When companies set their promotion budget which method uses the previous years percent of sales?

Several methods are used for setting advertising budget. Depending upon internal situations of the company, the suitable method is followed. Every method has its merits, demerits, and applicability.

Commonly practiced methods have been briefly discussed in this part:

1. 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. 300000 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.

Merits:

The method offers following merits:

(a) It is based on sales volume. Therefore, cost of advertising can be offset against profits earned from the sales. It satisfies financial management.

(b) This method encourages marketing manager to think in terms of relationship between promotional costs, selling price, and profits per unit.

(c) It maintains competitive parity. All firms in the industry spend approximately the same percentage of sales for advertising.

(d) It keeps the company in constant touch with the sales target to be achieved.

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.

(e) It is, to some extent, inflexible.

(f) It is assumed that only advertising affect sales. It is erroneous.

2. Objectives and Task Method:

This is the most appropriate ad budget method for any company. It is a scientific method to set advertising budget. The method considers company’s own environment and requirement. Objectives and task method guides the manager to develop his promotional budget by (1) defining specific objectives, (2) determining the task that must be performed to achieve them, and (3) estimating the costs of performing the task. The sum of these costs is the proposed amount for advertising budget.

The method is based on the relationship between the objectives and the task to achieve these objectives. The costs of various advertising activities to be performed to achieve marketing objectives constitute advertising budget.

Under this method, following steps are to be followed to set advertising budget:

1. Determine main objectives of marketing department.

2. Set advertising objectives in terms of sales, profits, brand loyalty, competitive stability, etc.

3. Determine advertising task in terms of various advertising activities required to be performed to achieve the advertising objectives.

4. Estimate cost of each advertising activity for the defined period.

5. Make sum of costs of all the activities. It is the estimated amount for advertising.

Thus, advertising budget is set on the basis of the objectives a company wants to achieve and in what way it wants the objectives to be achieved. This method is logically consistent and practically applicable for all the companies. The method emphasizes on actual needs of the company. It is considered as a scientific method to set ad budget.

3. Competitive Parity Method:

Competition is one of the powerful factors affecting marketing performance. This method considers the competitors’ advertising activities and costs for setting advertising budget. The advertising budget is fixed on the basis of advertising strategy adopted by the competitors.

Thus, competitive factor is given more importance in deciding advertising budget. For example, if the close competitors spend 3% of net sales, the company will spend, more or less, the same per cent for advertising. Here it is assumed that “competitors or leaders are always right.” If not followed carefully, this method may result into misleading.

It is obvious that a company differs significantly from the competitors in terms of product characteristics, objectives, sales, financial conditions, management philosophy, other promotional means and expenses, image and reputation, price, etc.

Therefore, it is not advisable to follow the competitors blindly. Marketing/advertising manager should take competitors’ advertising strategy as the base, but should not follow as it is. The advertising budget must be adjusted to the company’s internal and external situation.

Limitations:

Manager must be aware of following limitations of the competition parity method:

(a) In case of a new product, the method fails to guide for deciding on advertising budget.

(b) It is difficult to know in which stage of life cycle the product of close competitor is passing through.

(c) Company differs in terms of sales, profits, challenges, financial conditions, and so on. To follow competitors directly may be erroneous.

(d) Advertising is not the sole factors that affect the sales; interplay of many factors determines sales.

(e) In case, when there are many competitors, it is difficult to decide as to whom the company should follow.

(f) The method is followed only when there are dominant competitors. In absence of competition, the method cannot be used.

(g) The method can make a sense only to followers and challengers. It is not applicable to a market leader.

4. Affordable or Fund Available Method:

This is, in real sense, not a method to set advertising budget. The method is based on the company’s capacity to spend. It is based on the notion that a company should spend on advertising as per its capacity. Company with a sound financial position spends more on advertising and vice versa.

Under this method, budgetary allocation is made only after meeting all the expenses. Advertising budget is treated as the residual decision. If fund is available, the company spends; otherwise the company has to manage without advertising. Thus, a company’s capacity to afford is the main criterion.

Limitations:

Following are the limitations of the method:

(a) The method completely ignores the role or need of advertising in the competitive market environment.

(b) In long run, it leads to uncertain planning as there is no guarantee that the company will spend for advertising.

(c) Except company financial position, other factors like company’s need for advertising, consumer base, competition, and so forth are ignored.

(d) This method only guides that a company should not spend beyond its capacity.

(e) This is not a method in real sense.

(f) There is possibility of bias in deciding advertising amount.

5. Expert Opinion Method:

Many marketing firms follow this method. Both internal and external experts are asked to estimate the amount to be spent for advertisement for a given period. Experts, on the basis of the rich experience on the area, can determine objectively the amount for advertising. Experts supply their estimate individually or jointly.

Along with the estimates, they also underline certain assumptions. Internal experts involve company’s executives, such as general manager, marketing manager, advertising manager, sales manager, distribution manager, etc.

Whereas external experts involve marketing consultants, dealers, suppliers, distributors, trade associations, advertising agencies, and other professionals related to the field. Marketing consultants and advertising agencies provide such services on professional basis.

Advertising budget recommended by external experts is more neutral (bias-free) and, hence, is reliable. Experts considers overall situation and give their opinion on how much a company should spend. Mostly, the experts consider all the relevant factors related to advertising while deciding on advertising budget.

Merits:

Expert opinion method offers following merits:

(a) The estimates tend to be more balanced as various executives and experts are involved.

(b) The budget is more accurate and realistic because the internal executives are well aware of company’s strengths and weaknesses.

(c) It is the only option when a company is new, having no past experience.

(d) External experts tend to be more neutral as they are external to organisation

Demerits:

However, the user must be aware of following possible demerits:

(a) It is not a scientific method. Personal value, experience, and attitudes play vital role.

(b) It is difficult to fix responsibility of the final estimates as many experts contribute to budget estimates.

(c) External experts are not fully aware of the company’s marketing situations.

(d) When more internal experts are involved, it may deteriorate relation due to possible conflicts or lack of consensus.

(e) Possibility of prejudice or bias cannot be ignored.

(f) All opinions, right or wrong, are given equal importance

6. Other Methods:

There are some other methods used for setting advertising budget.

They have been listed below:

i. Arbitrary Allocation Method

ii. Profit Maximization Approach

iii. Incremental Method

iv. Sales Force Opinion Method, etc.