Planning a Marketing Budget: How Much, for What and How to Measure It

Why is the marketing budget a residual in many businesses?

Many small businesses have no marketing budget, just a sum of expenses: the website, a few ads, the trade show booth, promotional gifts at year-end. When the year goes well, something gets added. When it goes badly, things get cut. Nobody knows exactly whether the money works, because it was never measured against a goal.

The question this article sets out to answer: How does a small business decide how much to spend on marketing, on what, and how to measure whether it pays off? To answer it, I first present the two basic budgeting methods and weigh them up. Then we calculate a bottom-up budget using an example, distribute it across channels and determine how it is measured. At the end, we look at what should happen in weak years.

A budget that is not tied to a goal is not planning but habit.

Percentage of sales or objective and task: two methods

Marketing theory distinguishes two basic methods. With the percentage-of-sales method, a company sets a share of its revenue to spend on marketing. With the objective-and-task method, it first sets a goal, such as a number of new customers, determines the tasks needed for it and calculates what they cost.

Miller and Pazgal (2007) used a game-theoretic model to study when each stance benefits companies in competition. Their result is nuanced. If a company benefits from its rival’s advertising because it makes the whole category better known, a fixed budget is strategically more favorable. If the rival’s advertising hurts because it pulls share out of a fixed market, committing to a sales target is more favorable. The model concerns two competing providers with fixed prices and is a theoretical analysis, not a measurement.

For small businesses, I consider the objective-and-task method the better basis, with a safeguard from the first. The calculation starts with the goal. The result is then compared with what the business can afford and with what an order brings in. If the gap is too large, the goal is adjusted, not the budget quietly.

The thinking model: the bottom-up budget

I call the implementation of the objective-and-task method for small businesses the bottom-up budget. It follows the same logic as goal planning in the article Planning sales targets: from the desired result through the rates back to the activities needed. The metrics for it are those from the article Measuring marketing success: inquiry rate, conversation rate, close rate, cost per order and return per euro spent.

1. Set the order target

   How many new orders should marketing bring in a year? Not revenue, but the number of orders from new inquiries.

2. Work back through the close rate

   With a 25 percent close rate on proposals, 20 orders require 80 proposals.

3. Through the conversation rate to inquiries

   If every second conversation leads to a proposal and every second inquiry to a conversation, that makes 320 inquiries.

4. Value them at the cost per inquiry

   From your own figures for the previous year, per channel. Where there are none, with a cautious assumption and a test budget.

5. Compare with the return

   What contribution margin do 20 orders bring? If the budget exceeds it, the goal is too ambitious or a channel too expensive.

The last step is the most important. A budget only pays off if the contribution margin of the orders won clearly exceeds the costs. What an order actually brings in is described in the article Contribution margin per order. With customers who come back, the first order is not all that counts. How to calculate a customer’s value over the whole relationship is in the article Calculating customer value.

A worked example: what do 20 new orders cost?

Suppose a business recorded in the previous year where its inquiries came from and what each channel cost. This gives costs per inquiry. For the 320 inquiries needed, it distributes the target across the channels that, according to its own figures, can carry it.

With 20 orders, €21,800 means a cost per order of €1,090. Whether that is good or bad depends on the contribution margin. If an order brings an average contribution margin of €6,000, a little over five euros come back for every euro spent. If it brings €1,500, the budget is barely covered, and the business should either strengthen cheaper channels or work on its rates.

How do you split the budget between the proven and the new?

A budget distributed only by last year’s figures reinforces what exists and discovers nothing new. A budget that tries new channels every year loses what works. The solution is a fixed split that protects both.

A test needs three things: a clear question, a fixed duration and a number on which the decision is made. For example: do search ads for the maintenance service bring at least ten inquiries at no more than €80 each within three months? What such a test looks like for search ads is described in the article Search ads on a small budget.

Not every expense can be assigned to individual inquiries. A good website, a well-maintained business profile or articles work across many channels at once. I recommend keeping such foundations as a fixed item outside the inquiry calculation and measuring them by their effect on the inquiry rate, not by assigned inquiries.

Cutting in weak years: what research shows

In a weak year, cutting marketing is tempting. It affects results immediately, while its consequences only become visible later. Research calls this myopic marketing spending: a company unexpectedly lowers its spending on advertising and development in order to hit a short-term profit target.

Srinivasan and Ramani (2019) studied 781 listed U.S. companies over the years 2000 to 2015, a total of 5,907 company years. A year counted as myopic when profit was higher than expected and spending on advertising and development lower than expected. This applied to 15 percent of company years. In a supplementary survey of 60 executives in a part-time degree program, 30 percent said their company had acted this way in bad times. The authors stress that such cuts harm long-term performance.

A finding from the hotel industry points in the same direction. Kim, Choi, Song and colleagues (2019) found that hotel companies that spent more on advertising immediately after the financial crisis achieved better results, also in the long term. Both studies concern large listed companies. Whether this transfers to a business with twelve employees cannot be derived from the figures. A small business has fewer reserves and may simply be forced to cut in a crisis.

This leads to two readings. One says: invest all the more in weak years. The other says: liquidity comes first. I consider a third answer more robust: cut by impact, not by size. Whoever knows their cost per order per channel cuts the channels with the worst return first and protects those that bring orders. Whoever does not know them cuts across the board and often hits the wrong thing. How growth and liquidity are connected is discussed in the article Growth costs liquidity.

How do you measure and steer the budget during the year?

A budget is not decided in January and checked in December. It is compared with actual figures and adjusted every quarter. A table with five columns per channel is enough: planned and actual costs, planned and actual inquiries, orders.

If you work with an agency, ask for exactly these figures in the report. How to check an agency before signing is described in the article Choosing an agency.

What follows in general

The question of how big the marketing budget should be is really a question about the quality of one’s own figures. Whoever does not know their rates and cost per inquiry can only plan by habit or by percentage of revenue. Whoever knows them can calculate, and can cut selectively rather than across the board in weak years.

The limits of this guide are clear. The worked examples are based on freely chosen numbers, and the studies cited concern large companies or theoretical models. Generally valid percentages for the size of a small business’s marketing budget cannot be derived from them. What is established is the direction: myopic cuts are widespread, and their costs show up later.

Conclusion and next steps

We began by asking
a small business decides how much to spend on what and how to measure whether it pays off. The answer: it calculates bottom-up, from the order target through its own rates to the inquiries needed and their cost, compares the result with the contribution margin, splits the budget into proven, expansion and test, and reviews it every quarter. In weak years, it cuts by impact, not by size.

• Compile last year’s marketing expenses per channel.
• Count last year’s inquiries per channel and calculate the cost per inquiry.
• Determine conversation, proposal and close rates from your own figures.
• Set an order target for next year and calculate backward.
• Compare the result with the contribution margin per order.
• Plan a fixed test share with a question, duration and decision number.
• Put one date per quarter for the review in the calendar.

The right size for a marketing budget is not in any table of industry figures. It is in your own numbers, once you start keeping them.