Your Ad Spending: How Much is Just Right ?

August 9, 2010

Are you spending too much or too little on advertising? Don’t know the answer to this question? You’re not alone–it’s a big issue for almost all Marketers. Think about it for a minute: how do you make this decision for your brands?

How Much Should Your Brand Spend on Advertising?

The most common answer for many, it seems, is “whatever we can afford.” This is certainly the practical answer, and often the reality of managing a brand in a business environment that demands annual revenue and profit growth, but is it the right one?

There’s little glamour in this question, but I would argue that it’s a huge profit lever for Marketers that is rarely addressed in a systematic and rigorous manner. If you’re focused on improving Marketing ROI, it’s a question that deserves your time and thought.

The Usual Budget Approach

Many Marketers work backwards from a communications goal to determine ad spending levels. If we need 80% awareness to achieve our volume forecast, we can calculate the required GRP’s to achieve this. And, given our target audience and media strategy, we can then calculate the cost of the planned GRP’s. Presto—we know how much we need to spend. Or do we?

Advertising Spend: Volume Forecast & Planned GRPs

Requirements of Advertising Budgeting

How might CMO’s and Marketing leaders better defend their advertising spend levels? I’m always a fan of solutions that are:

  • Derived from empirical data and research
  • Connected to real business outcomes – revenue and profit
  • Are simple and practically possible to execute

Are there approaches to determining your advertising spend level that meet these requirements?

Advertising Responsiveness & Spending

One of the more rigorous approaches I’ve seen  to determining ad spend levels was written about by Malcolm Wright in the June 2009 Journal of Advertising Research. To greatly simplify, and avoid making anyone go thru the algebraic equations used (although you’re welcome to read about them here), Wright argues that advertising spend should be set based on:

  • Advertising elasticity as a % of gross profit

This requires that we know our gross profit—which every Marketer should know. But it also requires that we know advertising elasticity for our brand. This is a trickier topic.

Advertising Elasticity – What is it and how Can It be Measured ?

Advertising elasticity is simply the change in volume divided by the change in associated advertising spend. It’s essentially a return on advertising spend metric.

Within the CPG category, there have been a substantial number of studies done on advertising elasticity. These studies used rigorous single source data where it’s possible to observe what people watch and what people buy at the household level, and thus measure advertising elasticity with precision.

Household Level Research: Measuring Advertising Elasticity

What’s Known About Advertising Elasticity

These collective results show that the average advertising elasticity across 186 different studies is about .11. This means that for every $1 invested in advertising, sales increased by an average of $0.11.

Like all averages, it’s useful to deconstruct the .11 advertising elasticity to see differences under different conditions. For example:

  • Established vs. New Products – Using the case examples above, the average advertising elasticity for established products was .05. For new products, it was .24. So, new products are obviously much more responsive to advertising than established ones, and advertising levels should be set accordingly higher.
  • Cluttered vs. Non-Cluttered Environments – Another key factor in the studies was the impact of competitive clutter. In low clutter environments where competitors were not advertising heavily, advertising elasticity was .15. It was only .07 in a highly cluttered environment.

Competitive Clutter: Does Your Brand's Advertising Break Through?

Advertising Elasticity for Your Brand

The ideal is that you use single source research to measure advertising elasticity for your brand—and then use this learning to set affordable and appropriate spend levels.

Of course, this takes time and money and isn’t always affordable for small brands. For others, here’s a few useful guidelines:

  1. Start with the Advertising Elasticity Norms – A good starting place is the .11 average advertising elasticity norm. If you know nothing else about your CPG brand’s ad elasticity, you can assume that you should be spending about 11% of gross profit on advertising.
  2. Adjust for Other Meta Learnings – Adjust the ad spend up or down based on whether your advertising is for an established brand or is less than 3 years old. Consider whether your brand operates in a highly cluttered versus less cluttered environment. Review any additional learnings about differences in advertising elasticity by category, geography, etc. Make adjustments to the .11 as appropriate.
  3. Modify for Creative Strength – If your brand does copy testing, consider how your ad scored versus historical norms for the category or your brand. If your brand is well above norms, you should consider adjusting upward from the .11. If your brand scored below norm, reconsider whether you should be advertising at all until you get better creative.

Advertising Elasticity Guidelines: Copy Testing & Brand Learnings

I’ve spent enough time in Marketing to know that advertising spend is as much art as it is science. That said, there’s a big opportunity for CMO’s and their Marketing teams to be more rigorous in setting budget levels.

There’s financial upside to this exercise. Spending too much is wasteful and inefficient. Spending too little is missing a significant revenue and profit opportunity. Answering the “how much should I spend?” question is about getting your spend just right.

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