Advertising Primer 7: Advertising Budgets

The Cost of Advertising vs. The Cost of NOT Advertising

So you've reached the perfect marketing strategy and created the perfect ad. Now you must decide how much you want to spend. Obviously, you (or your boss) doesn't want to waste money on advertising. The goal is to spend as little as possible to get your message out there.

But should this really be the goal? Frankly, most organizations work off the idea that advertising is an expense. They put this cost in the same column as janitorial services and utilities. And, if that's how one views advertising, it make sense to reduce that cost as much as possible.

Other organizations—usually more mature and more successful organizations—view advertising as an investment. They recognize that advertising is one of the few tools at their disposal to actually increase revenue and profits. And unlike utilities and other expenses, the more they spend on advertising, the greater their potential for growth.

Companies that view advertising as an expense usually put their money into promotional ads: the "buy now, call today" type of ads that position products as commodities and typically compete on price alone.

Businesses that view advertising as an investment more often turn to brand image advertising. They realize that the key to long-term growth is to build brand equity. Over time, they create strong, recognizable brands. Brands that develop deep relationships with their users. Relationships that result in customer loyalty even in the face of stiff competition or price wars.

Budgeting Methods

With that in mind, here are some common ways that businesses budget advertising costs:

What's-Left-Over Method: Also known as the "what we can afford" method, many organizations simply budget for all other expenses first and then allocate any remaining funds for advertising. Obviously, this method rarely results in effective advertising campaigns because no thought goes into the potential benefits of increased advertising.

Historical Method: This method merely assigns an ad budget amount based on the previous year's numbers, perhaps only increasing to account for yearly inflation.

Percentage of Sales Method: Uses the Advertising-to-Sales ratio (A/S) to determine how much to spend. The problem with this methodology is that it tends towards stagnation. Far too often, advertisers base sales predictions on last year's numbers instead of setting new sales goals and allocating ad dollars based on that projected growth.
 
Competitive Method: The competitive budgeting method bases ad spending on how a company stacks up against the competition. Specifically, this method estimates the company's relative market share vs. the competition's market share. Next, formulas are calculated to determine how much advertising will be required to increase market share a given amount.

Two percentages are considered here. First is share of voice (SOV). Basically, SOV is how much an advertiser spends vs. how much the competitors spend in a given product category or market. The second percentage considered is share of market (SOM), or share of mind. SOM is a measure of how much market share (or how much mindshare) is owned by each advertiser for the same product or market area.

These two percentages are then used to calculate how much advertising a given company needs to spend to increase their market share a certain amount. But here's the sticking point: research shows that advertisers must increase their SOV by three times their desired increase in SOM. So consider that your company has a 30% market share which you want to increase to 50%. This means that for a 20% increase in market share you will need to increase your ad spending by 60% (3 x 20%). The bad news is that advertising does come with a cost. The good news is that this cost can result in real-world growth.

Objective/Task Method: Where the competitive method looks outwards, the the objective or task method looks inwards. The advertiser using this method is concerned not with where the competition is going, but where their own organization wants to go. This approach can be rather sophisticated, with advertisers considering specific growth in specific sub-markets and formulating elaborate budgets to achieve those growth objectives.


Some content for this series was derived from course notes from Introduction to Advertising, UC Berkeley Extension.