This is one of the first and most common questions our clients ask. There are a plethora of trustworthy resources that weigh-in on this subject but, ultimately, the answer is: it depends.
Yes, yes… such a cliché answer, right? We promise to modify that answer by the end of this article, but it really does depend on many things. We would never advise a new business in an unexplored market to funnel millions of dollars into digital advertising for their first year. Yet, we’d certainly have no reservations telling a well-established company like Walmart® to do that. In fact, that’s probably a requirement for a business of their magnitude to continue thriving in today’s world.
For anyone who’s looking for a simple, one-size-fits-all answer; this is what the Small Business Association recommends:
As a general rule, small businesses with revenues less than $5 million should allocate 7-8 percent of their revenues to marketing. This budget should be split between 1) inbound marketing costs (which includes all the channels you use to promote your brand such as your website, blogs, sales collateral, etc.), and 2) outbound marketing (campaigns, advertising, events, etc.).
This percentage also assumes you have margins in the range of 10-12 percent (after you’ve covered your other expenses, including marketing).Small Business Association
Although this recommendation is a fair starting point, we take issue with it because it’s incredibly broad, stifles potential, and indicates that unprofitable businesses shouldn’t spend money on advertising. Believe it or not, a lack of advertising can be one of the few reasons a business remains unprofitable. As such, we’ve provided some additional guidance below for those who are interested in a perspective other than the Fed’s.
Understand the difference between your budgets for marketing, advertising, and ad spend.
Many people think these three terms are interchangeable, which is evidenced by how commonly they’re misused in regular discussion. Although they are related with one another, it’s important to know the difference in order to understand the recommendations in this guide.
What is a marketing budget?
A marketing budget is the total amount of money you, or your business, sets aside for all marketing-related expenses. This can include branding, graphics, marketing employees, software, etc. The marketing budget is the overall sum of all inbound and outbound creative expenses.
What is an advertising budget?
The advertising budget is just one category of expenses within your marketing budget. This budget usually pays for media buying/creation, ad agency services, and the base cost of running ads on each respective platform.
What is a budget for ad spend?
In the same way an advertising budget is just one category of the marketing budget, ad spend is just the portion of your advertising budget that’s reserved exclusively for ad distribution. Advertising platforms such as Facebook or Google charge everyone the same amount to run ads, so ad spend excludes the cost of media creation, agency services, etc.
An agency’s responsibility is to make your ad spend produce a substantially better return than you could on your own. Remember, they’re subject to the same bidding controls as every other ad account, including yours. The cost to hire an agency is a different piece of your marketing budget.
If you hire an agency, it’s important to remember the agency’s return on ad spend should be compared to your personal return on ad spend (not your return on the total advertising budget). Otherwise, you’re comparing two different things.
Finding the right ad budget
For the purpose of this guide, we’re going to assume you have a decent grasp on your company’s average net monthly profit (or loss). When you’re trying to determine how much money to budget for digital advertising, you need to consider the following factors:
- How much money is available to put towards ad spend?
- How established is your business?
- Where is your service area and how large is it?
- What is your company’s maximum output capacity?
- What goal(s) do you hope to accomplish from advertising?
- Do you know if those goals can be accomplished by ads alone?
- Do you know your historical conversion rate, cost per acquisition (CPA), and average customer value?
Answering these questions is an important step in ensuring that you don’t overspend (or underspend) on ad distribution and will help you get a lot closer to finding a realistic budget for advertising.
Always error on the “safe” side but spare no expense to become profitable
The first thing you need to know is what’s at your disposal. Will you pay for ads with money you’ve saved, your monthly revenue, or some combination of both? If your business isn’t profitable, it’s operating on borrowed time (and money), meaning that your top priority is to reverse that trajectory as soon as possible. Is advertising part of that plan? If not, when – and how – will you become profitable?
Otherwise, you should have some idea of how much profit your business makes on a routine basis. Your ad budget will eventually need to be funded solely by your recurring profits if you want to scale your business.
Plan to run advertisements for at least 3+ months
We only encourage paying for ads with money you’ve saved if it’s to kickstart an all-new strategy that will reasonably become self-sustainable within a few months. This means that the revenue generated from your ads should fully pay for the amount you’re spending on them by the end of the third month. Keep in mind, this doesn’t apply to inbound advertising (e.g. Google Search) because those ads only appear to those actively looking for products/services you sell.
