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12: ADVERTISING BUDGET DECISIONS

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ADVERTISING BUDGET DECISIONS
The content of this supplementary note links with Chapter 16 (page 372)
Conceptually, advertising budget decisions can be analysed using marginal rules of economic theory. Expenditure on each method of communication is increased until any further increase reduces profits. Similarly, the allocation of total budget between different methods is such that each instrument is used to the level where all marginal revenues are equal. Economists have developed optimisation rules based on elasticitys (Dorfman and Steiner, 1954), also extended to situations of oligopoly (Lambin et al., 1975), as well as dynamic models to allow for lagged response to advertising (Palda, 1963; Jacquemin, 1973). The derivation of the optimisation rule for the advertising budget is illustrated on Table Web 12.1 (see page 4). As for the selling price, this approach is rarely operational in practice because of all the problems of estimating response functions (see Chapter 15 for further information on this). It is therefore necessary to use other more general methods, and to use only marginal rules as guidelines. When available, the analysis of elasticity can be useful a posteriori to evaluate the effectiveness of advertising and of the sales force. In this section we will examine different methods of determining the advertising budget.

Cost-oriented advertising budgets Cost-oriented budgets are calculated on the basis of cost considerations, without explicitly taking demand reactions into account. There are three types of cost-oriented budget:

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12: ADVERTISING BUDGET DECISIONS

Affordable Break-even Percentage of sales.

Affordable budget Affordable budget is directly linked to the companys short-term financial outlook. Advertising will be appropriated after all other unavoidable investments and expenses have been allocated. As soon as things go badly, this budget can be eliminated, and if cash is abundant then it can be spent. The fiscal system encourages this type of practice, since increased advertising expenditure reduces taxable profit. This is not a method as such, but rather a state of mind reflecting an absence of definite advertising objectives. Break-even budget The break-even budget method is based on the analysis of advertisings profitability threshold. The absolute increase in unit sales and in turnover necessary to recoup the incremental increase in advertising expenditures is simply obtained by dividing advertising expenditure (S) by the absolute gross profit margin or by the percentage of gross profit margin: Break-even volume = S / P-C and Break-even turnover = S/ (P-C/P) For instance, if the gross profit margin is 60, or 30% of the unit price, the absolute increase in unit sales to recoup a 1.5 million advertising budget will be 1,500,000 60

= 25,000 units

and the break-even turnover will be 1,500,000 0.30

= 5,000,000

To determine the percentage increase of sales volume or turnover necessary to maintain the previous level of profit, one can use the following expression: Percentage sales increase = where Q/Q = 100 x S/ (F+S+Profit)

S is the proposed change in budget.

The advertiser can determine by how much sales must increase to retain the same level of profit, and also calculate the implicit demand elasticity to advertising, by comparing expected sales levels with advertising to expected volume without advertising. Using this data, the advertiser can verify whether the proposed budget implies an unrealistic increase in market share given the state of the market, competitors power, etc. The weakness

Market-Driven Management: Supplementary web resource material

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12: ADVERTISING BUDGET DECISIONS

of the method is that it is strictly an accounting exercise, whereas advertising objectives are not necessarily reflected in higher sales in the short-run, even if they have been reached completely. Nevertheless, this type of analysis is useful because the advertiser is encouraged to view advertising as an investment rather than overhead costs. Percentage of sales budget The percentage of sales budget method is used frequently and treats advertising as a cost. In its simplest form the method is based on a fixed percentage of the previous years sales. One advantage of this procedure is that expenditures are directly related to funds available. Another advantage is its relative simplicity. Although this method is quite popular, it can easily be criticised from a logical point of view, because it inverts the direction of causality between advertising and sales. Relating advertising appropriation to anticipated sales makes more sense, because it recognises that advertising precedes rather than follows sales. Nevertheless, this approach can lead to absurd situations: reducing the advertising budget when a downturn in sales is predicted can be damaging, and increasing it when turnover is growing risks overshooting the saturation threshold. In practice, however, it seems that this method is mainly used with the objective of controlling total advertising expenditure at the consolidated level of turnover, in order to keep an eye on total marketing expenditure or to compare with competitors. More refined methods are used when deciding on advertising at the brand level. Cost-oriented advertising budgets are only the first stage of the process of determining the advertising budget. They enable the firm to define the problem in terms of financial resources, production capacity and profitability. As for the determination of prices, these methods must be completed with an analysis of market attitudinal and behavioural responses.

Communication-oriented advertising budgets These approaches emphasise communication objectives and the means necessary to reach them. Two methods can be adopted: Task and objective based on contact, which is defined in terms of reach and frequency Perceptual impact based on a measure of probably impact on attitude.

