What advertising budgeting method is more likely to be used by an entrepreneurial firm, a start-up?

Setting the marketing and advertising budget is a daunting challenge for many small-business owners because of the many ways to approach the task. Percentage of gross revenue is one of the more favored methods of budgeting because it allows your spending to fluctuate as your revenue does. In the real world, however, marketing and advertising budgets vary widely based on your industry, competition, profit margins and a host of other considerations.

While percentage spends vary widely, the SBA recommends that small businesses allocate 7 to 8 percent of their gross revenue for marketing and advertising.

The U.S. Small Business Administration recommends spending 7 to 8 percent of your gross revenue for marketing and advertising if you're doing less than $5 million a year in sales and your net profit margin – after all expenses – is in the 10 percent to 12 percent range.

Some marketing experts advise that start-up and small businesses usually allocate between 2 and 3 percent of revenue for marketing and advertising, and up to 20 percent if you're in a competitive industry. Still other marketing experts counsel a range between 1 percent and 10 percent, and even more depending on how long you've been in business, competitive activity and what you can afford.

It's apparent from these differing opinions that the percentage of gross revenue for marketing and advertising depends mainly on whom you ask. They're probably all correct if you know their assumptions.

A 2016 survey of 168 Chief Marketing Officers revealed that marketing budgets account for as much as 40 percent of a firm's budget, with a median of 10 percent of the overall budget and a mean average of 12 percent. When shown as a percentage of overall revenue, the mean was 8 percent and the median was 5 percent.

There's a limit to how much you can afford to spend regardless of what others are spending. Let affordability guide your spending. Then, recognize that certain internal and external factors may cause your spending to fluctuate. Starting a business or introducing a new product requires more spending than spending on an on-going business. Conversely, you may want to reduce marketing spending while you activate your exit strategy if your business is in its twilight years.

If you're selling high-ticket, high-margin goods or services, you can afford to spend more on marketing. Likewise, if the competition is giving you a fit, you may have no choice but to increase your marketing spending.

Marketing typically drives revenue rather than the reverse in most successful businesses. Moreover, marketing and advertising spending in most successful businesses is task- or project-oriented. Task-oriented marketing requires a marketing plan, something most marketing experts strongly recommend. The percentage-of-gross-revenue calculation is a useful ballpark gauge of spending parameters. But, you need to be flexible depending on the requirements of your marketing plan. You may be able to obtain specific marketing as a percentage of gross revenue figures for your industry from your industry trade association.

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The advertising budget of a business typically grows out of the marketing goals and objectives of the company, although fiscal realities can play a large part as well, especially for new and/or small business enterprises. As William Cohen stated in The Entrepreneur and Small Business Problem Solver , "In some cases your budget will be established before goals and objectives due to your limited resources. It will be a given, and you may have to modify your goals and objectives. If money is available, you can work the other way around and see how much money it will take to reach the goals and objectives you have established." Along with marketing objectives and financial resources, the small business owner also needs to consider the nature of the market, the size and demographics of the target audience, and the position of the advertiser's product or service within it when putting together an advertising budget.

In order to keep the advertising budget in line with promotional and marketing goals, an advertiser should answer several important budget questions:

1. Who is the target consumer? Who is interested in purchasing the advertiser's product or service, and what are the specific demographics of this consumer (age, employment, sex, attitudes, etc.)? Often it is useful to compose a consumer profile to give the abstract idea of a "target consumer" a face and a personality that can then be used to shape the advertising message.
2. Is the media the advertiser is considering able to reach the target consumer?
3. What is required to get the target consumer to purchase the product? Does the product lend itself to rational or emotional appeals? Which appeals are most likely to persuade the target consumer?
4. What is the relationship between advertising expenditures and the impact of advertising campaigns on product or service purchases? In other words, how much profit is earned for each dollar spent on advertising?

Answering these questions will provide the advertiser with an idea of the market conditions, and, thus, how best to advertise within these conditions. Once this analysis of the market situation is complete, an advertiser has to decide how the money dedicated to advertising is to be allocated.

