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BrandingBlog SoundBites is a new podcast. In contrast to my rambling weekly talk-show format, these are concise topics that will average about 10-minutes. I’m using the Shortcut Blogging method. I hope you find them useful. Please let me know.

A full transcript follows…

Our first Soundbite is a lesson in how to set an ad budget

Chris: Welcome to Branding Blog SoundBites, we’re with Dave Young from BrandingBlog.com and a Wizard of Ads Partner.

Dave: Hi, Chris.

Chris: How are you doing?

Dave: I’m doing great today, thanks.

Chris: I know you want to talk about how to calculate an ad budget and it’s going to raise a lot of questions because it’s an interesting topic for a lot of folks out there that have a business, and want to make the most of their money.

Dave: Absolutely it is. So what do you want to know, Chris?

Chris: Where do we start, first of all. How do you calculate an ad budget?

Dave: John Wanamaker, who was a big department store guy a hundred years ago – everybody knows the quote, yet not everybody knows it’s John Wanamaker – but one of the things he said is, “Half the money I spend on advertising is wasted. The trouble is, I don’t know which half.” We’ve come up with some techniques to calculate an ad budget that make a little bit more sense than just throwing as much money against the wall as you can, and seeing what sticks.

Chris: You guys don’t just sit around a conference room, decide, “Hey, this is going to work.” This is real experience, this is things that have worked, and things that haven’t worked, and you’ve kind of fine tuned it, right?

Dave: Yeah, it’s really actually the formula for it. This was given out in Roy Williams’ – I think it was in his, it was either his first book, or it was “Secret Formulas of the Wizard of Ads”; “Wizard of Ads” being his first book. And it’s basically simple straight forward math once you know the numbers. You just have to do some simple math. And I’ve actually got an online tool. If you want to follow along, I built this online tool back in 2006, and it’s at AdBudgetCalculator.com, so if anybody wants to go there, you can see how simple the math is, and play along with it as we go. But the important thing is that business owners need to figure this out. There are so many business owners that either spends until they don’t have any money left, on advertising, and hope for the best; or they’ll not spend enough. We always tell people not spending enough on advertising is worse than spending too much.

Chris: Right.

Dave: It’s like buying a ticket halfway to Europe – just not going to get the job done. The thing is, you can certainly overspend, but if you spend only half as much as you really need to spend, you’re wasting more money than if you overspend.

Chris: Yeah, you’ve got big dreams and you’ve got hopes and aspirations. You’ve started your business. How do you even know where to start? What part of your budget is it? Is that where we’re going with this – is how to start and how to build it from there?

Dave: Absolutely. So you start with your projected annual sales and depending on whether you need to play it conservative or you’ve got a little bit of money to spend, you can look at your previous year’s sales. If you want to be kind of conservative with it and see what your ad budget should have been, or you can say, “In an ideal situation, I think we can reach this amount in the coming year,” and base your ad budget on that number. And what I recommend to people is to do both and kind of then look for a middle ground somewhere. So if you look at the ad budget calculator, you just take a business’ projected annual sales – so let’s just assume that the town I live in, a million dollars might be a lot of money. That might seem awful big, but in most cities a retail store, a service industry business doing a million dollars in a year, that’s pretty reasonable, pretty doable, and some will be higher, some will be lower. But it’s a nice round number so the math is easy, so I like that.

Chris: Thank you for that.

Dave: So in the ad budget calculator, we basically just plug that number in and then, Step One is to budget 10 to 12 percent of that total sales number for what we call “cost of exposure.” And total cost of exposure includes things that most advertising and marketing handbooks or textbooks won’t tell you to include, and that’s things like the cost of occupancy – or your rent, and we’ll talk about that in just a minute. But we take that, so 10% of sales is $100,000 and 12% is $120,000. And then we multiply that by the average markup above cost of goods sold. And that’s where it get a little confusing, if people aren’t used to dealing in markup.

