Determining an Advertising Budget: 5 Methods

The following points highlight the top five methods of determining an advertising budget listed by Joel Dean. The methods are: 1. The Percentage of Sales Approach 2. The All-You-Can Afford Approach 3. The Return on Investment Approach 4. The Objective and Task Approach 5. The Competitive Parity Approach.

Method # 1. The Percentage of Sales Approach:

In this method, the sales value of the preceding year is first taken and then the expected sales during the year in question are arrived at. Thereafter, some percentage of the expected sales is consid­ered and this is known as the percentage of sales approach.

This method was dominant in the past and even now it is widely used. It may be a fixed percentage or a percentage that varies with conditions of sales. The method is simple in calculation. In this method, a clear relationship exists between sales and advertising expenses. By adopting this method advertisement war can be avoided.

In spite of these advantages, this method has little to justify it. This method does not provide a logical basis for choosing the specific percentage except what has been done in the past or what competitors are doing. It discourages experimenting with countercyclical promotion or aggressive spending.

The aim of advertising is to increase the demand for the product and therefore it should be viewed as the cause, not the result of sales. But this approach views advertising on the results of sales. It leads to a budget set by the availability of funds rather than by market opportunities.

Method # 2. The All-You-Can Afford Approach:

Under this approach, a company spends as much on advertising as it can afford. It can spend for advertising as much as the funds permit. From the name itself, it is clear that the affordable amount set aside for advertising is known as affordable method. This approach appears to be more realistic, for all companies generally spend that much amount on advertisements which they can afford, even though they may not say so.

As advertising outlays are growing out of all proportions in the modern business, this method seems to provide a basis for many firms with regard to advertising outlet. Generally, a firm has to take into account the financial constraints while resorting to advertisement schemes.

As Joel Dean rightly says, “The limit of what a company can afford ought to involve ultimately the availability of outside funds. In this sense firm’s resources set a real limit on advertising outlay. However, this limit may be above the limit set be marginal-return criterion.”

This approach to spending on advertising sometimes proves uneconomical. The point upto which a firm can afford to spend is a limiting point. If the increase in sales does not match the expenditure on advertising, it is evident that this is not a wise or economical way of determining the budget.

This approach is helpful in the following ways in determining the advertising budget:

(i) “It produces a fairly defensible cyclical timing of that part of advertising outlay that has cumulative long-run efforts.”

(ii) This method is more suitable to the marginal firms.

(iii) This method sets a reasonable limit to the expenditure to be incurred on advertising.

However, the method has got some inherent weaknesses and they are the following:

(i) It is difficult to plan long-term marketing development.

(ii) The opportunities of advertising may be overlooked.

Method # 3. The Return on Investment Approach:

This approach treats advertisement as a capital investment rather than as a more current expendi­ture.

Advertising has a two-fold effect:

(i) It increases current sales.

(ii) It builds up future goodwill.

An increase in current sales involves such decisions as the selection of the optimum rate of output in order to maximise short run profits. The building up of goodwill for the future calls for a selection of the pattern of investment which is expected to produce the best scale of production, leading to the maximum long run profits.

This method emphasizes the relation between advertisement and sales. Sales are measured with advertising and without advertising. The rate of return provides a basis for advertising budgeting, as the available funds will have to be distributed among various kinds of internal investment on the basis of prospective rate of return.

The limitation to the return on investment approach is that one cannot accurately judge the rate of return as advertising investment.

It involves the following problems and they are:

(i) Problem of measuring the effect of advertisement accumulation as long run sales volume.

(ii) Problem of estimating the evaporation of the cumulative effects of advertising, and

(iii) Problem of distinguishing of investment advertising from outlays for immediate effect.

Method # 4. The Objective and Task Approach:

This method is also known as the research objective method. This method became prominent during the war time. This method calls upon marketers to develop their promotion budgets by defining their specific objectives, determining the tasks that must be performed to achieve these objectives and estimating the cost of performing these tasks. The sum of these costs in the proposed budget.

This approach is an improvement over the percentage of sales approach. But the fundamental relationship between the objectives and the advertising media again depends upon the past experience of the firm. In reality, tasks to be determined should be related to the objectives of the firm and to the past records of the firm.

This method has the following advantages:

(i) It requires management to spell out its assumption about the relationship between amount spent, exposure level, trial rates and regular usage.

(ii) This method can be extended to highly promising experimental and marginal approaches.

(iii) With the help of this method a clear advertisement programme can be drawn.

There are inherent defects in this approach. The important problem of the method is to measure the value of such objectives and to determine whether they are worth the cost of attaining them. This method is also highly irrational.

Method # 5. The Competitive Parity Approach:

This approach is nothing but a variant of the percentage of sales approach. A firm sets its budget solely depending upon the basis of competitors expenditure. The advertising cost is decided on the basis of spending for advertising by the competitors in the same industry.

Two arguments are advanced for this method. One is that the competitors’ expenditures represent the collective wisdom of the industry. The other is that it maintains a competitive parity which helps to prevent promotion wars.

Joel Dean claims that this method is widely used. The defensive logic of large proportion of advertising outlay aims at checking the inroads that might be made by competitors. The money which an individual firm spends does not reveal how much it can afford to spend in order to equate its marginal benefits with marginal costs. He finds that no correlation appears to exist between the outlay and the size of the firm.

Further, Dean defends this approach on the ground that the advertising percentages of competi­tors represent the combined wisdom of the industry. Another advantage of this method is that it safeguards against advertising wars. The main advantages of the method are simplicity and security of its use. For this a firm has to collect relevant data about competitors. If it is quite easy for the firm then it is quite easy for it to follow its competitors.

The major problem in this method is that the firm has to identify itself with others in the industry. Another problem is that it breeds complacency.