1. Chapter 7
Budget Decisions

2. Major Decisions in Advertising

3. Budget Decisions Establishing the budget Budgeting approaches
Allocating the budget

4. Establishing the budget
Marginal Analysis
Sales response models
Additional factors in budget setting

5. Marginal Analysis Advertising / Promotion in $ Sales in $ Point A
Profit
Sales
Gross Margin
Ad. Expenditure

6. BASIC Principles of Marginal Analysis
Increase Spending IF:
The increased cost is less than the incremental (marginal) return.
Decrease Spending IF:
The increased cost is more than the incremental (marginal) return.
Hold Spending Level. . . IF:
The increased cost is equal to the incremental (marginal) return.

7. Problems with Marginal Analysis
Assume that sales are a direct measure of advertising and promotional efforts.
Assume that sales are determined solely by advertising and promotion.

8. Advertising Sales/Response Functions
A. Concave-Downward Response Curve
B. S-Shaped Response Function
Sales
Sales
Middle Level
High Effect
Initial Spending
Little Effect
High Spending
Little Effect
Range A
Range B
Range C
Advertising Expenditures
Advertising Expenditures

9. Factors Influencing Advertising Budgets

10. The Dorfman-Steiner Condition
The firm is a monopoly.
Demand function: Q = D(P, A), where P is the price and A is the advertising budget.
Profit function: π = (P – C)Q – A = (P – C) D(P, A) – A, where C is the marginal production cost.
εP: the price elasticity of demand; εA: the advertising elasticity of demand.
In the equilibrium, A/Sales = εA/εP.

11. Factors Considered in Budget Setting
Source: The Advertising Age Editorial Sounding Board consists of 92 executives of the top 200 advertising companies in the United States (representing the client side) and 130 executives of the 200 largest advertising agencies and 11 advertising consultants (representing the agency side).

12. Budgeting Approaches
Top-down budgeting
Bottom-up budgeting

13. Top-Down Budgeting Top Management Sets the Spending Limit
The Promotion Budget Is Set to Stay Within the Spending Limit

14. Top-Down Budgeting Arbitrary allocation The affordable method
Historical Method
Percentage of Sales
Competitive parity
Return on investment (ROI)

15. The Affordable Method
It is used when a company allocates whatever is left over to advertising.
It is common among small firms and certain non-marketing-driven large firms.
Companies using this approach don’t value advertising as a strategic imperative.
Logic: we can’t be hurt with this method.
Weakness: it often does not allocate enough money.

16. Historical Method
Historical information is the source for this common budgeting method.
The inflation rate and other marketplace factors can be used to adjust the advertising amount.
This method, though easy to calculate, has little to do with reaching advertising objectives.

17. Percentage-of-Sales Method
It compares the total sales with the total advertising budget during the previous year or the average of several years to compute a percentage.
Two steps
Step 1: past advertising dollars/past sales = % of sales.
Step 2: % of sales X next year’s sales forecast = new advertising budget.

18. Percentage-of-Sales Method
Based on (future or past) sales dollar or unit product cost
Method 1: Straight Percentage of Sales
2007
Total dollar sales
Straight % of sales at 10%
$1,000,000
$100,000
2008
Advertising budget
Method 2: Percentage of Unit Cost
Cost per bottle to manufacturer
Unit cost allocated to advertising $4 $1
Forecasted sales, 100,000 units
Advertising budget (100,000*$1)

19. 2007 Advertising-to-Sales Ratios by Industry Sector

20. Percentage-of-Sales Method
Pros
Financially safe
Reasonable limits
Stable

21. Percentage-of-Sales Method
Cons
Reverse the cause-and-effect relationship between advertising and sales.
Stable?
Misallocation, e.g. S-shaped curve.
Difficult to employ for new product introductions.
Sales↓ → Advertising budget↓

22. Competitive-Parity Method
This method uses competitors’ budgets as benchmarks and relates the amount invested in advertising to the product’s share of market.
Logic: share of media voice → share of consumer mind → share of market.
Share of media voice: the advertiser’s media presence.
The actual relationship above depends to a great extent on factors such as the creativity of the message and the amount of clutter in the marketplace.