BUDGETING METHODS

There are several allocation methods used in developing a budget. The most common are listed below:

• Percentage of Sales method
• Objective and Task method
• Competitive Parity method
• Market Share method
• Unit Sales method
• All Available Funds method
• Affordable method

It is important to notice that most of these methods are often combined in any number of ways, depending on the situation. Because of this, these methods should not be seen as rigid, but rather as building blocks that can be combined, modified, or discarded as necessary. Remember, a business must be flexible—ready to change course, goals, and philosophy when the market and the consumer demand such a change.

PERCENTAGE OF SALES METHOD Due to its simplicity, the percentage of sales method is the most commonly used by small businesses. When using this method an advertiser takes a percentage of either past or anticipated sales and allocates that percentage of the overall budget to advertising. Critics of this method, though, charge that using past sales for figuring the advertising budget is too conservative and that it can stunt growth. However, it might be safer for a small business to use this method if the ownership feels that future returns cannot be safely anticipated. On the other hand, an established business, with well-established profit trends, will tend to use anticipated sales when figuring advertising expenditures. This method can be especially effective if the business compares its sales with those of the competition (if available) when figuring its budget.

OBJECTIVE AND TASK METHOD Because of the importance of objectives in business, the task and objective method is considered by many to make the most sense, and is therefore used by most large businesses. The benefit of this method is that it allows the advertiser to correlate advertising expenditures to overall marketing objectives. This correlation is important because it keeps spending focused on primary business goals.

With this method, a business needs to first establish concrete marketing objectives, which are often articulated in the "selling proposal," and then develop complimentary advertising objectives, which are articulated in the "positioning statement." After these objectives have been established, the advertiser determines how much it will cost to meet them. Of course, fiscal realities need to be figured into this methodology as well. Some objectives (expansion of area market share by 15 percent within a year, for instance) may only be reachable through advertising expenditures that are beyond the capacity of a small business. In such cases, small business owners must scale down their objectives so that they reflect the financial situation under which they are operating.

COMPETITIVE PARITY METHOD While keeping one's own objectives in mind, it is often useful for a business to compare its advertising spending with that of its competitors. The theory here is that if a business is aware of how much its competitors are spending to inform, persuade, and remind (the three general aims of advertising) the consumer of their products and services, then that business can, in order to remain competitive, either spend more, the same, or less on its own advertising. However, as Alexander Hiam and Charles D. Schewe suggested in The Portable MBA in Marketing , a business should not assume that its competitors have similar or even comparable objectives. While it is important for small businesses to maintain an awareness of the competition's health and guiding philosophies, it is not always advisable to follow a competitor's course.

MARKET SHARE METHOD Similar to competitive parity, the market share method bases its budgeting strategy on external market trends. With this method a business equates its market share with its advertising expenditures. Critics of this method contend that companies that use market share numbers to arrive at an advertising budget are ultimately predicating their advertising on an arbitrary guideline that does not adequately reflect future goals.

UNIT SALES METHOD This method takes the cost of advertising an individual item and multiplies it by the number of units the advertiser wishes to sell.

ALL AVAILABLE FUNDS METHOD This aggressive method involves the allocation of all available profits to advertising purposes. This can be risky for a business of any size, for it means that no money is being used to help the business grow in other ways (purchasing new technologies, expanding the work force, etc.). Yet this aggressive approach is sometimes useful when a start-up business is trying to increase consumer awareness of its products or services. However, a business using this approach needs to make sure that its advertising strategy is an effective one, and that funds which could help the business expand are not being wasted.

AFFORDABLE METHOD With this method, advertisers base their budgets on what they can afford. Of course, arriving at a conclusion about what a small business can afford in the realm of advertising is often a difficult task, one that needs to incorporate overall objectives and goals, competition, presence in the market, unit sales, sales trends, operating costs, and other factors.

MEDIA SCHEDULING

Once a business decides how much money it can allocate for advertising, it must then decide where it should spend that money. Certainly the options are many, including print media (newspapers, magazines, direct mail), radio, television (ranging from 30-second ads to 30-minute infomercials), and the Internet. The mix of media that is eventually chosen to carry the business's message is really the heart of the advertising strategy.

