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Promotion - the Advertising Budget

Author: Jim Riley  Last updated: Sunday 23 September, 2012


A famous comment usually attributed to Lord Leverhulme goes:

“I know that half of my advertising budget is wasted, but I’m not sure which half”

It is notoriously difficult to measure the effect of advertising on a business’ sales. Advertising is just one of the variables that might affect sales in a particular period. These include:

• Consumer and business confidence
• Levels of disposable income
• Availability of product (e.g. does the retailer actually have stock to sell?)
• Availability of competing products
• The weather (often blamed by retailers for poor sales!)

How can a business know whether a specific advertising campaign was effective?

As a percentage of sales, advertising expenditure varies enormously from business to business, from market to market. For example, the leading pharmaceutical companies spend around 20% of sales on advertising, whilst business such as Ford and Toyota spend less than 1%. An average for fast-moving consumer goods markets (“FMCG”) is around 8-10% of sales.

In practice, the following approaches are used for setting the advertising budget:

Approaches to setting the advertising budget

Method (1) Fixed percentage of sales

In markets with a stable, predictable sales pattern, some companies set their advertising spend consistently at a fixed percentage of sales. This policy has the advantage of avoiding an “advertising war” which could be bad news for profits.

However, there are some disadvantages with this approach. This approach assumes that sales are directly related to advertising. Clearly this will not entirely be the case, since other elements of the promotional mix will also affect sales. If the rule is applied when sales are declining, the result will be a reduction in advertising just when greater sales promotion is required!

Method (2) Same level as competitors

This approach has widespread use when products are well-established with predictable sales patterns. It is based on the assumption that there is an “industry average” spend that works well for all major players in a market.

A major problem with this approach (in addition to the disadvantages set out for the example above) is that it encourages businesses to ignore the effectiveness of their advertising spend – it makes them “lazy”. It could also prevent a business with competitive advantages from increasing market share by spending more than average.

Method (3) Task

The task approach involves setting marketing objectives based on the “tasks” that the advertising has to complete.

These tasks could be financial in nature (e.g. achieve a certain increase in sales, profits) or related to the marketing activity that is generated by the campaigns. For example:

• Numbers of enquiries received quoting the source code on the advertisement
• Increase in customer recognition / awareness of the product or brand (which can be measured)
• Number of viewers, listeners or readers reached by the campaign

Method (4) Residual

The residual approach, which is perhaps the worst of all, is to base the advertising budget on what the business can afford – after all other expenditure. There is no attempt to associate marketing objectives with levels of advertising. In a good year large amounts of money could be wasted; in a bad year, the low advertising budget could guarantee a further low year for sales.

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