Ad Spending: A Primer

The advertising budget is a residual expense. This means that every additional dollar that is spent on advertising comes straight out of the profit. Also, if advertisements are done cheaply, it straight away impacts the bottom line. This is the reason why fourth quarters traditionally have lowest advertising spends. If companies know that they are going to miss their sales targets, they try to cut down on planned advertising expenses so that the profit remains unaffected.

In this article, we will understand more about ad spending and how it impacts the sales of a company.

Common Pitfalls in Ad Spending

  • The most common method of accounting for advertising is to allocate the brand’s advertising budget amongst the SKU’s sold. Hence, a few cents or dollars are apportioned to each SKU being sold. The problem is that this method does not provide the feedback necessary to improve the process.

    The company is not able to determine whether its ad spending is sufficient. Since there are no precise metrics available to measure the impact of advertising dollars on the sales generated, the result is a black box. Companies keep spending huge sums of money on ad budgets because they believe that these budgets contribute to sales. However, they have no proof or no way to determine whether this belief is the actual truth.

  • Advertisers believe that the benefits of advertising only accrue in the long term. However, they warn against cutting the advertising spends in the short term as well. The metric most commonly cited to make this argument is the advertisement spending to sales ratio.

    In many cases, this ratio has an elasticity of greater than one. This means that a dollar spent on advertising creates more than a dollar in sales. This also means that if advertising spends are reduced, the result is a disproportional drop in sales. However, the problem with this method is that it ties the efficiency of the ads with the money spent.

    However, nowadays, online marketing has evolved. This is allowing companies to spend less money on ads and yet be more effective. This method of analysis, therefore, disregards the productivity gains and compels companies to be inefficient and continue spending more.

  • There is a lack of tools which provides real-time data about the ad spends as well as the benefit that they generate. Most tools look at the situation after a time lag. There is a need to obtain real-time feedback so that actions can be taken proactively and not retroactively.

Alternative Ways to Gauge the Efficiency of Ad Spends

Another way to gauge the efficiency of advertising spends is to compare the share of voice that a brand generates to its market share. Note that the metric does not involve monetary terms. Instead, it involves share of voice. Hence, if a brand is able to generate more impact with a lesser budget, this act is appreciated by this metric.

The rationale behind this is that similar brands have similar cost structures in the market. Also, since markets tend to be oligopolistic it is easy to determine the share of voice generated by other companies as well. Hence, a comparison is enabled between the advertising effort and the outcome in the form of sales. This allows companies to benchmark against each other. This benchmarking then enables identification and adoption of best practices.

Ad Spends and Lifecycle of the Brand

The introduction of a new brand requires considerable effort. It is for this reason that when new brands are introduced, their market share will be much lower as compared to their share of voice. In fact, sometimes the entire sales revenue is less than the ad spends. Such companies need to aggressively pursue more sales rather than worrying about ad spends.

On the other hand, brands like Kellogg’s, Coca-Cola etc. which have been on the market for long require a stable share of voice. Since these brands are mature, any growth in sales happens because of population growth. Advertising has very less impact here. Hence, companies try to optimize their ad spends instead of aggressively pursuing more sales.

The scale of the brand also has a relationship with the advertising spends. For instance, a bigger brand has to do billions of dollars’ worth of ads. It is for this reason that they tend to get airtime and creative services at a cheaper rate compared to a startup that may have a budget of a few million dollars.

Cutting Down Ad Expenses

Several companies have tried to cut down ad expenses when the brand becomes mature. This strategy is often called milking the brand. This strategy takes advantage of a brand when it is at its peak. As a result, sales are generated without corresponding ad expenses and the company makes huge profits for a short time. However, over time the sales start declining.

Many companies believe in the brand life cycle theory. They believe that the sales of a brand will inevitably decline. Hence, they try to make the most money when the brand is at its peak. This cut in ad spending turns out to be a self-fulfilling prophecy and inevitably leads to the decline.

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