5. Budget Setting and Allocation

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The Advertising Process

Stage 1 Define The

Brand

Stage 2 Define The Customers

Stage 3 Identify The Overlap

Stage 4

Tell The Agency

Stage 5

Get The Money

Stage 6 Brief The Creatives

Stage 7 Book The Media

Stage 8 Stop

Stage 9 Evaluate Find Next

Today –two big questions...

How much should I spend?

...

What should I spend it on?

How Much Are We Talking?

1. Proctor & Gamble2. Verizon3. AT&T4. General Motors5. Pfizer6. Johnson & Johnson 7. Walt Disney8. Time Warner9. L’Oreal10.Kraft

4.193.022.792.222.102.072.001.851.831.75

2009 US SpendAd Age$USbn

And the UK?

Source: Neilsen. Marketing Magazine Jan 2011

Some go up, some go down…

Advertising is an investment!

Most methods attempt to justify a level of spend – advertising is a form of taxation

More recent commentators see advertising as an investment just like new

plant or personnel

Focus moves to profit not awareness or market share

Value of the investment needs to be judged in the medium term

How Much to Invest?

US Ad Ratios 2010Ad as %

salesAd as % margin

Transportation Services 22.2 29.2

Perfume, Cosmetic, Toilet Prep 20.1 29.2

Motion Pic, Videotape Prodtn 19.4 31.4

Mailing, Repro, Comml Art Svcs 18.2 26.9

Distilled And Blended Liquor 14.4 23.7

Rubber And Plastics Footwear 12.5 26.3

Food And Kindred Products 11.5 23.1

Auto Repair, Services,Parking 11.2 41.6

Dolls And Stuffed Toys 10.1 20

Educational Services 9.8 16.3

Special Clean, Polish Preps 9.8 19.5

Soap, Detergent, Toilet Preps 9.2 17.4

Source: Advertising Ratios & Budgets, 34th Edition, Schonfeld & Associates, Inc.,

A Little History

Over 2000 articles on budget setting since the 60's

17 different methods accounted for!

The Usual Methods

Percentage of gross margin

• begs questions of cost-efficiency.

Percentage of previous sales

• backward-looking and compounding failure.

Residue of last year’s profits

•focuses on source of funds, not their use.

And some more

•much the same result as percentage of forecast sales.

Fixed cost per unit of sales or “Case Rate”

•regards advertising as a fixed cost.

Historical - Maintaining previous spend, sometimes

inflation adjusted.

•assumes they are right.

Match competitors’ spend –

•mostly used to assess direct response.

Marginal return

•mostly used by business to business advertisers.

Cost per customer/capita

The sensible ones

Media weight tests

• looks empirical but difficult to evaluate or replicate.

Modelling

• the most sophisticated approach and seen as a necessary part of the “Object and Task” method.

Objective and Task -

• defines objectives, and works out cost of how to reach them but requires modelling to understand how goals can be reached.

Zero based

• each part of the budget must be justified from zero. It is a more stringent version of “Objective and Task”.

Broadbent's 3 Steps

Review information

Obtain suggestions

Evaluate and consider

1. Review four pieces of information

Brand objectives: what is the advertising task?

Brand budgets: The advertising budget is

part of a greater marketing budget,

revenue – fixed costs =

contribution + adspend + promotion.

Marketing history and forecast: What are the competitors spending?

Advertising effects.

2. Obtain suggestions

He writes a lot about possible

sources

In the end Objective and Task is best

3. Evaluate and Consider

Is the budget affordable?

What can the product afford?

Is it adequate to produce the

necessary results?

If the answers are negative,

go back to stage one .

Other systems

Much the same as Broadbent• Get information from a variety of

sources• Use skill and judgement to set a budget• Work out if it is too little or too much

The process is iterative

Broadbent's Formula

In:a = ln {E(R-V)A^E}/(1-E)• Where:

• a = new adspend• E = elasticity of advertising• R = revenue• V = variable costs• A = old adspend

I think this means…

…adspend should be proportional to margin times elasticity

What is Elastcity?

– The amount one thing changes as a result of another changing

Here– The amount sales change as a result of advertising

High Elasticity– Increasing or decreasing advertising spend changes

sales levels

Low Elasticity– Sales levels are constant in spite of changes in

advertising spend

And so...

“The larger the margin in proportion to the adspend the better the case for more adspend”.

– On this basis, optimal spends on brands within a portfolio, products within a brand or countries across a single brand should be proportional to the result of the following for each brand or country.

