Tag Archives: Return on investment

Models of budgeting

Return on investment (ROI) seems to be the mare of the strategic communicator. With financial executives constantly concerned that they are not getting enough bottom-line bang for the communicative buck, the burden of proof is often on the communications professional. Whilst the insecurity of what might be lost by not communicating can sometimes warrant expenditures in the here-and-now, harder evidence is usually needed to secure long-term funding.

The problem, then, is one of effect. It is often difficult to prove the (economic) effect of specific communication initiatives, but it is possible to establish a general connection between expenditures and profitability at the level of the over-all communication strategy. Let us look at this general connection before considering the available models for actually determining the right level of expenditures and, hence, establishing the communication budget.

customer equity

The marketing management scholars Roland T. Rust, Katherine N. Lemon and Valerie A. Zeithaml (2004) argue that there is a connection between a firm’s spending on and economic return from marketing efforts at the strategic level. They prove the point by looking at customer equity relative to expenditure, showing that an increase in the over-all budget will also increase each customer’s lifetime value. Thus, they argue that to get a general idea of the ROI of marketing communications, we should not only look at increased sales, but take such issues as brand perception and brand loyalty into account as well. They apply the model to a set of empirical cases, proving that increased spending resulted in increased customer equity in each case.

Strategic communication, obviously, is not equal to marketing communication, but given the inclusion of indirect effects relating to general brand value, we may assume that Rust, Lemon and Zeithaml’s argument applies to communications efforts more generally. However, we may also assume that the positive effect of increasing communication budgets does not go on indefinitely, but rather takes the shape of an S-curve, where increased spending does not take immediate effect, but where each increase will have a relatively large impact once the budget is of a certain size. If one continues to spend more, however, the return will gradually peter out until one reaches the point at which the ROI of extra spending will be zero or, indeed, negative.

Advertising_Curve

The exact saturation point is likely to be highly contextual and can probably only be located empirically, meaning that budgets should constantly be adjusted as organizational goals, market situations and other contextual factors change the demand for and/or restraints on communications efforts.

In the absence of a reliable and stable measure of the optimal communication budget, organizations have employed various models for establishing workable budgets. The Spanish professor of marketing J. Enrique Bigné (1995) provides a useful review of seven such methods:

  • The arbitrary approach
    • Setting the budget arbitrarily may not sound like the most strategic choice and, indeed, this method is not held in high esteem. However, in situations of great uncertainty it can be the only viable route. In such situations, arbitrary budgeting allows for maximum flexibility and adaptability, but it also means one will have to rely on ‘gut feelings’ rather than strict analysis, and it means effects are difficult to predict, let alone measure.
  •  Affordability
    • Affordability is a slightly more sophisticated model than the arbitrary one in so far as spending is now judged against what the organization can actually afford. However, this means increased conservatism and inflexibility as focusing solely on what is currently affordable does not take into account what might be gained from increased investment in communication. If one only spends what one can afford, one may lose out on growth opportunities, but this may be the only viable route for start-ups and small companies until growth has actually set in.
  • Use of previous year’s budget
    • For established organizations in stable markets, using the previous year’s budget to establish the current one may be an attractive alternative to affordability. One already knows what is needed and that it is affordable. However, the assumption that the present (and future) will be like the past, is constantly proven wrong in today’s communications landscape. Further, the model is not very useful if the organization sets new goals nor when its market situation changes.
  • Percentage of sales
    • The percentage of sales method has long been the most common tool for establishing over-all budgets. This is an easy and reliable method for establishing the budget top-down. It is more flexible than the model of using the previous year’s budget, yet guards against over-spending. Still, the method is quite conservative, especially if the set percentage is based on the sales of the previous year. To allow for a change in strategic goals, one may set the percentage in relation to projected sales, but this incurs the risk of not reaching the new goals.
  • Competitive parity
    • The principle of this method is that one should spend as much on communication as one’s competitors. Rather than setting the budget relative to the previous year’s spending or based on a percentage of (previous or projected) sales, then, this method looks to the environment for an indication of adequate expenditure. Taking the actions of others into account is important, but competitive parity only works if one can find out what competitors are actually spending, if the competitors know what they are doing and if all actors in a market have the same objectives. It is quite unlikely that any, let alone all, of these criteria are ever fulfilled.
  • Share of voice
    • Share of voice also begins with an analysis of what competitors are doing, but sets goals relative, rather than equal to this. The starting point is a decision on how ‘loud’ the organization should be in comparison to other actors in a market, followed by an analysis of what it will take to get the desired share of voice. This method is problematic in two respects; first, share of voice does not equal market share and, second, in today’s media landscape it is increasingly difficult to control who gets to speak how much – and speaking is not the same as being heard. One can no longer ensure a share of voice through paid media exposure. Instead, one has to partake in a process, the costs of which are hard to set – and the effects of which are impossible to predict.
  • Objectives and tasks
    • This leaves us with the objectives and tasks method in which the budget is built bottom-up based on the specific communication tasks deemed to be necessary to reach set objectives. This is in many respects the most sophisticated model as it actually links the return of the communication with the investment needed. Thus, one may use the objectives and tasks method to determine the cost of initiatives aimed at, say, increasing sales and then calculate whether the return is larger than the investment. However, such estimates provide no guarantee that the tasks will actually fulfil the objectives. Further, if all tasks are to yield a return, the model becomes a restriction rather than a help as it limits communication initiatives to those that can be deemed directly profitable. Finally, establishing a full communication budget based on the objectives and tasks model is an extremely laborious process. In sum, this method is the most appropriate for campaigns and other identifiable communication initiatives, but it can hardly stand alone at the level of the communication strategy.

None of the existing models, then, are perfect, meaning that most organizations are likely to use a combination of two or more methods – and rightly so. First, some top-down tool for setting the general budget is necessary (e.g. through the percentage of sales methods); second, a bottom-up method of establishing the cost of specific initiatives is also needed (thus, objectives and tasks should be considered); third, taking the communication efforts of competitors into account is also important (meaning some notion of what is needed to gain the desired share of voice is required); fourth, other environmental factors could change the situation rapidly and must constantly be monitored (some degree of arbitrariness, then, must always be accepted).