September 2009

Issue #13

How Much Can You Spend on Marketing?

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 you can 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.

1. Start with the average value of your sale.  To simplify, in our example your product or service sells for $1,000.
2. 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.
3. Next, include overhead (rent, salaries, office expenses, telecommunications, etc.) as a cost.  For our scenario let's assume these costs add up to $100.
4. 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)
5. 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)
6. 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.
7. 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?

About Business Mastery with John Lafferty

Every other month, Business Mastery provides financial tools that improve bottom-line results and build business equity.

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