By Mike Bradbury and Neal Kissel

  

Ever-rising marketing budgets are becoming an explosive issue. On advertising alone, companies spend fortunes: Nestlé, $11 billion; Unilever, $8 billion; General Motors, $4.7 billion; Procter & Gamble, $3.8 billion; Sony, $3.4 billion; and Coca-Cola, $1.7 billion.¹ With no end in sight to escalating marketing outlays, many CEOs, CFOs and CMOs are asking two questions: "Is our company spending the right amount on marketing?" and "Are we spending it in the right places and on the right activities?"

These days, companies can answer those questions much more precisely than department store pioneer John Wanamaker could in the late 1800s. It was then that the Philadelphia retail magnate lamented, "Half the money I spend on advertising is wasted; the trouble is, I don’t know which half." Using "return on marketing investment" (ROMI) and other approaches, companies today can know with unprecedented confidence which programs are paying for themselves.

But ROMI and similar techniques aren’t easy to use. They require extensive data gathering and analysis, and can take years to implement. To avoid these complexities, many companies adopt much simpler – and sometimes simplistic – approaches: a mark-up (or mark-down in lean times) of last year’s budget or benchmarking against competitors ("They spend 5% of revenue on marketing, so we should too"). Yet from our experience, these approaches often generate decisions that have little relation to how much a large organization should actually spend on marketing and how it should divide the pie among business units, product lines and geographies.

An alternative approach has helped a number of companies answer these questions and significantly boost their return on marketing investment. While not a replacement for ROMI, the approach works because it sets aside the first question – how much should the company spend overall on marketing? – and focuses on the second: How should marketing dollars be allocated?

In this article, we explore the limitations of current approaches to setting marketing budgets. We then explain a different approach that simplifies the task and gets to the heart of the issue: determining where – not how much – to spend on marketing.

Limitations to How Marketing Budgets Are Traditionally Set
Many companies determine their marketing budgets and allocations by benchmarking themselves against competitors. This can provide some useful insights if, in fact, their strategies are similar to those of competitors. Yet this is often not the case, even within an industry. Consider Target Corp. and Wal-Mart: Wal-Mart spends relatively little on marketing (0.3% of revenue) while Target spends 2.5%, eight times more as a percentage of sales.² Why? Target’s business strategy is radically different than Wal-Mart’s. While Wal-Mart is known for low prices across its merchandise lines, Target positions itself as more upscale and fashionable, with a number of exclusive-to-Target items. To do this, Target must advertise extensively to promote its brand, its unique products and their benefits. Wal-Mart’s marketing is more institutional (its whole business is geared to everyday low prices), which enables it to reduce investments in advertising.

A second way companies set marketing budgets is through ROMI and similar techniques. Marketers gauge the sales impact of various activities such as advertising, direct marketing and PR, and then let the profit impact of those activities drive their investment priorities. Programs meeting a hurdle rate of, say, a 15% return are permitted; those below the hurdle rate are cut or scaled back. The main advantage of such approaches is that they indicate which investments have low paybacks. By eliminating those with lower returns, executives can substantially boost their marketing ROI.

However, ROMI approaches suffer from several shortcomings. One is a bias toward short-term results. The return on a campaign is typically measured in a short period of time after the campaign (usually less than a year). That doesn’t account for the longer-term impact of marketing activities, such as brand building. Second, ROMI techniques tend to favor activities that improve profitability (return on sales) over those that drive revenue growth. Our analysis of many leading companies has shown that both are necessary for superior shareholder returns.³ Third, new budgets are based on historical data. This data is irrelevant because if consumer responsiveness to the firm’s marketing wanes, the marketing programs of the past will not have the same effectiveness in the future. Lastly, ROMI approaches don’t factor in changes to business unit strategies. If the business changes tack – to emphasize, for example, premium products – marketing budgets set by ROMI will continue to allocate spending according to price-based promotions as before. In other words, the new marketing budgets and allocations will be clearly incompatible with the future direction of the business.

But the biggest shortcoming of ROMI is time and effort. Collecting sales information and tying it directly to every marketing campaign in every product unit, geographic territory and division can take months, even years.⁴ Frustrated by the sheer effort of ROMI approaches, many companies give up and revert to "last year plus" or competitor benchmarking.