Rich Harshaw, the author of “Monopolize Your Marketplace,” says, “Any dollar spent on advertising and marketing should come back to you — and bring some friends with it.”
So let’s take a few minutes and talk about how to figure out how much money you should spend on advertising. There are many who tell you a “rule of thumb” is 4 percent of gross sales for insurance or 8 percent of gross sales for wineries, or 10 percent of gross sales minus rent for retail.
I am of the opinion your advertising budget should be as much as possible as long as the return on investment (ROI) is positive. These “rules of thumb” are for those who don’t take the time to calculate what the true ROI is on their marketing and advertising dollars.
When I have recommended a specific budget for advertising in a certain media for a specific market to some clients, they have reacted with sticker shock. For example a 60-second radio spot on a popular San Francisco station can cost $2,500, or a 6-inch ad in a local paper costs $2,000. But it is not what the ad costs that matters — it is ROI on the ad that matters. If you spent $40,000 on a magazine ad that brought you $50,000 of business, did it cost too much? NO!
Let’s break this down into a few simple steps. First, you need to know how much profit you make on each sale. For example, if you buy something for $50 and sell it for $100 your gross profit is $50. The second thing you need to determine is your closing ratio. For example, if on average you close one sale for every four people who inquire, you have a 25 percent closing ratio. If 9 out of 10 buy, you have a 90 percent closing ratio.
Next, you must figure out what your break-even is. You calculate this by taking the cost of the ad and dividing it by the amount of gross profit per sale. For example, if the ad cost $1,000 and your average gross profit is $50, that means you have to make 20 sales to make back the $1,000. That is your break-even point.
Lastly, you need to figure out how many leads you need to generate from the ad to break even. In this example we know our closing ratio is 25 percent so we need 20 sales to break even – so we need 80 leads to break even on our $1,000 ad. If our ad generates 160 leads you will cover your break-even and have a profit of $1,000. That’s an ROI of 100 percent. The key is obviously tracking your results so you know from where your leads come.
You have other costs of doing business that come out of the net revenue, but your marketing spend should not be dependent on those. It should be based on the ROI.