Margin/Spend x Elasticity

– Put more simply, money should be put behind those brands that will give a good return on investment, bearing in mind the possible cannibalisation effects of increasing adspend.

The Exceptions...

There are three exceptions to this, which should be treated as special cases, requiring disproportionately large investment: 1. Launches or line extensions where spend cannot be

based on history.2. Brands that are judged to have an as yet unexploited

potential. If each brand is funded solely according to its profit contribution, brands with high potential but modest current sales could be starved of the resources necessary for long term growth.

3. A flagship brand that will have a large positive effect on others in the portfolio. Think iPod and Razr.

Problem is...

... you need to balance time and resources against output

...you need a system which works in the real world

Basic SOV:SOM

John Philip Jones undertook the first serious study of the relationship between Share of Voice (SOV) and Share of Market (SOM) in 1989.

Based on data on 1096 international brands, collected by Jones in 1989 and elaborated upon in Broadbent,

On average, Jones’ data show larger market shares associated with larger shares of voice.

In most sectors, an “equilibrium SOV” is observed. At this level of spend, share of market does not change.

Equilibrium SOV

3

Graphical Representation of Theory

SOV

SOM

Excess SOV (-ve)

Theory predicts this brand will decline

Theory predicts this brand will grow

Equilibrium line (SOM = SOV)

Excess SOV (+ve)

Any deviation from the Equilibrium SOV, i.e. any excess of SOV, will change market share.

The deviation from the Equilibrium, i.e. Excess SOV, = Actual SOV – Actual SOMSo

•If Excess SOV > 0 (i.e. Actual SOV > Actual SOM) then market share will increase•If Excess SOV < 0 (i.e. Actual SOV < Actual SOM) then market share will decrease

The rule of thumb is to spend enough so that

SOV-SOM = 0

across advertised brands.

Basic SOV-SOM

Jones’ findings suggest that, on average, larger brands can get away with spending relatively less on advertising, while smaller brands and new brands, trying to get a foothold in the market, have to invest more than average on advertising.

Recent analysis confirms this to be true of growth as well: smaller brands have to disproportionately increase their share of spend ahead of share of market in order to grow, while larger brands, conversely, have to make relatively smaller increases in share of voice to derive those same market share increases.

Not a Straight Line but a Curve

There is also evidence of threshold effects, where a certain amount of spend is necessary to show any effect, and diminishing returns, where increase in SOV does not create the same increase in SOM. The implication of all this is that the relationship between SOV and SOM is not a straight line.

SOV v SOM for specified brands (2000-2004)

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%

SOV

SO

M

Basic SOV-SOM

Additions to the rule of thumb:– Launch brands will need a larger SOV than SOM– Large brands will probably have a smaller SOV than

SOM

A number of individual differences exist for different product categories, and external factors such as the use of promotions, introduction of new brands and heavy retail brand activities influence this basic relationship in the individual markets.

SOV-SOM Stage 1

First, a scatter plot of share of market v share of voice in a given category in a given market is created.

Then, the “Equilibrium Line”, the best fit curve through the data is estimated.

This will identify threshold and diminishing return levels.

 

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 150

2

4

6

8

10

12

14

16

18

20

SOV

SO

M

Diminishing returns

Threshold

SOV-SOM: Stage 2

“Excess” share of voice is calculated for each point and plotted against Change in Market Share

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 150

2

4

6

8

10

12

14

16

18

20

SOV

SO

M

Diminishing returns

Threshold

Negative SOMPositive SOV

SOV-SOM: Stage 3 The best fit line through the data is estimated. This line represents the responsiveness to media investment and can be used to estimate Excess Share of voice required (and therefore Share of Voice required) for achieving share growth.

Excess Share of Voice v Delta SOM

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Excess SOV (t)

Mar

ket

Sh

are

Ch

ang

e (t

+1)

Use this line for budget

setting

SOV-SOM: Stage 4

Repeat these steps for all segments in all markets. Then an understanding of share of voice requirement (and hence investment requirement) for achieving market share gains will be known.

Excess Share of Voice v Delta SOM

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Excess SOV (t)

Mar

ket

Sh

are

Ch

ang

e (t

+1)

Use this line for budget

setting

Weighting SOV:SOM

Methods of using Share of Voice and Share of Market focus on adapting a previous year's SOV based on• Sales objectives• Competitive effects• Halo effect contribution to the brand

Weighting SOV:SOMAn approach is to take and multiply the current year’s SOV by

coefficients:

1. Strategic Coefficient: this is the Brand factor, showing the

contribution of a line or sub-brand to a masterbrand. A high figure

would indicate a large halo effect on the brand as a whole. This

coefficient is usually set between 0.8-1.2.