Why three months..? Because very few customers commit something to memory the first time they see it – especially something like a small business. You live and breathe your brand while others, quite frankly, don’t even know that it exists. How often do you see a commercial for the first time and instantly buy the product? Probably never. That’s why even the best ad campaign will take a month or two to establish familiarity. This is a process known as building brand awareness and it’s a critical part of every customer journey.
Once people have become familiar with your product or brand, you’ll start seeing the results flood in. In short, there’s not much reason to start advertising if you aren’t going to commit to the campaign long enough for it to mature.
Forecast the budget you’ll need to reach maximum capacity
When your company is profitable, your main responsibility while calculating your ad budget is to determine how much business you can acquire without leaving money on the table. You can only leave money on the table in one of two ways:
- Having idle resources by growing slower than you’re capable of.
- Turning away customers because you grew faster than you could handle.
To properly forecast the budget needed to reach (and sustain) maximum capacity; you need to know your company’s max monthly output, the amount of organic business it receives, and its average cost per acquisition (CPA) of a customer from advertising. Just so you know, organic business in this context is any sale that wasn’t a result of advertising. These metrics should all be available after a few months of running ads.
Ad Spend = (Max Production Capacity – Units Sold Organically) x CPA
Ad Spend = (Max Sales Capacity – Organic Sales) / CPA
Using these simple formulas, you can set your ad spend to an amount that will bring your sales to the maximum your business can fulfill without needlessly wasting money on ads. This will give you an opportunity to focus on scaling your business by increasing your maximum capacity with additional employees, facilities, etc.
The built-in handicap that can’t be ignored for self-managed ad accounts.
You’re probably somewhat interested in running digital ads if you’re reading this article. As you might’ve guessed, a professional advertising team can almost certainly produce better results than a non-professional.
With that said, you also have to recognize that people running their own ads have a tremendous advantage over anyone they hire to manage them. Why..? Because you have to pay whoever manages them, of course. This means that anyone with a low budget for ad spend should manage their ad account themselves. Seriously. Here’s why:
Let’s say you’ve been spending $1,000 per month running your own ads that consistently return $1,000 in sales… Hoping for better results, you hire someone for $500 per month to manage the rest of your $500 advertising budget. Now, most professionals can create ads that are at least 2x more effective than non-professionals. However, that would only break-even with your original strategy because you cut your budget for ad spend in half. The person you hired needs to be 3-4x more efficient than you to produce a noticeable difference, which isn’t really a fair comparison.
“So – I guess I should just manage the ads myself, then?”
Well… the story is different with an equal budget. You’ll notice far more desirable returns if whoever you hired works with the same budget you gave yourself. In that case, you’d see a return of $2,000 on your $1,500 investment – which would make you profitable for the first time! As you can see, low budgets for ad spend have no place in a professional/agency setting.
“What’s considered a low budget?“
Any amount that’s less than (or equal to) what you’re paying someone else to manage the ad account.
Determine your ad spend budget
Now that you’re familiar with some of the basic mechanics that impact the efficiency of digital advertising, you can set your budget for ad spend from an educated perspective. The only question that remains is: Who is going to manage your ad spend?
The minimum you should budget for ad spend if you manage the ad account yourself:
There is nothing that obligates you to spend money on digital ads. However, our best advice is to budget enough towards ad spend to generate at least 30 conversions per month. This recommendation is actually provided by Facebook and Google because that’s the threshold where your data becomes normally distributed, statistically-speaking, which matters because the algorithms that optimize ads will use that data to improve your performance.
The minimum you should budget for ad spend if you hire an expert or an agency:
The amount you’re paying to have them managed.
Remember: we’re talking about ad spend, not your entire advertising budget. If you pay an expert $1,000/month to manage your ads, be prepared to commit an additional $1,000/month towards the platform(s) being used. This reasoning comes from the simple fact that, in order to break-even, an expert will still have to perform 2x better than you. However, a good agency can usually produce anywhere from a 4-16x return on ad spend.
The maximum you should budget for ad spend in any scenario:
The budget required to reach maximum capacity.
Look… we love a good flex as much as anyone, but running ads for something that’s sold-out is just plain stupid. The goal here is to get as much business as you can handle for the least expense possible. Once you’re at maximum capacity, it’s time to focus on increasing those limits.
Still uncertain what your ad spend budget should be? Get in touch with us and we’ll have a professional marketing consultant make some recommendations tailored to your brand.