Last month, I touched on how the measure of value is understated against chargeable fees. This led me to realising that almost every company would have an ROI review to help size and optimise their advertising and promotional budgets. The altruistic intent is of course, to primarily ensure the company captures the full, business-building value of earned media value and its impact on the reputation of its brand.
In this day and age, one would have to look closely at the return one gets from digital and social marketing, beyond the limited reach of traditional marketing mix-measurement model and certainly, the advent of digital screens as a brand building tool – blink and you will miss them. That would be the norm.
But how should you set your brand communication budgets and figure out the optimal allocation across your portfolio or support your business units?
One way would be to set a brand marketing communications budget that optimises against marginal return on investment.
So, taking your current plan as the starting point,
If you apply a margin to the sales variation and deduct the cost of the spend, it’s pretty simple to optimise the size of the budget to the point where the last dollar of spend gives the last dollar of profit.
Because it is the marginal returns on investment that matters, we are not interested in a brand’s average payback on the marketing spend. This is because marketing ROI in and of itself is not an especially useful tool. The problem is that while an effective campaign may increase sales, it will not do so in a linear fashion. Sooner or later the law of diminishing returns becomes apparent.
Too high a spend can lead to significant volume gain but at the cost of reduced or even negative ROI. Conversely, too little spend and the campaign might not achieve its full potential in delivering bang for buck. So, what you are really interested in is not the historic average ROI but the shape of the campaign response curve and where your spending puts you on that curve.
Understanding marginal return on investment, the ROI of the next dollar you invest, and figuring out where you sit on the curve is the important first step.
critical considerations when setting the budget
3 critical considerations when setting the budget
One, how much do the margins vary across your portfolio and the products you are mandated to push?
This is usually more important than the differences in effectiveness. Over hundreds of portfolio optimisation projects, we have realised that differences in margin tend to matter far more than differences in campaign response. This is because margin is a linear function, and a highly profitable product will always have an advantage over a less profitable one.
In contrast, campaign response is non-linear which tends to a flat line, so ultimately all brands have quite similar shapes of ad response.
Two, what then is the horizon of payback? And three, how long do you give the marketing campaign to payback?
If you demand the payback to be all in the first year, the budget will tend to be somewhat smaller than if you take a three year or five year view. In terms of sizing budget, it is the horizon of payback that makes the most difference. Yet, it is often the most neglected element. For example, spending more this year may return a negative ROI if only immediate sales or customer acquisitions are considered. But over a 5-year period it may be the most optimised scenario of profit increase as benefits of long-term brand building are realised.
That said, a horizon of longer than 5 years probably makes little sense. This is because when you take into account the time value of money, a dollar received in the future will be worth less than a dollar received today. For example, at a discount rate of 12%, future dollar profits are worth $0.89 in Year 1 and $0.80 when received in Year 2. By Year 6, the future profits would have been discounted by half. In fact, by Year 6 more than half of the infinity cashflows have been achieved.
Within this framework, one approach might be to size a budget to maximise 5-year payback with an objective view that the first year does not return a negative ROI.
What should matter most to you as a brand custodian!
Well, it’s the horizon that we want to measure the payback over that has the biggest influence on sizing a budget. Second most important, certainly for a brand owner, is the variation in margin across products to be advertised or communicated. Third most important is the shape of the campaign response curve and (to know) especially where you are on that curve. What doesn’t really matter? The average return on investment of your marketing communication spend.
The answers to these three questions show that the importance of where you are on the curve, the margin of brands in your portfolio, and the time horizon of payback are the factors that really matter to sizing ad budgets – not typical average ROI payback measures.
It’s important to have this framework right before embarking on econometrics to measure the payback of your communication activities.
At COMMUNICATE, we assist clients in identifying intended outcomes by conducting customised landscape and econometric market-related research and then proposing realignment to meet their business needs. The idea is to make sense of the research, enable our valued clients clarity and to rise above the numerical noise that often arise from deep-rooted analytics and social media listening tools. We do this so that your consumers understand your intended business and brand proposition clearly. If you have been handed a stack of data analytics without identified outcomes, let us help you declutter them!