2. Segment Aggressiveness Coefficient: this coefficient relates the

brand to its competitive environment, giving a single figure to

account for competitive media weight in the segment and the

number of competitors. Again, this coefficient is set between 0.8-

1.2.

Weighting SOV:SOM

Further coefficients may be used to describe such things as cannibalization effects from specific lines and brands where a negative Strategic Coefficient would not be appropriate.

This is then subjected to a “reality check”, assessing whether the budget is affordable and will achieve the desired result.

Failing these tests requires a reassessment of the coefficients.

Using SOV/SOM

The process for using a SOV/SOM approach is:– Set market share objective– Decide on appropriate coefficients/refinements to

basic SOV/SOM calculation – Examine graph of Excess Share of Voice against

Change in Market Share to give increase in SOV needed

– Multiply total SOV required by cost per % SOV– Result is budget required

Regional Testing

– Regional testing can be used to set budgets by testing a potential change in marketing activity against a sales – or other KPI - target

– It is particularly useful where there is a new factor or a lack of historical data, for example

• Media changes• New products• Price changes

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Some Rules of Thumb

1. A test region should represent at least 10% of sales and should be analysed against– a control region (either the rest of country, or a similar consumer

landscape and size to the test region)– a control period

2. Care must be taken to ensure that other factors haven’t changed between the regions or periods

3. If they have changed, an econometric estimation of the demand elasticity of the factor in question is needed to strip out its differential effect from both regions

4. A test can only explain the change in terms of one factor. To change more than one, multiple test regions and different levels of the multiple factors are needed.

5. For proper evaluation of a national test, a robust, high explanation econometric model of sales must be in place that can be updated post-test to measure and report the result

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Some Rules of Thumb

6. For proper evaluation of a national test, a robust, high explanation econometric model of sales must be in place that can be updated post-test to measure and report the result

7. Test only activities/levels that are willing to be implemented

8. Test high enough: at least a 40% increase is recommended – and a secondary test of a 40% decrease

9. A test of less than four weeks is likely to be unreadable. With weekly data, test for 4 to 8 weeks, with monthly data, test for two to three months

10. With advertising typically having a carryover effect of 40 to 80%, the whole effect won’t be seen for at least 4 weeks after the test

Econometric Modelling

– Econometric modelling can provide a basis to some of the techniques described above but also provides a basis for budget setting in its own right

– The output of a model provides demand curve by marketing activity– These can be combined with a likely marketing/media mix to provide an

overall demand curve which can then be used to calculate a budget based on a target KPI

– The same process can also be used to calculate the optimal budget by calculating points of diminishing return for spend on different media

How Does it Work?

– Multiple regression– Dependent variable

– What we want to change – e.g. sales, market share

– Independent variables– The things that cause the change– What we can directly change – marketing mix

(using Adstock)– What we can’t change – competitor activity,

macro factors

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External coverage/PR/WOM

Price Mix/Promotions

Competitors

Availability/Distribution

Economic/Market Trends

New Product/Packaging ChangesAdvertising

Key Metric

Econometrics separates out the impact of all significant factors – builds a recipe from your kpi ‘cake’…

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kpi

Ingredients Product Advertising x mediumSponsorshipDirect MailGiftsTrialLeaflets/CataloguesPRBrand/Halo advertisingPromotionsPricingAvailabilityProduct changesCompetitor distributionCompetitor pricingCompetitor communicationsMarket TrendsSeasonalityEconomic change

...to isolate and quantify drivers of a KPI, e.g. Sales

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Base

Distribution 1Price

discounts

TV1

Distribution 2

PR

Press

TV2

DM

And relate the sales uplift to the investment in each strand to determine ROI

SALES

WEEKS

What econometrics can’t do

– Tell you the impact of something you haven’t done before

– Tell you accurately the impact of doing something at

levels way beyond those already experienced

– Overcome problems with the data

– Always tell you a positive story, it may bring bad news

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What econometrics can do

– Provide accountability

– Objectively and fairly quantify• what is important• when it affects sales (short and long term)• how much it affects sales• factors outside of your control

– Provide starting point • For the strategic planning process• For investment allocation

– country/regional portfolio– brand/product portfolio– Media/communication portfolio

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Rules of thumb

An optimum budget is arrived at by:

• Considering the ad budget as part of the overall company budget.

• Being prepared for an iterative budget setting process.

• Using a defined method.• Backing this up with knowledge from

econometric modelling.

How It Should Work...