Task and objective budgeting The task and objective method starts either with an objective of reach and frequency for which a budget is calculated, or with a budget constraint for which the best combination of reach and frequency is sought to maximise total exposure. By trying to maximise exposure, this approach places the emphasis on the first level of advertising effectiveness communication effectiveness while clearly linking the communication objectives to costs.

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12: ADVERTISING BUDGET DECISIONS

The term exposure used in this context has a very precise meaning, because it only refers to opportunity to see (OTS) or to hear (OTH), which does not imply perception. Newspapers only sell OTS to advertisers: a certain number of readers will (in theory at least) have the paper in their hands, but this does not imply that they will see the advertisement, or that they will familiarise themselves with it or assimilate it. The task and objective method ensures the productivity of the budget by searching for the best way to spend the money in the media given the target audience and given an expected creative level of the campaign. For this reason, it is the method widely chosen by advertising agency people. By way of illustration, let us consider the following example: A Company wants to reach women in the 2549 age group. The socio-professional profile is determined by the following criteria: Business Middle management Owners of smallmedium sized companies.

The size of the target population is 3,332,000 women, or 16,7% of women of 15 years old and more. The vehicles are magazines selected for their affinity with the target. The budget is 650 000 francs. The advertising agency has suggested the three media plans presented in Table Web 12.1 (below). For each alternative, the agency has specified the number of ads per magazine, the reach, the frequency, the budget and the Gross Rating Point (GRP). Table Web 12.1 Comparing three media plans
Media Plans Plan 1 Plan 2 Plan 3 Magazine 1 3 (1+2) 4 (1+3) Magazine 2 2 (2) 3 (1+2) Magazine 3 3 (1+2) 4 (1+3) 4 (1+3) Magazine 4 3 (1+2) 4 (1+3) 4 (1+3) Magazine 5 3 (1+2) 4 (1+3) Magazine 6 3 (1+2) 4 (1+3) 4 (1+3) Budget 660,500 652,120 650,30 Reach 67.07% 66.3% 65.4% Frequency 3.7 4.1 3.7 Gross Rating Point 248.2 271.8 242.0 3 (1+2) = 3 ads, of which 1 is double page quadrichrome, and 2 are full page page quadrichrome
Source : Troadec (1984, p.47)

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12: ADVERTISING BUDGET DECISIONS

Logically plan 2 will be preferred because it has the highest GRP. The value of this budgeting method is its attempt to search for the best possible allocation of the budget given the profile of the target group and the structure of the audience of each media or vehicle. Another advantage is its simplicity. The major drawback is its systematic overestimation of the number of people reached by the ad. The gap between the number of people exposed and the number of people having perceived the message may be very high. Perceptual impact budgeting Perceptual impact budget is based on psycho-sociological communication objectives. To achieve these objectives, conditions are defined in terms of the means used for example: Media Reach Repetitions Perceptions.

Next, the cost of the various activities is calculated and the total determines the necessary budget. What is sought here is an impact on one of the three components of attitude cognitive, affective or behavioural. It is a much more fundamental approach, based on the learning process (Lavidge and Steiner, 1961) and the resulting hypothesis about the hierarchy of advertising effects (Colley, 1964). The difficulty with it is that the advertiser must be able to link the communication impact to the perceptual impact, and the perceptual impact to the attitudinal impact, and finally to the behavioural response. The problem is stated in the following terms: How many OTS or exposures to the message in a given medium are necessary to achieve, among 60% of the potential buyers within the target group, the cognitive objective of knowing product characteristics, the attitudinal objective being convinced of product superiority and the behavioural objective intention-to-buy? In the task and objective budget example given above, all the women belonging to the target group were simply supposed to be exposed to the vehicle. Using the perceptual impact budgeting approach, this number should be corrected by two factors: The probability of reading (which is, in general, specific to each magazine) An estimate of the ads perception probability (which will be determined by the creativity of the message, its relevance for the target group, its ability to get attention and so on.

This method is much more demanding, but it has the advantage of requiring management and advertising people to spell out their assumptions about the relationships between money spent, exposure, perceptions, trial and repeat purchase.

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12: ADVERTISING BUDGET DECISIONS

Communication-oriented advertising budgeting methods constitute the second stage of the process of determining the advertising budget. They offer a way of explicitly taking into account market response. Because they are mainly based on intermediary objectives of communication, their advantage lies in the emphasis they place on results directly attributable to advertising, and the fact that they allow the advertiser to control the advertising agencys effectiveness. The limitation of these methods is that there is not necessarily any link between achieving the intermediate communicational objective and the final goal of improving sales. One cannot therefore view measures of communicational effectiveness as substitutes for direct measures linking advertising to sales or market share.

