Every small business owner struggles with deciding out how to allocate their resources. Even if you’re profitable each year, you still need to balance your overhead against your foreseeable profits.
With content marketing and social media use on the rise, it can be especially tricky to determine where your paid advertising budget should be. You want to ensure to spend enough to expand your business, but not so much that it ends up hurting you financially.
We’re here to assist. We’ll walk you through the process of determining the most efficient advertising budget for your business based on your sales and profit margins. The resulting number might end up shocking you.
The first thing you need to do is determine your allotted paid advertising budget. A majority of companies underspend or overspend on advertising. They may also be making unwise choices in terms of where to spend their budget, but that’s a separate topic.
The key to calculating the amount of your budget is to factor your profit margins and mark-up into the calculation. Here’s a formula you can utilize to figure out your minimum and maximum allowable advertising budget.
- Calculate 10% and 12% of your gross annual sales. A company with a million dollars in sales would begin with figures of $100,000 and $120,000.
- Divide your gross profits by the cost of the goods you sold to determine your mark-up. For example, if you paid $480,000 for products and made $520,000 in gross profit, you’d divide to figure out that mark-up is 93.7%.
- Multiply your two earlier figures (10% and 12% of gross annual sales) by 93.7% to determine your minimum and maximum budget for exposure. In this case, it would be $93,700 on the low end and $112,440 on the high end.
- From those two figures, subtract your annual rent. For example, say that your rent was $2,000 per month, or $24,000 per year. You’d end up with a low budget of $69,700 and a high budget of $88,440 on the high end.
These numbers can assist you in forming the framework of your budget. You may decide that you want to stick to the low end of the budget, especially if it’s more than you’ve been spending. On the other hand, if you’ve been spending more than you should, it may be a challenge just to bring your spending down to the high end.
It’s not sufficient just to set the proper amount for your paid advertising budget. You also need to crunch the number to ensure that the money you spend is producing the results you need.
Many small business owners focus on ROI (return on investment) as the number that determines whether an advertising campaign is a success. They figure if they end up making more than they spent to advertise, then they’re doing just fine.
We like to recommend a different strategy. Customer Acquisition Cost, or CAC, is a significant number to consider as you finalize your marketing budget.
You can determine the cost of acquiring a new customer by looking at your website’s conversion rate. Let’s use a simple example to illustrate the point.
Envision a company that spends $50 for each visitor to its website. They might be paying for pay-per-click ads on Google or Bing, or even using Facebook advertising.
Once visitors land on their site, they’re converting 50% of those visitors to paying customers. That means that for every two customers who visit their site, they’re selling something to one.
In this scenario, the CAC is $100. They spend $50 for each customer and convert one of every two. You can observe why looking solely at the PPC rate is a mistake. This company is spending twice as much on CAC as they are on PPC. That’s a huge difference.
Examine your current advertising budget and determine what you’re actually spending to acquire a new customer. That can aid you going forward.
The final statistic you need to know to make the most of your advertising budget is the lifetime value of a customer.
Why is this number important? Simply put, you need to ensure that the average customer’s lifetime value (LTV) is greater than the CAC. If it isn’t, you’re in big trouble.
Let’s continue with the scenario we provided in the previous section. If a company has a CAC of $100, they would need to have an LTV higher than that to justify the money they are spending on their PPC ad.
If their average sale is only $20, it means that a customer would have to make more than five purchases at that price to exceed the CAC.
To determine your average LTV, you’ll need to track customer behavior closely and figure out how many of your customers are buying from you multiple times. You’ll also need to determine how much they’re spending on your products or services over the course of their relationship with you.
Let’s say that the company in our example had an LTV of $150. Based on that number, they would know that their advertising dollars were being reasonably well spent. Every customer they acquire is spending, on average, more than it costs to acquire them.
On the other hand, if that same company had an LTV of merely $75, it would show that they are not allocating their advertising budget in an efficient manner. They would need to take a good look at their marketing strategy.
After you’ve crunched the numbers, the final step is to examine your advertising budget and determine what you need to do differently.
If you’re utilizing Google AdWords, you should remember that the best three paid options on the search results page get approximately 41% of the clicks. Rather than trying to compete for a top keyword, focus your attention on long-tail keywords that are less competitive.
You may also want to think of moving away from search engine advertising and reallocating your budget to social media advertising and other, more cost-effective methods.
