Theoretical approaches to establishing a marketing budget are seldom employed. In smaller firms, they may never be used. This is the case with most of our clients. Often the conversation of budgeting comes up during the courting process so it is difficult to persuade them to change their budgeting method or to start using one.
They are many top down approaches where budgets are
established at the executive level and then distributed to different departments
or products. Some top down methods
include the affordable method, arbitrary allocation, percentage of sales, and
competitive parity.
The most commonly used method is percentage of sales. The purpose of this post is to highlight the common pitfalls even large corporations slip into when budgeting using percentage of sales.
With this method, management will either take a percentage
of the sale dollars(advertising budget=20% of sales) or assign a fixed amount
of the unit product cost (advertising budget per product= $5 on a $10
product). Most companies use this method
whether they recognize it or not because it has some minor advantages. It is easy to implement and seems logical to
most business owners.
Percentage of sales also has very serious disadvantages:
- The first disadvantage is the premise(sales) for which the budget is established. This reverses the cause and effect relationship between marketing and sales. It also forces business owners to think of marketing as an expense of sales rather than an investment- completely disregarding communication objectives.
- It ignores communication objectives. No matter what model you follow: AIDA (attention, interest, desire, action), Hierarchy of Effects (awareness, knowledge, liking, preference, conviction, purchase), Innovation Adoption Model (awareness, interest, evaluation, trial, adoption), or the Information Processing Model (presentation, attention, comprehension, yielding, retention, behavior) there are communication objectives that have to be accomplished before getting someone to buy your product or service. The percentage of sales approach does not account for the investment required to get past the attention, awareness, and interest steps.
- Percentage of sales is not strategically flexible. The competitive landscape may call for an aggressive marketing push, especially in drag race situations. The word from management after identifying this critical need is often, “its not in the budget.”
- There may be severe misappropriation of funds. Products with low sales have smaller promotion budgets ensuring the product will always have low sales. On the other hand, products with high sales have excess budgets, when that extra money could be allocated elsewhere. This becomes a critical mistake when launching new products or beginning to sell to an underserved market.
- Decreases is sales will lead to decreases in marketing budget- the moment when it needs to be increased the most. Continuing to cut the budget will spiral sales downwards.
- Isolate communication objectives
- Determine strategies and tactics
- Estimate the required expenditures
- Monitor using leading and lagging indicators
- Reevaluate to stress high priority objectives
While it seems very elementary in concept, it is hardly
executed in practice. The bottom up
approach allows the objectives to drive the budget.
While I understand that it is not our money we’re spending, this is one of the more frustrating topics with clients. Hopefully this post illuminates the severe problems with percentage of sales budgeting and the accompanying mentality frequently adopted by management.