Sales-oriented advertising budgets Determining a sales or market share-oriented advertising budget requires knowledge of the parameters of the response function. In some market situations, in particular where advertising is the most active marketing variable, it is possible to establish this relationship and then use it to analyse the effects of various levels of expenditure on market share and profits. Various models of determination of advertising budget exist, the most operational among them being the model by Vidale and Wolfe (1957) and the model ADBUDG by Little (1970). Both models have some strong and some weak points that we shall consider briefly. The contribution of economic analysis will also be reviewed. Budgeting to maximise profit Advertising optimisation rules can be used to verify whether the current level of advertising spending is about right or whether the firm is over-advertising. As for the price optimisation problem, these rules can be used as a guide for the budgeting decision. The normative value of this type of economic analysis is reduced, not only because of the everpresent uncertainty about the true value of the response coefficients, but also because the advertiser faces multiple objectives other than profit maximisation. Also, the advertising quality (copy and media) is taken at its average value, while large differences may exist from one campaign to another. For these reasons, the output of economic analysis should be used as a guideline for advertising budget decisions and be complemented by other approaches. The Vidale and Wolfe advertising model The model developed by Vidale and Wolfe expresses the following relationship between sales (in units or value) and advertising expenditure:

ds S -s = [().(A). ] - (1 - ).(s) dt S
where ds/dt = rate of increase of sales at any time t = sales response constant when q=0

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12: ADVERTISING BUDGET DECISIONS

A s S

= rate of Advertising = company or brand sales = product category saturation level = sales retention rate

In words, within a given period, the increase in sales (ds/dt) due to advertising is equal to: The product of the sales response constant per dollar of advertising when sales are zero and of the rate of advertising during the period (response effect) ... o ... adjusted by the proportion of the untapped market potential (saturation effect) ... ... reduced by the fraction of current sales that will decrease in the absence of advertising because of product obsolescence, competing advertising, etc. (depreciation effect).

This is an interesting model because it takes into account the main features of advertising response functions while explicitly setting out the key parameters to be estimated. By way of illustration, let us consider the following example. Sales of brand X are $40,000 and the saturation level is $100,000; the response constant is $4 and the brand is losing 10% of its sales per period when advertising is stopped. By adopting a $10,000 advertising budget, the brand could expect a $20,000 sales increase. ds/dt = 4 (10,000) (100,000 40,000 / 100,000) 0.10(40,000) = 20,000 One can also state the problem in terms of the advertising budget required to achieve a given sales objective. Referring to Table Web 12.2., the equation has to be solved for A, the advertising budget. The Vidale and Wolfe model does however have some weak points: It does not allow explicit consideration of marketing variables other than advertising, such as price, distribution, etc. It does not integrate competitive advertising and is therefore implemenTable Web only in monopolistic situations. It assumes that advertising merely obtains new customers and increased customer usage is neglected. It does not explicitly consider possible variations in advertising quality, unless one could assume different sales constants per medium or per advertising theme. In some markets, it is difficult to estimate the absolute market potential. It has an interesting conceptual structure, but its range of application is limited.

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12: ADVERTISING BUDGET DECISIONS

Table Web 12.2 Comparing two Advertising Budget Models


The Vidale and Wolfe model ds/dt = ().(A). (S -s / S) - (1-).(s) where ds/dt A s S = sales increase per period = sales response constant when s=0 = advertising expenditures = company or brand sales = saturation level of sales = sales retention rate

Littles ADBUDG model

MS(t) = MS(min) + [MS(max) - MS(min)]


Where MS(t) MS(min) MS(max) Adv

Adv + Adv

= initial market share = minimum market share with zero advertising = maximum market share with saturation advertising = effective advertising (adjusted for media and copy effectiveness) = advertising sensitivity coefficient = constant
Source: Vidale M.L. and Wolfe H.B. (1957) and Little J.D.C. (1970).

The ADBUDG model The ADBUDG model, developed by Little (1970), can be applied to a market where primary demand is non-expansible and where advertising is a determinant factor in sales and market share development. The model establishes a relationship between market share and advertising and assumes that managers are able to provide answers to the following five questions: What is the current level of advertising expenditure for the brand? What would market share be if advertising were cut to zero? What would maximum market share be if advertising were increased a great deal, say to saturation (saturation advertising)? What would market share be if the current level of advertising were halved? What would market share be if the current level of advertising were increased half as much?

