Deciding the Appropriation

Deciding the Appropriation

Deciding the Appropriation

Before it can be decided how much advertising should be undertaken, it is necessary to know how much one should spend. The usual answer to this question is: 'How much can we afford ?' Unfortunately, there are no established guidelines for arriving at an optimum advertising appropriation.

The budgeting of advertising expenditure has been the subject of many theories, but few definite conclusions. The problem, of course, is that the effectiveness of advertising is almost impossible to measure. For this reason businessmen and accountants are distrustful. They recognize the necessity for a certain amount of advertising, but can never prove how much is enough.

One of the most favoured arguments and, indeed, one of the most logical, justifies the amount spent on advertising if the marginal revenue which the company earns because of the advertising is greater than the cost of that advertising plus the marginal cost of satisfying the additional demand. It is no longer justifiable if the marginal cost of providing the additional goods or services, plus the advertising cost, exceeds the marginal revenue.

Let me illustrate the point with the following example:

A manufacturer sells towels to retail outlets at �360 per dozen. His annual sales total 10,000 dozen and he achieves a turnover, therefore of �36,000. After deducting his manufacturing and distribution costs, he makes a profit of �6,000.

Sales Revenue �36,000 Production and Distribution

Costs �30,000

Profit 6,000

�36,000



He decides to expand his activities and spends �3,000 per annum on advertising and promotion. As a result his sales increase by 20 per cent. He engages an extra salesman and finds that he must deliver towels to almost twice as many separate shops as before. This increases his costs by 25 per cent. When he comes to calculate the value of his business he discovers the following situation:

Sales Revenue �43,000 Production and Distribution

(up 20%) Costs �37,500 (up 25%)

Advertising 3,000

�40,500

Profit 2,700 (down 55%)

�43,200

The fault with the above example, of course, is that it oversimplifies the situation. Advertising is only one of the means by which sales turnover may be increased. Another problem which arises from this kind of approach is that the activity of competitors is completely ignored. It is a mistake also, to try to calculate the effect of advertising in the short term only. It has a long-term value which the above example disregards.

Many very successful business organizations establish a relationship between advertising expenditure and sales volume on a percentage basis. The theory is that a final satisfactory product figure will be achieved if the investment in advertising and promotion is held at a fixed percentage of sales turnover. An immediate objection, however, is that promotion begets sales, not the other way round! Apart from this, however, one must consider the situation of the multi-product company. Where there are several products, competing in different markets and each, perhaps, at a different stage of development, one cannot relate optimum advertising expenditure strictly to the volume of sales.

If, in spite of these difficulties, one opts for the 'percentage of sales' approach to the calculation of an advertising appropriation it is still necessary to decide which sales one is to take into consideration-this year's or last year's?

There are firms who take the total value of their sales for last year and decide to spend, say, 3 per cent of that figure as this year's advertising budget. The notion is that, having achieved a certain level of sales last year one stands a good chance of at least doing as well this year, and that 3 per cent of the sales turnover is an affordable sum for advertising. The trouble with this historical approach, of course, is that one cannot be sure that this year will compare with last year. Market conditions may change, the level of sales of the product may go up or down. Either way, the work which advertising has to do may be different from what it had to do last year.

The alternative is to budget the anticipated sales for this year and to agree a percentage of that figure for advertising expenditure. But further problems arise. When we speak of 'sales' are we talking in terms of value or volume? We may sell more goods at a lower price or less goods at a higher price. More pertinently, how many actual sales of the product are we asking advertising to induce?


Further reading - The Identity of The Product



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