budgeting process heeding the famous advice, “It is better to be vaguely right than precisely wrong.”[1] Use a blend of techniques, letting each balance the other, and stop looking for that elusive “best” algorithmic method. Recognize that sophisticated does not automatically mean better — and sometimes, it’s worse, entangling your process and wasting precious time and resources. As Oliver Wendell Holmes said, “I would not give a fig for the simplicity this side of complexity, but I would give my life for the simplicity on the other side of complexity.”

Above all, remain transparent about what actually works over time, since experience truly is the best teacher.

Paul W. Farris co-authored “How Corporate Cultures Drive Advertising and Promotion Budgets: Best Practices Combine Heuristics and Algorithmic Tools,” named Best Academic Paper by the Journal of Advertising Research, with colleagues Douglas West of King’s College London and John B. Ford of Old Dominion University.

Professor Farris teaches in the Executive Education program Strategic Marketing Analytics: Leveraging Big Data, which teaches participants to translate data into valuable marketing investments.


[1] The quote is often attributed to economist John Maynard Keynes; however, Keynes’s wording was actually based on a very similar, older quote by logician and philosopher Carveth Read.

 

About the Faculty

Paul W. Farris

Farris is a top specialist in promotion and distribution. He is also well-versed in consumer advertising and branding strategy. His current research is focused on building coherent systems for integrating financial and marketing metrics.

In 2006, he wrote Marketing Metrics: 50+ Metrics Every Executive Should Master, which was selected by Strategy... Learn More

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