What’s it: An advertising budget is a money a company plans to spend on advertising over a period of time. The allocation decision considers various aspects, including the type of media, marketing budget, and production costs involved in preparing an advertising message for placement in various media.
Why is the advertising budget important
Advertising budget affects company profits. It affects two aspects at once. First, the advertising budget indirectly affects the success of advertising and product sales. Second, it also contributes to the company’s marketing costs.
Ideally, the company gets a positive return. I mean, they get more money from sales than they spend on advertising.
Not only products, but advertising is also essential to build a company image. Indeed, measuring the advertising’s effectiveness on the corporate image is problematic because it is qualitative.
Factors affecting the advertising budget
Big budgets are not necessarily effective in generating sales. So, ensuring that the budget is in line with promotional and marketing objectives is a key factor.
Several factors to consider in determining an advertising budget are:
- Marketing goals
- Target audience
- Types of products
- Selected media types and their frequency
- Expected profit
- Product life cycle stage
Companies should align their advertising budgets with their overall marketing goals. Say, the goal of marketing is to increase penetration in the mass market. Companies may tolerate large advertising budgets because they have to increase consumer awareness and expose a broader market.
Also, marketing objectives affect other aspects of determining advertising spending, including media selection.
Target audience profile
Understanding the target audience’s profile is important, not only in deciding the type of media to use, but also in the effectiveness of the advertisement. For example, if a company targets millennials, online advertising may be more appropriate than advertising in print newspapers. The reason is that they are more active in using online media than reading printed newspapers.
Types of advertising media
Not all media are right to target audiences. Apart from affecting the effectiveness of the delivery of advertising messages, media selection also affects costs.
Some media have the local reach, while others have international reach. Which is more suitable? It depends on the target audience, target market, and company’s marketing goals.
Online media, for example, is cheaper than television advertising. Their range is relatively the same. However, television advertising may be more appropriate for some family products than for others.
Apart from cost, advertising frequency is also an important consideration in choosing advertising media. Advertising on television and online media has a higher frequency than in print newspapers and magazines.
Types of products
The type of product also determines the type of promotion used. Some items may not really need intense advertising.
Production machines or heavy equipment usually require a more personal approach. So, companies need less advertising. Likewise, advertisements for products such as laptops and furniture are shown more in magazines than on television.
Meanwhile, for mass products, companies adopt mass advertising. In this case, the company chooses the type of advertisement and media that has a broad exposure.
Advertisements for new products and existing products also require a different budget. Marketers have to introduce new products because consumers haven’t realized it. It usually requires a significantly more budget.
Projected sales and profits
Some companies may use metrics such as advertising elasticity. That metric tells management how sensitive sales are when they change advertising spend.
However, such a measure is less accurate. Advertising only affects the intangible aspect (i.e., the audience’s mind). So it is challenging to quantify the effect of advertising on sales directly.
Therefore, companies usually use revenue projections as tolerance in setting their advertising budget. This is useful so that the company does not spend too much or too little on advertising.
Product life cycle
The product life cycle also affects the advertising budget. In the introduction stage and the growth stage, companies usually allocate a higher advertising budget.
Consumers are not familiar with the product. So, the company’s first task is to educate and increase their awareness of the product. It will require more intensive advertising.
When the product reaches maturity, the need for promotional spending will usually be lower. Companies usually focus on differentiating or reducing the cost structure. Some advertising may still be necessary; however, it is more to maintain current sales.
Advertising budget methods
Companies have several options to set advertising budgets. Each of them has advantages and disadvantages. The following are four of them:
- Percentage of sales method
- Affordable method
- Competitive parity method
- Objective and task method
Percentage of sales method
In this case, the company allocates an advertising budget based on a certain percentage of the previous year’s total sales or the last few years’ average sales. For example, the company sets a 2% -5% budget of the previous year’s revenue.
This method is safe and straightforward.
But, this method also has several drawbacks. This method assumes that market conditions do not change. The company also assumes that the audience behavior and competition map is relatively the same as before.
Such assumptions may not be realistic for some companies. Past performance and advertising’ success are not the best predictors of current or future advertising effectiveness.
Companies may need a larger advertising budget this year than in the previous year, for example, because the competition is getting tougher. Some of the major competitors are budgeting for more advertising spending. If you don’t do the same, the company will probably see its sales drop this year.
Long story short, the percentage of sales method is not the most appropriate choice when the market continues to be dynamic.
The second assumption of this method is that sales are directly related to advertising. The higher the sales target, the higher the advertising spend.
Such assumptions are unfounded. Advertising does not affect sales directly, but only affects how consumers perceive a product. It is only one source of information for them in making purchasing decisions.
Under the affordable method, the advertising budget depends on the company’s capacity to spend on advertising. In other words, the budget depends on how much money the company has. The stronger the company’s financial position, the bigger the advertising budget.
With this method, the company will allocate the advertising budget only if it has allocated other expenses. If the company has large enough remaining funds, the company spends it on advertising. Conversely, if there are no funds, the company naturally has to manage the product without advertising.
For example, suppose that the company’s operating budget is $2 billion. Of this total, expenses for inputs, salaries, and other operating expenses amounted to $1.7 billion. So, the remaining fund is $300 million, and the company can spend it on advertising.
Competitive parity method
Under the competitive parity method, firms calculate budgets according to competitors’ advertising spending or industry averages. The aim is to at least offset the effects of competitor advertising spending.
Budgets may be right or above competitors’ average. It depends on the company’s goals.
If it targets higher sales than your competitors, the company charges higher advertising spend. An advertising budget equal to the average competitor is to maintain current sales and market share.
The competitive parity method assumes that advertising budgets correlate with sales. If the company charges a higher budget, it should increase sales by more highly than competitors.
Such assumptions are imprecise because sales don’t always positively correlate with advertising budgets. Various other aspects, such as company image and products, also have an influence on purchasing decisions.
This method also considers the uniformity of audience responses to various advertisements, whether owned by companies or competitors.
Of course, such an assumption can be misleading. No market and consumer responses are precisely the same. Despite getting the same information, individual subjectivity determines their response and decision to buy.
Objective and task method
The objective and task method is considered the most sensible. Therefore, some larger companies prefer to use this approach. In this case, the company sets the advertising budget based on the activities or tasks consumed.
This method’s main benefit is that it allows companies to correlate advertising spend with overall marketing objectives.
Under this method, the company first sets concrete advertising goals. Then, they determine the specific resources and activities needed to achieve these goals. The company then determines how much it costs for each activity and adds them up to get the total cost.