If you're challenged with building your company's marketing budget you probably already know there's no perfect formula to refer to. Budgets can range greatly due to many factors but it is important to build a budget that you can justify and defend. To help your cause I'm providing a few different ways to build a budget so you can determine the best methodology for you.
How to Set a Marketing Budget - 3 Methods to Consider
1. Budgeting from the Value of New Customers
How to establish
The first step in this method is calculating the value of a new customer. If you decide to enlist an agency for an inbound marketing campaign, they'll likely cover customer valuation within an assessment. For those that aren't interested in talking to a professional right away, a handy way of identifying the value of your customers is to calculate their expected lifetime value (LTV). If you have access to good historical data you derive your numbers directly from your sales history. If not, you can build the calculation out in a predictive manner.
LTV = Average Purchase Price x Purchase Frequency x Length of Relationship
- Example 1 - You sell monthly services contracts averaging $10,000/month and you retain them for an average of 2 years. LTV = $240,000 ($10,000 x 12 x 2)
- Example 2 - You sell large-ticket items (we'll say new cars at $50,000 average). Your industry data reveals your ideal customers purchase a car every 5 years over 25 years and your sales history proves 50% repurchase rate because 'you build customers for life'. LTV = $125,000 ($50,000 x 5 x .5)
Once you've calculated what a representative client is worth to your business you'll be able to calculate how much you're willing to spend to acquire more. For instance, let's assume you're willing to reinvest 10% of a new client's value into adding another client and you'd like to add one new client per month. In the first example you'd be willing to budget $24,000 per month towards marketing, assuming the spend resulted in new client acquisition.
Finally, you'll want to measure the production of your marketing campaign to identify the cost of customer acquisition (COCA).
COCA = Amount Spent on Marketing / Number of New Customers
From the same example, spending $24,000 per month over 12 months and obtaining the goal of 12 new clients the COCA would be $24,000 (as estimated above). However, if you only secured 6 new clients over the course of the year your COCA would be $48,000. This would mean you effectively spent 2x as much as you estimated it would cost to acquire the 6 clients and would surely leave you with some explaining to do.
The upside
This methodology can be built from both historical data or predictive data. If you're getting more revenue for your services today than you did a year ago that can easily be factored in. If you're retention rate is improving you can account for that by predicting a longer term of relationship.
The downside
It can be very difficult for new businesses to establish accurate data. Whether you're working off of spotty historical data or you're using a predictive method the math might not be as accurate as you think. Only careful analysis of your budget and future results will reveal the actual LTV and COCA values. If you're going to utilize this methodology for establishing your marketing budget you should be prepared to continually monitor and adjust.
2. Budgeting a Percentage of Sales
How to establish
This method of establishing a marketing budget is easier to calculate but identifying the proper percentages to apply is more difficult. If you're just looking for a number to work from you should know that the average is around 10%.
Companies spent, on average, 10% of total revenue on marketing in 2014. - Information Management
It's difficult to identify more specific benchmarks because standards range widely between industry, size of company, and life cycle stage.
As a general rule, small businesses with revenues less than $5 million should allocate 7-8 percent of their revenues to marketing. - US Small Business Administration
The industry you're in can influence these numbers heavily. As a sales and marketing agency our industry standards have 84% of peers spending 10% or less of revenue on marketing.
Marketing Budget (as percent of revenue):
|
% of Revenue
|
% of Companies
|
|
No Budget
|
1.1%
|
|
0-2%
|
28.6%
|
|
3-5%
|
33%
|
|
6-10%
|
21.1%
|
|
11-15%
|
8.6%
|
|
16-20%
|
4.3%
|
|
20+%
|
3.2%
|
courtesy of Go-To-Market Strategies
Start up agencies may need to budget 20% or more of monthly revenue for marketing efforts. Larger, more mature agencies may continue to grow by investing closer to 2% of revenue. You should identify the benchmarks for your industry and select the percentage you're comfortable dedicating according to your organization's life cycle.
The upside
It's really very easy to calculate your marketing budget as a percentage of sales once you've established your parameters. If you plan to write $1,200,000 in sales next year as a start up you might establish a budget target of 10%. That would give you $120,000 in annual budget and $10,000 in monthly budget assuming even distribution. If you have a seasonal business you can massage the numbers to insulate yourself from over-spending in lean months.
The downside
Just because you have revenue doesn't mean you have profits to pay your marketing-related bills. It certainly doesn't equate to cash flow either. Spending money on marketing based on a calculation on revenue won't be sustainable if the business isn't profitable. You might get away with it for a year or two but the chickens will eventually come to roost if you're unable to produce results with the budget.
3. Goal-Based Budgeting
How to establish
This methodology assumes you have the ability to set very good goals. Good goals meet specific criteria, I believe in the SMART goal process:
- Goals must be very specific
- They must be measurable
- They must be realistic
- They must be attainable
- There has to be an end date
For this exercise I suggest starting with the baseline your current financial reporting can provide. By taking your actual financial data from the previous year(s) you can build a specific goal for the coming year using the 'x to y by when' approach. SMART Goal example: Increase revenue from $1,200,000 to $1,600,000 in 2016.
With your newly formed goal in place you'll want to build complete financial projections, marketing budget included. Build your annual projection based on your existing overhead and revenue and calculate in what kind of growth you'll need to reach your goal. The marketing budget section of this projection will be an extremely important line item considering it should have a direct effect on customer acquisition. I suggest using elements from either of the first two methods to ensure you're investing enough to hit your goals.
If you're in position to set overly ambitious goals you better be in a position to establish and extremely aggressive budget and have a lot of patience and faith in your plan. As an example, look at how salesforce.com approached trying to penetrate the saturated CRM market:
Salesforce.com spent $25.4 million on marketing during its first year in business with only $5.4 million in sales — 470% of its revenues. - Rhonda Abrams, USA Today
The upside
This methodology involves the most amount of strategy and intuition. It allows for all other factors to be considered and integrated into your budget planning. The fact that this approach allows you to consider all elements of your business environment, build goals, consider other budget options, and establish a budget that will help you accomplish your goals is appealing.
The downside
It can be a dangerous practice to build a budget based on goals without strongly considering reality. Many goals are never reached and remaining stubborn with your budget can compound the issues. Be sure to build goals that are measurable, realistic, and attainable and carefully monitor performance so you can make adjustments if necessary.
Establishing your budget might be your next step, but it shouldn't be your last.
Regardless of the approach you choice to employ, you'll need to justify the money you spend on your marketing efforts. If you're hoping to maximize the value of your spend you'll need a detailed marketing plan, a strong team to execute, and accurate attribution tracking.
good planning + great people + robust tools = marketing success
