December 11, 2006

Setting Your Online Marketing Budget

Undoubtedly, many of you are putting the finishing touches on your online marketing, e-mail marketing, or catalog marketing budget for 2007. Oh, the excitement!

Is there anything more enjoyable than sitting across from your Chief Financial Officer, having to defend why it is important to advertise with a certain affiliate at a time when expenses need to be trimmed by ten percent?

CFO's demand rapid, financially-based answers to questions. The humble Chief Marketing Officer or Online Marketing Executive needs to be able to respond in a credible, but timely manner.

Most of the time, when asked a random question, you don't have the appropriate data with you to answer the question quickly. This is where the "square root" function comes into play.

Frequently, sales generated by advertising follow a "square root" function. In other words, if you had the opportunity to increase your marketing budget by twenty percent, your net sales would increase by the square root of 1.2. This number is (1.2 ^ 0.5) = 1.095. In other words, a twenty percent increase in marketing spend yields a 9.5% increase in net sales.

This becomes important when the CFO makes a random statement like,"Please reduce your marketing budget by ten percent, you have no choice in this, everybody must share in the pain."

Look at this example, where the online marketing budget is reduced by ten percent:

High-Level Online Marketing Scenario

Reduce Ex- Incremental

Base Case pense by 10% Sales Lost

Orders 90,909 86,244 4,665
Average Order Size $110.00 $110.00 $110.00
Cost per Order (CPA) $22.00 $20.87 $42.87

Net Sales $10,000,000 $9,486,833 $513,167
Gross Margin @ 40% $4,000,000 $3,794,733 $205,267
Marketing Cost $2,000,000 $1,800,000 $200,000
Pick/Pack/Ship Expense @ 13% $1,300,000 $1,233,288 $66,712
Variable Operating Profit $700,000 $761,445 ($61,445)

Profit as a % of Net Sales 7.0% 8.0% -12.0%
Ad to Sales Ratio 20.0% 19.0% 39.0%

Notice how the profit and loss statement changes. In this case, the CFO may have a good suggestion, as the incremental advertising dollars are not yielding a sufficient return on investment. Conversely, the numbers might work out in your favor, giving you the ammunition to actually ask the CFO for more money!

Not every business follows the "square root" rule. Your analyst can help you figure out which relationship makes the most sense to build the scenarios around. But in a pinch, go with the square root function. And then ask your CFO to quickly cost-justify some of her investments!!


  1. Anonymous12:27 PM

    Your square root rule is very insightful and useful. Our research at Marketo shows that the actual relationship bewteen advertising spending and results varies from x^0.4 to x^0.6, where 0.5 would equal a square root.

    Once you have that data for each advertising medium (or even each keyword), it becomes very useful for allocating spending optimally across options.

  2. Agree ... I don't think I've seen it vary outside of a range between 0.35 and 0.65.

    There are other relationships that do a better job, but for a quick and dirty estimate, there are few relationships easier to implement.

  3. You coould also try and dig into a software platform like Headlight to actually demonstrate the ROI on specific campaigns and easily and flawlesly report online marketing results to your CFO.

    MRM systems is the next big thing, I would check them out and learn how that can help your overview of your online marketing cost/benefits.

    Check for more details.


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