SELECTING MEDIA The target consumer, the product or service being advertised, and cost are the three main factors that dictate what media vehicles are selected. Additional factors may include overall business objectives, desired geographic coverage, and availability (or lack thereof) of media options.

SCHEDULING CRITERIA As discussed by Hiam and Schewe, there are three general methods advertisers use to schedule advertising: the Continuity, Flighting, and Massed methods

• Continuity—This type of scheduling spreads advertising at a steady level over the entire planning period (often month or year, rarely week), and is most often used when demand for a product is relatively even.
• Flighting—This type of scheduling is used when there are peaks and valleys in product demand. To match this uneven demand a stop-and-go advertising pace is used. Notice that, unlike "massed" scheduling, "flighting" continues to advertise over the entire planning period, but at different levels. Another kind of flighting is the pulse method, which is essentially tied to the pulse or quick spurts experienced in otherwise consistent purchasing trends.
• Massed—This type of scheduling places advertising only during specific periods, and is most often used when demand is seasonal, such as at Christmas or Halloween.

ADVERTISING NEGOTIATIONS AND DISCOUNTS

No matter what allocation method, media, and campaign strategy that advertisers choose, there are still ways small businesses can make their advertising as cost effective as possible. Writing in The Entrepreneur and Small Business Problem Solver, author William Cohen put together a list of "special negotiation possibilities and discounts" that can be helpful to small businesses in maximizing their advertising dollar:

• Mail order discounts—Many magazines will offer significant discounts to businesses that use mail order advertising.
• Per Inquiry deals—Television, radio, and magazines sometimes only charge advertisers for advertisements that actually lead to a response or sale.
• Frequency discounts—Some media may offer lower rates to businesses that commit to a certain amount of advertising with them.
• Stand-by rates—Some businesses will buy the right to wait for an opening in a vehicle's broadcasting schedule; this is an option that carries considerable uncertainty, for one never knows when a cancellation or other event will provide them with an opening, but this option often allows advertisers to save between 40 and 50 percent on usual rates.
• Help if necessary—Under this agreement, a mail order outfit will run an advertiser's ad until that advertiser breaks even.
• Remnants and regional editions—Regional advertising space in magazines is often unsold and can, therefore, be purchased at a reduced rate.
• Barter—Some businesses may be able to offer products and services in return for reduced advertising rates.
• Seasonal discounts—Many media reduce the cost of advertising with them during certain parts of the year.
• Spread discounts—Some magazines or newspapers may be willing to offer lower rates to advertisers who regularly purchase space for large (two to three page) advertisements.
• An in-house agency—If a business has the expertise, it can develop its own advertising agency and enjoy the discounts that other agencies receive.
• Cost discounts—Some media, especially smaller outfits, are willing to offer discounts to those businesses that pay for their advertising in cash.

Of course, small business owners must resist the temptation to choose an advertising medium only because it is cost effective. In addition to providing a good value, the medium must be able to deliver the advertiser's message to present and potential customers.

RELATIONSHIP OF ADVERTISING TO OTHER PROMOTIONAL TOOLS

Advertising is only part of a larger promotional mix that also includes publicity, sales promotion, and personal selling. When developing an advertising budget, the amount spent on these other tools needs to be considered. A promotional mix, like a media mix, is necessary to reach as much of the target audience as possible. As Gerald E. Hills stated in "Market Opportunities and Marketing" in The Portable MBA in Entrepreneurship, "When business owners think about the four promotion tools, it becomes obvious why promotion managers must use a mix. There are clear trade-offs to be made between the tools."

The choice of promotional tools depends on what the business owner is attempting to communicate to the target audience. Public relations-oriented promotions, for instance, may be more effective at building credibility within a community or market than advertising, which many people see as inherently deceptive. Sales promotion allows the business owner to target both the consumer as well as the retailer, which is often necessary for the business to get its products stocked. Personal selling allows the business owner to get immediate feedback regarding the reception of the business' product. And as Hills pointed out, personal selling allows the business owner "to collect information on competitive products, prices, and service and delivery problems."

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