Your marketing budget is hyper-critical to scaling your business successfully. However, most small businesses don’t budget nearly enough for an effective marketing spend. The U.S. Small Business Administration recommends spending seven to eight percent of your gross revenue on marketing and advertising if your small business has less than $5 million in annual sales. Yet, a report from Small Business Trends shows the average business spends an underwhelming 1.08 percent of its revenues on advertising, with variations from industry to industry.
Reducing your marketing spend can make a bad financial situation worse. Many businesses — startup or mature tend to cut marketing expenses first when they don’t have enough cash flow. Marketing expenses often get reduced or eliminated during lean times because it’s one of the easiest to cut. Ironically, you often end up increasing your company’s burn rate because without sales, you don’t have revenue and without revenue you won’t have a business. Further, it seems logical to “tighten your belt” during slow revenue periods, but many startup leaders fail to recognize that you can almost never save your way to profitability.
Bottom line, if you’re committed to your company’s high-growth, your marketing budget should be treated as seriously as payroll. Here are three methods of establishing a data-based marketing spend.
What’s in a Marketing Budget?
In a 2020 CMO Survey, Highlights and Insights Report, it lists typical expenses and what percentage of companies include them in their budgets:
- Direct Expenses of Marketing Activities – 92.8 percent.
- Social Media Marketing – 86.9 percent.
- Brand-Related Expenses – 80.4 percent.
- Marketing Employees – 79.1 percent.
- Marketing Analytics – 72.5 percent.
- Marketing Research – 69.9 percent.
- Other Overhead Associated With Marketing – 65.4 percent.
- Mobile Marketing Tools – 56.2 percent.
- Marketing Training – 54.2 percent.
- Sales Support Tools – 40.5 percent.
- Sales Employees – 13.7 percent.
1: Use Your Customer Acquisition Cost As a Guide
First, define how much it will cost you to acquire a customer. Whether you calculate this number or not, there is an aggregate price to pay for getting new customers. Your Customer Acquisition Cost includes your expenditure on sales, marketing and distribution activities. Answering this question will give you a bird’s eye view of how expensive (or not) your marketing spend will be initially. It’s well worth the effort to know this number.
Additionally, it can also give you an idea of how many customers you can expect based on your marketing spend. Justify greater marketing spends by determining your Lifetime Value to Customer Acquisition Cost (LTV:CAC) Ratio. You can calculate your customer’s Lifetime Value by multiplying the average purchase value by the purchase frequency. This becomes your average customer value. Multiply the average customer value by the average period (months or years) that the customer is retained. A strong LTV to CAC is 3:1. In general, if it costs you $100 to secure a customer with a LTV of $300 or more, deploying more strategic capital doesn’t just make sense — it’s good business.
You can also use Google Ads as a proxy for your cost of advertising. Research relevant keywords on Google Keyword Planner to identify the keywords with the highest conversion rates. Find the average Cost Per Click (CPC) for your specific set of keywords. For example, if you have an eCommerce store focusing on the CrossFit target audience, targeted keywords may include “best CrossFit headband” or “best CrossFit gear.”
A lower-priced CPC on your selected keywords might mean you can get more out of a small marketing budget. Alternatively, a high CPC of $10 or more could indicate you’re going to need a much bigger budget to get new customers.
2: Calculate Your ARPU
Understanding your Average Revenue Per Customer or User (ARPU) is very helpful in defining your marketing budget as well as growing your company in general. ARPU is the average revenue your user generates for your business during a specific timeframe. Calculate ARPU by taking your total revenue over a period (month, year, etc.) and divide it by the total number of customers during that same period. ARPU = Total Revenue (month, year, etc.) / Total number of customers (same time period)
If your ARPU is low, $100 or less, then you’ll need to find or develop lower-cost methods of attracting new customers. Conversely, if your ARPU is higher, in the thousands of dollars, then you can and should spend more on customer acquisition and still maintain profitability.
Establish a Cost Per Acquisition (CPA) goal that allows you to see good returns on your marketing spend. Then, test it with a campaign to verify that your CPA goal is realistic, or if changes need to be made. Each marketing channel will have different CPAs, so test them individually to prove out those costs.
3: Percentage of Your Gross Revenue
This method is the most straightforward. Take your Gross Revenues and commit a set percentage as your overall marketing spend. This is by far the fastest method, but it won’t be very useful for startups or early-stage companies because of their pre-revenue status. According to a 2020 survey by Deloitte, here is marketing spending as a percentage of company revenue among specific industries:
- Banking/finance/insurance/real estate – 15.9 percent.
- Communications/media – 13.7 percent.
- Tech/software/biotech – 13.1 percent.
- Service consulting – 8.3 percent.
- Consumer packaged goods – 7.7 percent.
- Retail/wholesale – 7.5 percent.
- Education – 7 percent.
- Healthcare/pharma – 6.1 percent.
- Consumer services – 6 percent.
- Manufacturing – 5.1 percent.
- Transportation – 3.6 percent.
- Mining/construction – 1.1 percent.
- Energy – 0.1 percent.
Your advertising budget comes down to what you can initially afford. However, it’s deceptively easy to forget or underspend in marketing. Your marketing spend should increase over time if you have aspirations of being a high-growth organization. As you develop and refine your LTV:CAC ratio to 3:1 or better, it becomes clear that reducing your marketing spend is akin to not exercising or eating right and still expecting to be healthy. It won’t likely happen without solid healthy activities.
Your marketing spend is an integral part of your company’s overall, long-term health. Treat it accordingly. There’s no scaling your business without it.
Marty Aquino has been a passionate writer on venture capital, technology, forecasting, risk mitigation, wealth and entrepreneurial topics since 2009. He is the founder of Carbonwolf Energy, a venture-capital firm specializing in world-changing and status-quo-defying technologies and people.
Sources:
U.S. Small Business Administration – Marketing | The U.S. Small Business Administration
SmallBizTrends – How Much Do Small Businesses Spend on Advertising and Marketing?
Inc.com – 4 Reasons Why Marketing Should Never Be the First Expense You Cut
Corporate Finance Institute – Average Revenue Per User (ARPU) – Definition, Formula, Example
The CMO Survey –Highlights & Insights Report
Cambridge Dictionary – TIGHTEN YOUR BELT
Forbes – Penny Wise, Profit Foolish.. You Can’t Save Your Way to Profitability (vlog)
The CMO Survey – The_CMO_Survey-Results_by_Firm_and_Industry_Characteristics-Feb-2020.pdf