Here are three steps to identifying the budget allocations that maximize returns.
With budgets under increasing pressure, marketers must allocate every dollar with precision and purpose.
Often, however, budget managers feel tied down by expectations from marketing managers, commitments to sponsorships, and upfront media buys. With little latitude for significant changes to their budgets, they carve up spending by business-unit size or simply tweak last year’s plan.
When allocating budget dollars, most marketers use three factors: spend criteria (e.g., sales, profit, market share, competitive intensity); weights and guardrails (e.g. minimum/maximum thresholds, weighting of criteria); and allocation unit (e.g. market, product, brand, etc.).
The problem is that budgeting criteria are often retrospective and are not aligned within the organization. The CEO may be focused on recent sales growth or how to increase EBITDA, for example, while the CMO is looking to boost brand-health scores and market share. A lack of alignment on allocation metrics usually leads to a mindset of “Let’s stick to what we’ve done before.”
Meanwhile, guardrails for spending and the weight given to any one criterion (sales, market share, etc.) are often determined by instinct rather than by a detailed understanding of business drivers. Added to this, allocation units are often broad, and budget managers don’t drill down to uncover pockets of prospective growth at, for example, the sub-brand or micro-geography level. What companies need is an analytical, forward-looking approach that allocates marketing dollars to customer segments as well as products or geographies that have the highest growth potential rather than to those that have traditionally performed well.
Here are three ways to improve allocation logic:
Blend corporate finance and marketing thinking. Instead of looking at inputs like market share or competitive pressure (share of voice) to inform budget allocations, look down the road to ROI drivers.
One auto OEM (original equipment manufacturer) that we worked with used corporate-finance principles— market growth, competition, and internal economics—to project future profit pools for brands and geographies and made a base allocation for each of its regional markets. It then tweaked the budget according to its business goals in a given region and its related marketing needs, such as the launch of a new product or the need to increase brand share. Allocations were further refined to reflect the profit feedback loop or factors specific to a given region, such as the ratio of share of voice to share of market.
The result? About a quarter of the overall marketing budget was allocated to a few key regions in order to meet business goals. The marketing team got better support from management for future budget allocations, and the marketing budget as a whole was much better aligned with the organization’s strategic direction.
Similarly, a global consumer-electronics company used discounted cash-flow techniques to estimate the value of each of its businesses and make initial allocations of marketing spend. The company then adjusted these allocations for business objectives, such as revenue or margin goals for a particular region. As a result, it reallocated about 20 percent of its marketing funds, compared with an average of 12–15 percent it would have reallocated using traditional models.
Engage the organization around facts, not feelings. When it comes to judging how to weight a given criterion or set guardrails for spending, sophisticated regression models beat gut feeling every time.
Here’s one example: A telecom company looking for a fact-based method for allocating discretionary spending to particular regions recently tested 60 drivers of business performance, including brand-specific characteristics, external drivers, and competitive intensity. It then applied linear regressions to test model accuracy and the relative influence and statistical significance of each driver. It found that it could fine-tune its marketing allocations by using a combination of internal and external drivers, and as a result, ended up shifting about 30 percent of its marketing dollars from large, saturated markets to small markets with greater opportunities for growth. Moreover, by using the regression-based model, it was able to increase customer acquisitions by 3 percent.
In another instance, a European retailer that frequently had to increase local media advertising in order to maintain sales decided to adopt a granular approach. It enlarged its focus from 200 cells to about 2.4 million, each including household data (socio-demographics, income, and amount and frequency of customer purchases by retail category). The organization then matched these cells to a broad media database to identify the best marketing vehicles for each.
As a result, the organization reallocated the entire advertising budget from roughly defined regions to a micro-cell level and put sales growth back on track. In addition, the match with target-group criteria rose 150 percent, and spending on leaflet distribution dropped 30 percent.
Stage the implementation. Don’t go cold turkey. A drastic budget shift in one year could complicate vendor relationships and marketing activities. Your organization may have product-launches or campaigns it cannot alter. Budgeting shifts can and should be phased in through pilot programs that offer early evidence of success and learnings along the way.
One option is to set caps on budget reallocation. One consumer-electronics company, for example, made sure that no business unit's budget was reallocated by more than 30 percent in the first year. You can also earmark a percentage of funds for marketers to use in response to marketplace developments. Select a handful of brands or markets for a pilot, set clear ROI goals—for example, a lift in sales or margins for Brand A—and establish a feedback loop from markets to the management, where budgeting decisions are made. Measure performance against those goals. And if the pilot works, scale up.
Traditional budgeting approaches have been stretched to their limits. Organizations must migrate toward more granular, analytical, and forward-looking approaches if they want to make their dollars work for them.