How Much Should Your Marketing Budget Be?
There are several unique factors that go in to deciding your marketing budget. This is how to yield a positive return on investment, regardless of budget size.
Key Takeaways
Knowing your Average Offer Value, Life Time Value, Customer Acquisition Cost, and measuring your return on adspend will determine what the marketing budget should be.
The two methods on determining a marketing budget is the Growth Method and Revenue Method.
So what's your marketing budget?
Logically, you start off with a given budget. Then you create a strategy plan that you could afford. Right? Here is a way to understand, breakdown, and calculate your marketing budget in 4 simple steps:
Determine your average order value. Your marketing budget is a very simple number. But there are other numbers that go into making up your budget. And one of these numbers is average order value. The average order value or AOV is simply the average price a customer pays you for your products or your services. So if you have one product that is priced at $100, then your AOV is $100. But if you have multiple products and multiple services, then getting your AOV can require a little bit more work. The best way to do this is to go back and look at some historical data. So, if you have an established company, you’ll want to take your total revenue and divide that by your total amount of customers.
Total Revenue/ Total Account of Customers = AOV
Determine your lifetime value. Now once you have your average order value or your AOV, then it's time to determine your lifetime value. Now lifetime value or LTV is simply the total amount of revenue or value you receive from your customers. For example, if you have an AOV of $100, and your customer buys from you 10 more times, then your LTV is $1,000. It’s very important to know what's your LTV when you're thinking about your marketing budget. Here's a simple formula for LTV:
LTV = AOV x Purchase Frequency
The goal for most successful companies is to constantly increase the LTV of their customer base. Think about Amazon, for example, their goal isn't to get you to buy one product, but to get you to come back and buy again…. and again… and again.
Determine your customer acquisition costs. Customer acquisition costs, otherwise known as CAC is simply the amount of money that you're willing to pay to acquire a customer. This will help you assess your own risk tolerance. That's because it helps you determine how much money you're willing to burn before you are profitable. This is very important if you're bootstrap or you're taking out personal loans to get your business started because every dollar counts.
On the other hand, it's probably less important if you have some capital from an outside investor who was chasing appreciation instead of profitability. To determine your desired CAC. You must consider all your expenses like staffing costs, product costs, office space shipping, and more. Now sticking with our last example, if your LTV is $1,000 and your expenses is $100, and you want to be at least 10% profitable, then your max CAC is $800. The formula for CAC is simply:
CAC = LTV x Profit Margin.
However, it may take a while to receive that $1,000 so you'll have to burn $800 right now. And even though this is a positive return on investment, you can quickly run out of cash.
Remember, a lower desired CAC shows a lower risk tolerance or a low amount of cash to spend. And a high desired CAC displays a higher risk tolerance or more cash to spend.
Determine your desired return on adspend. Return on adspend or ROA, is simply the multiple of the money that you spend against the money that you make. For example, if you spent $100, and then make $150, then your return on adspend is 1.5. Sticking with our last example, let's say you want to make at least a 20% gross profit margin and your CAC is $800. That means your desired return on adspend will be 1.25. Personally, I like to target a minimum of 1.5 return on adspend. But we've all seen that number be much higher or much lower. So the key is to really think about how much you're willing to burn, especially in the context of the competitive landscape that you're in (your competitor’s prices).
Brining it all together into a marketing budget.
The first thing I recommend is to set an annual marketing budget. That way, you'll have some good data on all the metrics that we just went over. After about a year, you can do your review. During the review, you need to make sure that you are increasing your average order value, your lifetime value, or your return on adspend. Especially, before you decide to make any changes to your marketing budget.
Bringing these metrics into your next marketing budget meeting will definitely impress everyone:
“Hey boss, we increased our AOV by $50, which means we have another $50,000 to spend. If we can take that $50,000 and invest it into customer service then we can also improve our LTV”
Two methods on how to determine a budget.
The first way is what I like to call the growth method. This method is ideal for anyone who's making under $250,000 in annual revenue. At this level, you're likely a 1-3 man show with maybe some affordable contractors. So if you want to grow, then you have a minimum. For now you're just going to focus on growth, I recommend you spend at least $12,000 to $24,000 a year on marketing and advertising. And along the way, make sure you're gaining some traction. That means gaining some data on your AOV, LTV, and return on adspend but not trying to perfect it yet. Then after a year, go back, and look at your results and make some honest conclusions.
The second way to do this is what I like to call the revenue method. This method is ideal for anyone who's making over 250,000 annual revenue. Here's how it works, you will allocate at least 10% of your revenue for your marketing cash. So, if you make $250,000 a year, then 10% of that will give you $25,000 in marketing cash. This is the amount that you can burn each year while maintaining profitability. At this point, you just need to figure out how quickly you want to grow. Remember that your CAC is the money that you're willing to spend to acquire a customer. So sticking with the previous example: if your CAC is $800 and your annual marketing cash is $100,000, then you can expect to acquire about 125 customers a year.
Therefore, the formula for your marketing budget is simply:
Marketing Budget = CAC x Customers
The questions you must ask are: How much do you want to spend to acquire customer? And, how many customers do you want on the context of your marketing burn?
The best way to answer those questions is to know your AOV, LTV, CAC, and along the way, measure your return on adspend.
Here is a bonus tip to help you get started…
Determine your marketing channels.
Certain marketing channels and platforms cost more than others. For example, paid advertising channels like Facebook ads and Google Ads usually cost more than organic advertising channels like Facebook post or SEO. But the trade off here is that organic advertising takes a lot of time before you start seeing results. However, if your CAC is too low, then some advertising channels may be too pricey to start out with thus forcing you and some more organic brand building strategies.
The biggest mistake that I see people make again and again is starting with a marketing channel that won't work long term. Just because you have the money now, doesn't mean you'll be able to scale it out later.