7 Methods to Calculate your Marketing Budget
How to calculate the perfect marketing budget for your company? It does not matter how small or big your company is, at one point you will have to start planning your annual marketing budget in order to reach your business goals. Choosing the right one depends on the size of your business, how long you’ve been in operation and your current sales.
Let’s start by saying that all budgets are always rough approximations and should be interpreted as such. This does not mean that they can be easily exceeded, but rather that the experience curve needs to be taken into consideration before reaching the final figures in line with forecasts.
Before discussing the pros and cons of the different methods used to calculate marketing budgets, a brief consideration must be made to fully understand one’s own company and its market context. Let’s start by defining the company’s category based on its size as established by the European Union with the Commission Recommendation (96/280 / EC) on April 3rd, 1996:
- Micro companies – less than 10 employees.
- Small companies – 10 to 49 employees. Their annual turnover must be less than 7 million euros or their budget must not exceed 5 million euros.
- Medium-sized companies – less than 250 employees. Their turnover must be less than 40 million euros or their annual budget must not exceed 27 million euros.
- Large companies – more than 250 employees. Their turnover is over 40 million or their annual budget exceeds 27 million euros.
- Startups, not be confused with the start-up of a new business, or with the start-up phase of a new business. As a matter of fact, according to Steve Blank, a startup is a new company in the form of a temporary organization or a corporation looking for a repeatable and scalable business model. Scalability is a key element of this type of company.
Once the company’s category has been defined, we can proceed to establish its specific industry – pharmaceutical, consumer goods, automotive, and so on – and then analyze its product lines, product families and brand names that need communication support. Obviously, this process will be simpler and more straightforward for single-product companies than it is for companies with different product lines on the market. It is important to establish the goals to be achieved as soon as possible based on the profitability of each product, and then decide how to allocate the marketing budget among the different product categories.
Once we have a clear idea of the company structure, we must carry out a market analysis for each brand’s reference market. Using the previously elaborated structure, the type of business in which one operates should be identified: business-to-business (B2B) or business-to-consumer (B2C) and the reference market (target market) in which the company wishes to operate. We then proceed to determine whether the company is a local, regional, national or multinational player and, depending on the target market, we outline the appropriate market competition levels: low, medium or high. After we have a clear idea of the company’s position in the market, we can move on to select the methodology we want to apply.
There is plenty of information online about how much money we should be investing in communication and, generally speaking, estimates that are often found online are not so distant from reality. Certainly, these estimates do not take into consideration many subjective factors being specifics to a certain company as they are merely market averages.
In the world of B2C companies operating in the pharmaceutical and consumer goods sectors, estimates account for around 20% of net revenue for mature products and up to 50% for products being launched and offered. In the B2B sector, on the other hand, a threshold of 1% of sales for established businesses is considered for the industrial sector.
For most companies, a percentage between 5% and 7% of forecast sales appears to be an average investment. As a matter of fact, companies wanting to keep their market shares in a not too competitive market aim at 5% of sales, whereas companies wishing to increase their market share aim at a higher percentage of 10%.
On the other hand, startup companies invest on average between 20% and 30% of their total budget during the first and second years of activity – a period during which they must verify the real potential of their business idea to attract lenders.
Being familiar with your own financial data will help you to calculate the marketing budget. So let’s look at our budget and start calculating.
Marketing Budgets: 7 Calculation Approaches
1 – Percentage of Gross Profit Margin
This method is based on gross profit margin, that is the percentage of total revenue a company has left over above costs directly related to production and distribution. Certainly less aggressive than the calculation method based solely on production revenues, it offers extra security because it takes into consideration the company’s ability to generate wealth.
- Pros: easy and quick to calculate, it requires access to the company balance sheet and offers more security since it is based only on gross margin.
- Cons: not very accurate because it is not linked to any goals; it has value only for companies with a minimum of six-figure turnover and requires several attempts before reaching the perfect percentage.
2 – Percentage of production revenue
This is the method most used by micro and small companies because it is easy to calculate. The calculation is carried out by applying a fixed percentage to all company turnover to determine the marketing budget. The most frequently used percentages are 5-10% for medium-sized companies, 20% for small companies, and 2-5% for large companies.
- Pros: easy and fast, this method does not require any historical information about the company.
- Cons: not very accurate because it is not linked to any goals; it does not take into consideration the overall company margins; it has value only for companies with a less than six-figure turnover and requires several attempts before reaching the perfect percentage.
3 – At competitor levels
This apparently simple method is based on the assumed knowledge of the company’s competitors’ marketing budgets and, for this reason, it’s extremely difficult to apply. It is often used as a benchmark by companies that have acquired employees from their competitors and through them have managed to become aware of their competitors’ investments.
- Pros: it is a good estimate of how much it needs to be invested to be competitive in the reference market.
- Cons: the initial information is difficult to acquire; it does not take into account the differences between the company and its competition. Moreover, based on the last assumption, it does not take into consideration the possibility of a new player entering the market and altering the status-quo by pushing the company’s competitors to increase their investments.
4 – All-in
This approach is very popular among startups and small companies looking for fast growth at the expense of profits. It is calculated by subtracting the personal financial expenses essential to and investing everything else in marketing. Supporters of this approach are venture capitalists mainly, who want to see the real potential for growth of the companies they invest in.
- Pros: very aggressive and easy to calculate, this method immediately demonstrates a company’s potential.
- Cons: very risky. Ideal only for companies supported by a fund or a venture capitalist.
5 – Customers’ growth rate
This system is based on the company’s client base growth expectations to achieve its objectives. It requires a considerable amount of information for its correct implementation. You need to know your customer acquisition cost (CAC) and multiply it by the number of new customers you want to acquire in order to reach your goal.
- Pros: very accurate in calculating the investment needed to achieve set goals.
- Cons: this method requires precise information and does not take into account the added value created for the brand.
6 – At the industry level
A thorough research on the different industry sectors through trade associations will enable you to obtain an average estimate of how much companies in the sector invest in marketing.
- Pros: very accurate in calculating how to standardize marketing investments to match those of the reference sector.
- Cons: since industry indicators can include many large companies that could influence spending budgets, this method is the least suitable for startups and small companies that are approaching budgeting for the first time.
7 – Market shares
This method requires an accurate definition of the reference market in primis, and then it will be possible to analyze the total volume of marketing investments carried out by all market players. Assuming that all investments correspond to 100% of the shares, you can calculate a percentage of these shares according to your objectives.
- Pros: this method can be quite precise and easy to calculate at the aggregate level.
- Cons: in addition to requiring good knowledge in defining the reference market, it is rarely possible to find the exact figure of the total investments of a sub-market. Furthermore, the real market shares are not always correlated to marketing investments and the entry of a new player can easily generate distortions in the market.
Regardless of the method chosen, it is important to remember that budgets are estimates and, more importantly, you need structured historical data and many attempts in order to understand the right mix for your company. Applying a formula isn’t enough. Companies are dynamic bodies that live in a dynamic market: any move, whether it’s yours or your competitor’s, can easily alter the balance.