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Monday, May 30, 2011

The Advertising Budget

This is a tricky one and honestly, there are a few ideas out there on how to best determine your advertising budget.  Frankly, at the end of the day you can’t spend what you don’t have, however, if you’ve planned correctly and/or are in the process of starting up a business, then you need to have enough working capital put aside to get you through, this includes your advertising budget.

The first thing to remember is that any calculations you make using Gross Sales must be based on the Gross Sales you WANT to achieve, your projected Gross Sales – not what you have achieved or may be currently achieving.  So if you did $100,000 gross sales last year but you want to reach $300,000 this year, you must base your calculations on the $300,000.

So what are the calculations?  Well the easy “rule-of-thumb” approach is to simply take 5%-6% of your projected Gross Sales.  So if you want to gross $500,000 your advertising budget should be $25,000 to $30,000… in theory.  Unfortunately, if you don’t have a very good location then in reality you should be spending more than this on your advertising.

What this tells us is that one thing that this method fails to take into consideration is your location.  The theory is that if you have a strong, high visibility location then you’re paying a higher rent, therefore you should need to advertise less.  If you’re saving money on rent with a less desirable location, then you’ll need to spend more on advertising.  The other thing the above calculation doesn’t take into consideration is your markup.  So, another means of calculating your advertising budget taking these two factors into consideration is:

1)      Estimate your Projected Annual Gross Sales
2)      Budget 10% to 12% of total sales for Cost of Exposure (which is rent + advertising)
3)      Multiple this budget by your store’s average mark up (for example 92%)
4)      From this total, deduct your annual rent
5)      The remaining balance is your advertising budget

In action:
1)      $500,000
2)      Multiple 1) by 10% and 12% = $50,000 to $60,000
3)      Multiple 2) by 92% = $46,000 to $55,200
4)      Subtract $18,000 from each of the numbers in 3)
5)      Advertising budget = $28,000 to $37,200 for the year

As I mentioned, there are several different ideas on the best way to calculate your advertising budget, but for the purpose of this article I am only going to cover one more.  This one is based on the cost of acquisition of a new customer.  There’s a couple of ways to look at this, but I’m going to go for a simplified method on a much smaller scale.  So for example purposes, let’s say that your average customer is worth about $300 per year to you in gross sales.  So in theory, to break even on your advertising you need to acquire one new customer for every $300 you spend in advertising, per year.  Unfortunately, that’s often as far as a business owner will take it and they will look at it only in terms of short term spending.  But in reality, advertising is a long term endeavour.  So a better way to look at it is on an annual budget.  $300 per month equals $3,600 per year which should then result in 12 new customers per year to break even.  The problem comes in when businesses expect to see the results of new customers on the same monthly schedule that their advertising expenses are on.  The other problem comes in when businesses only look at the direct response and not the residual response.  By this I mean, you place an ad and you get a new customer, you do a good job with that customer and they start referring other new customers.  So while your ad brought you the direct response of one new customer, the residual effect of your advertising was in fact several new customers.

Seeing it in action locally

A current client of the Gateway Gazette recently expressed her surprise at the effectiveness of long term advertising.  Donna Turner, a massage therapist in Black Diamond, commented that had I tried to tell her a year ago that she will see more results after 6 months or more she never would have believed me.  In fact, it was often her practice to run a small business card size ad for the duration of about 3 months and then stop the ad unimpressed with the lack of response – regardless of where she ran the ad.  However, in her last marketing plan she made the jump to run an 1/8 page ad plus a small Business Directory ad and committed to keep it going for a full year with no breaks.  As was the pattern from the past she was rather discouraged after the first 3 months.  However, once she passed the 6 month mark and now moving into around 9 months she is simply tickled pink.  She has been tracking the new clients that she has been getting from her advertising, specifically with the Gateway Gazette, and has been rather astounded at the number of new clients she is now getting on a continuous, consistent and regular basis, specifically from the Gateway Gazette.  During another conversation she also commented in passing that she has also been getting a fair number of new referral clients recently.  Forever in work mode, I asked her if she was also tracking which customers these new referrals were coming from.  As it turns out, yes she had been tracking who was giving the referrals, but she had not correlated them back to the customers that had come specifically from her Gazette advertising.  She is now in the process of working this out, but just from the conversation we already know that the total number of direct and indirect new customers she has attained via her advertising with the Gazette has far exceeded the cost of her advertising.

Donna is an excellent example of how many small businesses think in terms of their advertising.  She has also given me permission to offer her name up as a reference for the Gazette and I invite you to contact her to hold your own personal discussion and ask your own questions.  (May I also be so bold as to recommend booking a massage, she certainly knows what she’s doing and it’s a marvelous treat to ease our aging muscles – no matter what age we are!)

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