The market share level estimates in response to these five questions can be represented as five points on a market share response to advertising curve, as illustrated in Figure Web 12.1 (overleaf).

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12: ADVERTISING BUDGET DECISIONS

Figure Web 12.1 The ADBUDG Model


Static Advertising-Sales Response Curve : Input Data
Market Share Max share at end End share with +50% Adv Initial Share MSt-1 maint adv
t=MSt-1 Status quo share MS

Min share at end

t-1

Time

Market Share MSmax +50% adv. MSt-1


MSmin

Static Advertising-Sales Response Curve : Graphic Representation

Smaint

+50%

Smax

Advertising St

Dynamic Advertising-Sales Response Curve : Graphic Deduction of Retention Rate

MSt-1

l =

2 1

1 2

MSmin

MSt+k

t-1

t+k

Time

Source: Little (1970).

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10

The ADBUDG model has the following mathematical expression: MS(t) = MS(min) + {MS(max) - MS(min)} . where MS(t) MS(min) MS(max) Adv = initial market share = minimum market share with zero advertising = maximum market share with saturation advertising = effective advertising (adjusted for media and copy effectiveness) = advertising sensitivity coefficient = constant

Adv + Adv

The expected market share in any given period is then equal to: The minimum market share (min) expected at the end of the period if advertising is cut to zero (depreciation effect) ... o ... plus a fraction of the maximum market share change due to advertising; this maximum change is equal to the difference between the maximum share expected with saturation advertising and the minimum share expected with zero advertising.

The intensity of the response is determined by an advertising intensity coefficient characterised by two parameters: , which influences the shape of the response function and which is a moderator factor. Both parameters are determined by input data. Effective advertising is given by the following expression: Adv(t) = {medium efficiency(t)}.{copy effectiveness(t)}.{Adv. dollars}

Both indices will be assumed to have a reference value of 1.0. These indices can be determined on the basis of copy testing and media exposure data. This is an interesting model in many respects, and it has most of the features of advertising response functions. Furthermore, it can be easily estimated on microcomputers in interactive mode. Thus, users can test the model themselves without any help from outside experts. These are the models strengths: The model parameters can be estimated either on the basis of management judgements (using the five questions procedure), or through econometric analysis of historical or experimental data. The dependent variable can be sales, market share or measures of cognitive response, like awareness. The advertising input data can be adjusted for advertising quality using indices of media efficiency and of copy effectiveness.

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12: ADVERTISING BUDGET DECISIONS

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It is also possible to add marketing variables other than advertising, which makes the models more difficult to manipulate. The model used is then the BRANDAID model (Little, 1979). The ADBUDG model was initially made essentially for interactive use relying on the decisionmakers subjective judgements. However, experience has shown that this approach is elusive because most decision-makers hold only a small fraction of the necessary information. On the other hand, it forms a useful framework for integrating objective information coming from various sources and for simulating the implications of different advertising strategies on market share and profits (for a similar approach, see Lambin, 1972).

Bibliography
1. Colley, R.H. (1961) Defining Advertising Goals for Measured Advertising Results, New York, Association of National Advertisers. 2. Dorfman P. and Steiner P.O. (1954), Optimal Advertising and Optimal Quality, American Economic Review, Vol.44, December, pp.826-833. 3. Jacquemin A. (1973), Optimal Control and Advertising Policy, Metroeconomica, Vol.25, mai., pp.200-207. 4. Lambin J.J., Naert P.A. and Bultez A., (1975), Optimal Advertising Behavior in Oligopoly, European Economic Review, Vol.6, pp.105-128. 5. Lambin J.J. (1972), A Computer On-Line Marketing Mix Model, Journal of Marketing Research, May, p.119-126. 6. Lavidge R.J. and Steiner G.A. (1961), A Model of Predictive Measurement of Advertising Effectiveness, Journal of Marketing, Vol. 25, October, pp.59-62. 7. Little J.D.C. (1970), Models and Managers, the Concept of a Decision Calculus, Management Science, Vol.16, April, p.466-485. 8. Little J.D.C. (1979), Decision Support for Marketing Managers, Journal of Marketing, Vol.43, Summer pp.9-26. 9. Palda, K.S. (1963) The Measurement of Cumulative Advertising Effects, Englewwod Cliffs, NJ, Prentice Hall. 10. Vidale M.L. and Wolfe H.B. (1957), An Operation Research Study of Sales Response to Advertising, Operations Research, June, pp.370-381.

Market-Driven Management: Supplementary web resource material

Jean-Jacques Lambin, 2007 Published by Palgrave Macmillan