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|CHAPTER 14 Engaging Customers and Communicating Customer Value 461
of my advertising is wasted, but I don’t know which
half. I spent $2 million for advertising, and I don’t
know if that is half enough or twice too much.” Thus,
it is not surprising that industries and companies
vary widely in how much they spend on promotion.
Promotion spending may be 10–12 percent of sales
for consumer packaged goods, 20 percent for cosmet-
ics, and only 1.9 percent for household appliances.
Within a given industry, both low and high spenders
can be found.15
How does a company determine its promotion
budget? Here, we look at four common methods used
to set the total budget for advertising: the affordable
method, the percentage-of-sales method, the competitive-
Setting the promotion budget is one of the hardest decisions facing a parity method, and the objective-and-task method.
company. Coca-Cola spends hundreds of millions of dollars annually, but Affordable Method
is that “half enough or twice too much”?
Some companies use the affordable method: They
Associated Press set the promotion budget at the level they think the
company can afford. Small businesses often use this method, reasoning that the company
Affordable method cannot spend more on advertising than it has. They start with total revenues, deduct operat-
ing expenses and capital outlays, and then devote some portion of the remaining funds to
Setting the promotion budget at the level advertising.
management thinks the company can Unfortunately, this method of setting budgets completely ignores the effects of pro-
afford. motion on sales. It tends to place promotion last among spending priorities, even in
situations in which advertising is critical to the firm’s success. It leads to an uncertain
annual promotion budget, which makes long-range market planning difficult. Although
the affordable method can result in overspending on advertising, it more often results in
underspending.
Percentage-of-sales method Percentage-of-Sales Method
Setting the promotion budget at a certain
percentage of current or forecasted sales Other companies use the percentage-of-sales method, setting their promotion bud-
or as a percentage of the unit sales price. get at a certain percentage of current or forecasted sales. Or they budget a percentage of
the unit sales price. The percentage-of-sales method is simple to use and helps manage-
ment think about the relationships between promotion spending, selling price, and profit
per unit.
Despite these claimed advantages, however, the percentage-of-sales method has little
to justify it. It wrongly views sales as the cause of promotion rather than as the result. Al-
though studies have found a positive correlation between promotional spending and brand
strength, this relationship often turns out to be effect and cause, not cause and effect. Stron-
ger brands with higher sales can afford the biggest ad budgets.
Thus, the percentage-of-sales budget is based on the availability of funds rather than
on opportunities. It may prevent the increased spending sometimes needed to turn around
falling sales. Because the budget varies with year-to-year sales, long-range planning is dif-
ficult. Finally, the method does not provide any basis for choosing a specific percentage,
except what has been done in the past or what competitors are doing.
Competitive-parity method Competitive-Parity Method
Setting the promotion budget to match
competitors’ outlays. Still other companies use the competitive-parity method, setting their promotion bud-
gets to match competitors’ outlays. They monitor competitors’ advertising or get industry
promotion spending estimates from publications or trade associations and then set their
budgets based on the industry average.
Two arguments support this method. First, competitors’ budgets represent the collec-
tive wisdom of the industry. Second, spending what competitors spend helps prevent pro-
motion wars. Unfortunately, neither argument is valid. There are no grounds for believing
that the competition has a better idea of what a company should be spending on promotion
than does the company itself. Companies differ greatly, and each has its own special promo-
tion needs. Finally, there is no evidence that budgets based on competitive parity prevent
promotion wars.
