Objectives-based Budgeting

Why is the advertising budget the first area to be cut during a recession? Most likely, it is because advertising is viewed as an “expense” rather than an “investment”. And the reason advertising is often viewed as an expense is because the methods to determine the appropriate budget has little to do with revenue goals, and the activities are not measured to link advertising with sales results.

Today, we will review a few of the most common methods companies employ to establish their marketing budgets (and why they are not the best approaches).

Then we will discuss an approach that ties advertising to revenue and begins to turn the advertising budget from an expense to an investment.

Common Budgeting Methods

Percent of Sales

This is a formula-driven method based on the previous year’s sales results (such as 2% of sales). This is considered to be one of the most common approaches because it is simple, and ties the budget to revenue (albeit, historical). However, by looking backwards, companies are ignoring the current or projected economic conditions, marketing trends or the future opportunities.

What Can We Afford?

This approach considers the financial projections for the organization, and management decides how much it is willing to spend on advertising. This approach is used often because it sounds “fiscally responsible” and is very simple. However, this method is unrelated to sales revenue and (again) ignores future opportunities.

Increase Over Last Year

A third common approach is to take last year’s budget and allocate an increase (or decrease). Generally, this becomes an Accounting process rather than a Marketing one. Again, this makes budgeting simple and may even account for economic conditions such as inflation or a recession. However, it also assumes that the “original” budget was developed soundly (and this is often a very big assumption). The budget may be completely arbitrary and ignores current market conditions.

Objectives-based Budgeting

A better approach is Objectives-based Budgeting. This is the process of developing a marketing budget based on measurable revenue objectives and projected return-on-investment (ROI) to determine the correct advertising allocation.

Key Advantages

o It is based on FUTURE business opportunities and economic climate, not historical
o It forces organizations to make sound business decisions that align resources with organizational goals
o It turns advertising from an “expense” into an “investment”

So why doesn’t everyone use this approach? Objectives-based Budgeting is a more complex approach and requires individuals within the organization to be accountable. Also, many of the measurements needed to prepare the budget have not be available in some organizations. However, we will attempt to provide a straight-forward, simplistic approach to this method.

Key Steps

o Establish an ROI Parameter

ROI is generally expressed as a percentage, such as a Certificate of Deposit generated a 3% ROI on the initial investment. For organizations, it is common to set a more significant ROI level, such as 200% (or more) of the projected profit margin. This level is a managerial prerogative to establish a budgetary tolerance.

o Estimate Client Lifetime Value

If you don’t already know, it is important to determine the lifetime value of your clients, especially if you rely on repeat business to grow your organization. This involves multiplying the average annual revenue per customer times the average client tenure. Then determine the projected margin for your clients to determine the expected value for each new client you secure.

o Establish Objectives

It is important to set specific, quantifiable and realistic sales objectives to calculate projected revenue. Review historical statistics to estimate key metrics such as close ratio, appointment-to-proposal ratios or lead-to-appointment ratios. Each organization will have its own unique set of metrics. Use these historical values to project the level of sales activity that will be needed to secure the correct number of new clients and resulting revenue.

o Do the Math

If you have been able to determine all of the values listed above, you can calculate the appropriate funding levels to acquire new clients.

For example:

o Your organization wants to achieve at least a 200% ROI of its profits.
o You expect that the average annual gross revenue of a new client will be $3,000 with a profit margin of 10% (or $300), and that a new client is typically retained for five years. This means a new client is projected to be worth $1,500 in lifetime profit.
o If your sales objectives call for the acquisition of 500 new clients, then the projected profit margin from these new clients will be [$1,500 x 500] or $750,000.
o The generally-accepted formula to determine an advertising budget that will achieve the target ROI is:

profit margin – advertising costs / advertising costs = ROI


To achieve a 200% (or 2:1) ROI in this example, the advertising cost calculation would be then be:

$750,000 - $250,000 / $250,000 = 200%

In other words, to achieve a 200% ROI on $750,000 profit, you can justify a $250,000 advertising budget.

o Now you need to go back to your sales metrics and determine if this budget is sufficient and appropriate to generate the level of activity necessary to produce the sales. In other words, can you generate enough leads, appointments or proposals with this budget so the end sales result meets expectations?

Clearly, we have provided an incredibly simplified approach to a fairly complex process, but hopefully it will provide enough of an overview to help you to begin applying this process within your own organization.

For more information on objectives-based budgeting, or other strategy-based advertising applications, contact DMC Advertising at (262) 523-2000. We are specialists at targeted and measurable marketing programs.