Setting the Marketing Budget
The aim of marketing is to make sales easier. All things being equal, spending on marketing should result in either an increase in revenue or savings in the cost of the sales function. The question is, how much should a business spend on marketing?
It is not uncommon for business owners to be unsure how much they should spend on marketing. There are two commonly quoted benchmarks, which are: a new business should spend 8 to 12 percent of revenue on marketing; and an existing business should spend 3 to 6 percent on marketing. Unfortunately, sometimes even the people who quotes these figures aren’t sure if this includes or excludes the cost of the marketing team. The fact is that every marketing budget needs to be set based on some key business parameters.
Setting the Parameters
Before setting a percentage of revenue figure, it is important to fully understand the relevant parameters of the business. The first of these parameters is the value of a customer, (sometimes called ‘lifetime customer value’). This is often calculated based on the average revenue-per-customer per annum multiplied by the average (mean) customer-lifetime in years (time as a customer). But this can be very misleading – it is much better to calculate this as the average-annual gross-margin-per-customer multiplied by the mode (most common) customer-lifetime.
The second parameter is the cost-of-acquisition. There are several different ways that this is calculated. Sometimes it is related to individual transactions, whereas at other times it is limited to obtaining new customers. The more useful way of calculating the cost-of-acquisition is to include all sales and marketing expenses (including salaries) and dividing this by the total number of active customers in the year. Calculating it this way can make it easier for business to align the cost of acquiring and keeping customers, with the value of those customers. Over time the business should aim to reduce the cost-of-acquisition.
The third parameter relates to your business ambitions. If the intent is for the business to grow its customer base, expand its product range, or re-position its brand (including responding to competition), then an allowance will need to be made for an increase in the cost-of-acquisition.
Marketing Budget as Proportion of Cost-of-Acquisition
Once you have established these parameters, the next step is to consider your buyer’s journey and what sales and marketing activities are required to support your current and potential customers through this journey. In some businesses, the marketing is so successful that the sales activity has been reduced to simply order taking from a queue of customers, (e.g. the release of the first few iPhones, which had people queuing around the block). In other businesses, the buyer’s journey requires a considerable amount of consultation, discussion and negotiation, requiring a larger portion of the acquisition cost to be allocated to the sales function. Generally, the less complicated the buying process, the lower the cost-of-acquisition and the higher the proportion of the cost-of-acquisition budget that is allocated to marketing.
This ‘top down’ approach to setting the marketing budget needs to be referenced against a ‘bottom up’ approach.
Marketing Budget from the Bottom Up
Having established what elements of the buyer’s journey that marketing is responsible for, it is worth establishing what people, resources and budgets the marketing team believe are required to complete them successfully.
Modern marketing is both more complex and more measurable than it has been historically. This means that marketers are increasingly looking at the return on investment of each individual marketing activity. It is also important to understand that marketing works like a fishing net, in that it is the execution of the entire strategy that facilitates the outcome, not the individual components on their own. Failing to understand this concept can result in elements of the strategy being removed which significantly reduce the effectiveness of the remaining elements.
By having clearly defined responsibilities and setting targets for each stage of the buyer’s journey, the marketing team should be able to devise a unique and detailed strategy and cost the required marketing activities. These costs can then be cross referenced against the proportion of cost-of-acquisition allocated to marketing in the top down budget.
Another useful reference is to compare the cost of marketing preparation and management against the in-market costs. Generally, one third is allocated to preparation and management, and two thirds are allocated to in-market costs. If you find these ratios significantly different to these benchmarks then you may need to dig a little deeper. For example, if the in-market cost is less than two thirds of the overall marketing budget, then either the budget may not be big enough or the marketing team is too large.
Finally, don’t be afraid to ask the key questions – what is the best way to increase your number of customers, as well as your gross margin per customer, while reducing the cost-of-acquisition? The answer might be a pleasant surprise!
Conclusion
It is important not to create a marketing budget in isolation. Focusing on the cost-of-acquisition will better enable you to explore the best way to reduce this cost at the same time as growing your business. This may result in a reallocation of budgets between the sales and marketing functions.