23. Competitors’ Advertising Outlays Do Not Always Hurt

24. Competitive-Parity Method
Pros
Take advantage of the collective wisdom of the industry
Spending what competitors spend helps prevent promotion wars.
Cons
Companies differ greatly.
There is no evidence that budgets based on competitive parity prevent promotion wars. (Prisoners’ Dilemma)

25. Prisoner’s Dilemma Cooperate Fink 2, 2 -3, 3 3, -3 -2, -2
Player 1 ╲ Player 2
Cooperate
Fink
2, 2
-3, 3
3, -3
-2, -2

26. Discussion Question
In 1981, American Airlines first introduced the AADVANTAGE frequent-flier program. When other airlines copied this strategy, did they engage in the prisoner’s dilemma?
How can a firm escape from the prisoner’s dilemma?

27. Return on Investment (ROI)
In this method, advertising and promotions are considered investment, like plant and equipment. Thus, the budgetary appropriation leads to certain returns.
ROI has received a great deal of attention by practitioners over the past few years, with many still disagreeing as to how it should be measured.
Aegis Rated ROI of Various Media
While the ROI method looks good on paper, the reality is that it is rarely possible to assess the returns provided by the promotional effort – at least as long as sales continue to be the basis for evaluation.

28. Bottom-Up Budgeting Total Budget Is Approved by Top Management
Cost of Activities are Budgeted
Activities to Achieve Objectives
Are Planned
Promotional Objectives Are Set

29. Bottom-Up Budgeting Objective and Task Method Payout Planning
Quantitative Models

30. Objective and Task Method
It looks at the objectives for each activity and determines the cost of accomplishing each objectives.
Three steps:
Defining the communications objectives to be accomplished
Determining the specific strategies and tasks need to attain them
Estimating the cost associated with performance of these strategies and tasks

31. Objective and Task Method
Establish Objectives
(create awareness of new product among 20 percent of target market)
Determine Specific Tasks
(advertise on market area television and radio and local newspapers)
Estimate Costs Associated with Tasks
(television, $575,000; radio, $225,000; newspaper, $175,000)

32. Objective and Task Method
The major of advantage of this method is that the budget is driven by the objectives to be attained.
The major disadvantage of this method is the difficulty of determining which tasks will be requires and the costs associated with each.
This method is not as easy to perform or as stable as some of the methods discussed earlier.
It is especially difficult for new product introduction (There is no past experience to use as a guide).

33. Payout Planning
The first months of a new product’s introduction typically require heavier-than-normal advertising and promotion appropriations to stimulate higher levels of awareness and subsequent trial.
The average share of advertising to sales ratio necessary to launch a new product successfully is approximately 1.5~2.0.
This means that a new entry should be spending at approximately twice the desired market share.

34. Share of Advertising/Sales Relationship

35. Share of Advertising/Sales Relationship

36. Payout Planning
The basic idea is to project the revenues the product will generate, as well as the costs it will incur, over 2 to 3 years.
Based on an expected rate of return, the payout plan will assist in determining how much advertising and promotions expenditure will be necessary when return might be expected.

37. Example of a three-year payout plan ($ millions)
Payout Planning
To determine how much to spend, marketers develop a payout plan that determines the investment value of the advertising and promotion appropriation
Example of a three-year payout plan ($ millions)
Year 1 Year 2 Year 3
Product sales
Profit contribution
per case)
Advertising/promotions
Profit (loss) (7.5)
Cumulative profit (loss) (7.5) (0.25)

38. Quantitative Models
For the most part, these methods employ computer simulation models involving statistical techniques such as multiple regression analysis to determine the relative contribution of the advertising budget to sales.
Attempts to apply quantitative models to budgeting have met with limited success.
Such methods do have merit but may need more refinement before achieving widespread success.

40. Allocating the Budget Allocating to IMC elements
Client/agency policies
Market size
Market potential
Market share goals
Economics of scale in advertising
Organizational characteristics

41. Allocating to IMC Elements

42. Allocating to IMC Elements

43. Share of Voice Effect Decrease–find a defensible niche
Increase to defend
Attack with large SOV premium
Maintain modest spending premium
Competitor’s
Share of Voice
High
Low
Your Share of Market