Using a unit-cost strategy can help you get a handle on your marketing budget
As mentioned in my last blog, it’s critical that companies decide upfront how much to spend on marketing in a given year. That’s tough for start-ups to do. But it’s a bit easier for established companies that use a unit-cost model.
First, take a standard profit-and-loss statement and break it down into values per unit. Each transaction equates to one unit. Then project the number of units you will sell in the coming year. In this example, let’s call that number 100.
Next, determine the transaction value. That’s the unit selling price. For this example, let’s say it is $1,000, and those 100 units multiplied by $1,000 is $100,000. At this point, we’ve established the two most critical considerations: the number of transactions you are likely to have, and their unit selling price.
Now, let’s turn to the calculation of unit costs. The first thing we will examine is the direct costs associated with those sales. That is the cost of goods sold, the cost of the order process and fulfillment. This cost will include everything but overhead and marketing.
When you add up those costs, applying them to the units that will be sold, you have unit costs for the direct costs associated with the sale. Let’s call this $500.
Next, let’s examine overhead-per-unit costs, including rent, electricity, other utilities, office expenses, telecommunications and salaries. Let’s call this $100.
Adding direct per-unit costs and overhead per-unit costs, we will add $500 and $100, for a total of $600. What’s left to us is $400 per unit.
Now, we want to set a profit objective. Let’s say that’s going to be a combination of 20 percent of sales, less direct costs, less overhead. Taking a 20 percent slice of that $400 above, we come out with a profit of $80 per unit.
Now we’re ready to calculate the allowable marketing costs. We’re going to subtract direct cost, overhead cost and profit per unit, which comes out to $680 per unit ($500 + $100 + $80) from average selling price, leaving $320 per unit.
Based on the projected unit sales of 100, times the $320 per unit marketing costs, leaves us an allowable marketing spend of $32,000. That’s how much you can spend on marketing in the coming year.
In this simple exercise, we’ve established how many units you’re going to sell, what the selling price will be, and what the costs of making that sale will be, and your profit objective, leaving the remainder available to spend on marketing.
Knowing your allowable marketing spend answers a very critical question. Many people struggle with how much money they should spend on marketing. But you don‘t ‘t have to face a similar struggle. The key is to establish how much profit you want, before you start spending your marketing money wildly.
If you need insight on your marketing spend, please contact me. I offer a 100 percent guarantee on my work. I take on only clients I can help. Call me and let’s talk about your business.
My phone number is 630-269-7646.
What you need to know to make smart financial decisions on marketing costs
Not long ago, I counseled officers of a fast-growing information technology firm on how to create a marketing budget. The company was generating tremendous margins, and its officers had a good grasp of their operating expenses. The hurdle confronting them was an inability to determine how much the company should spend on marketing. An elegant solution was needed.
I worked out a formula for the company, based on profits per unit. The formula had two distinct advantages. It enabled leaders to understand what they could spend on marketing. And, they now could rein in company managers pushing to spend a lot more on marketing than was justifiable.
How-to calculate your annual marketing budget
There’s a cost associated with marketing efforts, but your dollars are finite. Your company must establish a ceiling on how much it will spend on marketing over the course of the year. While it’s not often easy for start-ups to identify a marketing budget, they can establish a hard stop on marketing costs.
In start-ups, the money for marketing will come from start-up funds. Those funds may be from your own savings, or from moneys obtained from family or financial backers. Because these are important funds, they must be spent wisely.
That means addressing key costs in areas from lead generation to use of social media, from lead conversion to content creation.
But ultimately, the crux of the matter is your sales volume and margins. The question upon which marketing spending decisions hinge for start-up companies is, very simply, “How fast will the company’s sales volume and margins grow?”
As important as it is for start-up companies to get a handle on marketing costs, it’s equally important they don’t spend a disproportionate amount of time on that task. The overriding aim is to begin attracting customers and sales.
For established businesses, financial models can make the challenge of determining a marketing budget for the coming year much easier.
They already have profit-and-loss statements, and those statements can provide information that can be used in models to determine optimal marketing spend.
We know now why it is important to identify the amount a company will spend on marketing in the next 12 months. In the next blog, I will present a simple way to determine how much you can spend in the coming year.
Many business owners rely on guesswork or product enticement to determine the amount of money to be spent on marketing to increase sales. This is a risky strategy as it doesn’t provide a hard cost calculation method. Following is a straightforward formula to help you understand where your marketing dollars are coming from.
One way to determine how much should a company spend on marketing is to develop a “Unit Cost” model. You can apply this model formula to virtually any medium. Use the following steps to determine your allowable marketing costs.
- Start with the average value of your sale. To simplify, in our example your product or service sells for $1,000.
- Calculate every conceivable direct cost (fixed and variable) such as the cost of goods, fulfillment, premiums, order processing, etc. (Do not include overhead or marketing costs here.) Assume these costs add up to $500.
- Next, include overhead (rent, salaries, office expenses, telecommunications, etc.) as a cost. For our scenario let’s assume these costs add up to $100.
- Now, establish a profit objective. For example, you might set your profit objective at 20% of sales minus direct costs and overhead, or $80 per order ($1,000 – $500 – $100 = $400 x 20% = $80)
- You can now calculate your allowable marketing cost by subtracting the direct costs, overhead, and profit objective, from the average sale price. In this example, it amounts to $320 ($1,000 – $500 – $100 – $80)
- Now you can calculate your allowable marketing expenses on a cost per thousand (CPM) basis. Use the CPM of the medium you are employing. Assume that you have a cost of $4,000 per thousand delivered ($4.00 each), inclusive of creative costs, printing, inserting, mailing list rental, and postage.
- Finally, calculate the response rate required to support these numbers. When you divide the marketing CPM ($4,000) by the allowable marketing cost ($320), you learn you must generate 12.5 orders per thousand — a response rate of 1.25% — to meet the profit objective of 20% (or $80 per order).
A response rate of 1.25% means everyone gets paid and your profit objective is reached.
Keep in mind that if you wanted to increase the allowable marketing cost by say 5%, the required response rate must also move up 5%, to 1.3125%. The crucial question then is: can you increase your response rate more than enough to pay for the added cost?