Advertising Budget
(2) Percentage of Sales Method:
It
is a commonly used method to set advertising budget. In this method, the amount
for advertising is decided on the basis of sales. Advertising budget is
specific per cent of sales. The sales may be current, or anticipated.
Sometimes, the past sales are also used as the base for deciding on ad budget.
For example, the last year sales were Rs. 3 crore and the company spent Rs. 3
Lakhs for advertising. It is clear that the company has spent 1% of sales in
the last year.
Company
has the tendency to maintain certain per cent (or percentage) of sales as ad
budget. Based upon the past, the current and the expected sales, amount for
advertising budget is determined. This method is based on the notion that sales
follow advertising efforts and expenditure. It is assumed that there is
positive correlation between sales and advertising expenditure. This is not the
scientific method to decide on advertising budget.
This
is the most commonly used method for budget setting. Large firms generally go
by this method. According to this method, advertising and promotions budget is
based on sales of the product. Management determines the amount by either.
i.
By taking a percentage of the sales revenue
ii.
Assigning a fixed amount of the unit product cost to promotion and multiplying
this amount by the number of units sold.
Some
companies instead of considering the past sales consider the
percentage-of-projected future sales as a base. This method also uses either a
straight percentage of projected sales or a unit cost projection. In the
straight-percentage method, the marketing manager estimates projected sales for
the coming year. The budget is a percentage of these sales, often an industry
standard percentage.
In
its simplest application, a fixed percentage of last year’s sales figure is
allocated as the budget. For example, suppose the total sales of a company ABC
Pvt. Ltd. in 2005-2006 were Rs 20 Lakhs. Now according to this method, the
simplest calculation for advertisement budget is say 10% of the last year’s
sales. So, the advertisement budget for the year 2006-2007 is 10% of Rs 20
Lakhs i.e. Rs 2 Lakhs.
In
case the ad budget is to be decided on the basis of sales units, let us assume
that the manufacturing cost per unit of table fan for ABC Pvt. Ltd. is Rs 500
and the advertising money allocated per unit is Rs 30. The projected sales
figure is 1,00,000 fans for the coming year 2007-2008, then the total
advertising budget can be calculated as Rs 1,00,000 x 30 = Rs. 30,00,000).
The
percentage figure selected is definitely not a standard percentage across any
industry. This figure varies from one industry to the other and also among
different firms in the same industry. It depends on the company policy. Actual
money spent varies considerably depending on the individual company’s total
sales figure.
As
shown in the example the budget for a current year depends on the sales of the
last year. Now if a company keeps the percentage fixed and then sales this year
decreases then advertisement budget for next year is also less. But marketing
says that if the sales are less in a year one way out of many to increase it in
the next year could be an increase in the advertisement and promotional budget.
Thus,
one advantage of using future sales as a base is that the budget is not based
on last year’s sales. As the market changes, management should consider the
effect of these changes on sales into next year’s forecast rather than relying
on past data.
Merits:
1.
It is based on sales volume. Therefore, cost of advertising can be offset
against profits earned from the sales. It satisfies financial management.
2.
This method encourages marketing manager to think in terms of relationship
between promotional costs, selling price, and profits per unit.
3.
It maintains competitive parity. All firms in the industry spend approximately
the same percentage of sales for advertising.
4.
It keeps the company in constant touch with the sales target to be achieved.
5.
It is somewhat financially safe and helps a company keep advertisement spending
within limits irrespective of the fact whether the base is past year’s sales or
what the firm expects to sell in the upcoming year.
6.
This method is simple, straightforward, and easy to implement.
7.
Regardless of which basis-past or future sales-is employed, the calculations
used to arrive at a budget are not difficult.
8. This
budgeting approach is generally stable when competing firms spend approximately
the same percentage of their sales on promotion
9.
Promotion expenditures vary with what company is aiming for in terms of sales
10.
It encourages management to think of the relationship among promotion cost,
selling price and profit per unit.
11.
This method is suitable for the companies whose ad budget is small relative to
sales
Demerits:
The
method has been criticized on following grounds:
(a)
In absence of specific guidelines, it is not possible to decide the appropriate
per cent of sales. It lacks a scientific base.
(b)
Long-term planning is not possible because a long-term sales forecasting seems
difficult.
(c)
It neglects other objectives of advertising. Only sales are given priority. It
doesn’t consider the need of advertising.
(d)
Stage of product life cycle is not considered. New Product or Innovative
Product
(e)
It is, to some extent, inflexible.
(f) It is assumed that only advertising affect sales. It is erroneous.
The
basic premise on which the budget is established is sales. As just discussed,
if the level of sales determines the amount of advertising and promotions to be
spent then the cause-and-effect relationship between advertising and sales is
reversed. It treats advertising as an expense associated with making a sale
rather than an investment. Companies that consider promotional expenditures an
investment and reap the rewards.
In
explaining the advantages, it was just mentioned that since it is a percentage
of sales, either past or future expected, the method is stable. Now this can happen
when all firms in the industry uses a similar percentage, but then what happens
if one firm varies from this standard percentage? The problem is that this
method does not allow for changes in strategy either internally or from
competitors. But this is a highly impractical proposition because there are
many kinds of market structures and in any time the leader can choose to divert
from the standard.
The
percentage-of-sales method of budgeting may result in severe misappropriation
of funds i.e. over budgeting or under budgeting. When sales decrease, we may
need more budget in advertisement as decrease in budget might lead to further
decrease in incremental sales.
The
percentage-of-sales method is also difficult to employ for new product
introductions because in this case there is no sales history available. Also,
projections of future sales may be difficult, if the product is highly
innovative and absolutely new in the market.
Marlboro:
Marlboro
cigarettes were introduced in the 1920s. The brand share was only one per cent
in the early 1950s. The company invested heavily in building brand image in
1954 (cowboy country) and now the brand share among young smokers is in excess
of 60% in the USA.
Glaxo:
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