Everybody understands margins, but markup is gross profit divided by cost of goods sold, expressed as a percentage; so 100% markup, which is commonly called “keystone” if you ask a retailer, “Are you getting anywhere near keystone?”, it just means the items they sell at retail are doubled the cost that the retailer purchased them for – so if it’s a furniture dealer and he’s got a Lazy Boy chair that he sells for $600 and he paid $300 for it, he’s at keystone, and that’s a 100% markup. So it’s basically expressed as a percentage. He’s getting profit – gross profit equal to the amount that he paid for the item, so he’s getting 100% average markup.

And the key here is that that’s different in every industry. Grocery stores are lucky to get 2% on an item. A jeweler might get anywhere from keystone up to 300%, 400%, depending on the item. So a store owner has to know their average markup above cost of good sold in order to do this calculation. So If we just assume that keystone is where they’re at, to make the math simple, we multiply that 10% of sales number that we had in the previous equation, times 100%, we still have $100,000. It’s that same number times itself because it’s 100%. If you had 150% markup, now you’d be looking at $150,000. So you just take your average markup and multiply it by that total cost of exposure in the first step.

Then, Step Three, this is where it kind of interesting, you deduct your annual cost of occupancy. What does it cost to be in the building that you’re at, in the location that you’re at, for your business? Now, if you’ve had that business for 50 years, you probably own the building outright – there’s no real cost of occupancy. There’s no mortgage payment, there’s no rent, so you wouldn’t deduct anything from this. You’d spend it all on advertising. But sometimes the best advertising that you can spend is on rent.

If I ever have a client that is thinking about opening a new location, or moving, we always tell him, “Follow the bulldozers.” If there’s a new power center going up in your town, or a new shopping area, that’s where you want to be. You want to be where the people are, and that’s always money better spent, than spending it buying ads, whether it’s radio, newspaper, or anything else.

Chris: And obviously I would think because of – they always say, “Location, location, location.” If you’re in a newer section, or a busier section of town it’s going to make sense; also, if you have a nicer looking storefront, or whatever it might be.

Dave: Absolutely. And you know, the other thing, Chris, that happens, is when a business has been there for 50 years, and you haven’t freshened up the look and put new signage in, and a fresh coat of paint, pretty soon the place becomes invisible. We’ve driven by it so many times, and for so many years that we take it for granted. There’s nothing new about it, there’s nothing remarkable, so we don’t even think about it.

Chris: And it’s interesting when you say, “Follow the bulldozers,” because if there is something new or a new section of town that’s being built up, people are going to forget.

Dave: Yeah, everybody’s going to go through it. And this is another reason why most businesses that are located in malls don’t have a lot of ad budget. You locate in a mall because that’s where people are; your rent is very high in a mall because you’re paying for the privilege of being in a place that’s hopefully bringing in a crowd all the time, and the mall is doing a lot of the advertising, so theoretically the people in a mall don’t have to spend as much, and that works out quite well in this equation.

You actually just take the annual cost of your rent and subtract it from that number that you got after multiplying by your average markup. And the remaining balance is your ad budget.

So if, for the sake of argument that if this business that we’re talking about actually had a $24,000 rent every year, we would subtract that from the low end of $100,000 for their ad budget, and from the high end of $120,000, so their ad budget’s going to be somewhere between $76,000 to $96,000. And it’s really that simple.

Chris: And what if that, at that point, they’ve reached the conclusion, what if that makes them really nervous, or jumpy, or afraid to make that kind of commitment?

Dave: I’ve run into people that were spending double what they thought they ought to be spending, and we always pull them back and say there are probably higher and better uses for that money. And if they’ve never spent that much before, they’ve probably been just trying things here and there, and coming to the conclusion that advertising just doesn’t work very well for their business. And that’s really sad because that’s one of the most common mistakes people can make with their advertising.

Chris: Could very well be too much money in the wrong place?

Dave: It could very well be, or spreading it out too thin, buying more reach than they really can afford. And then there’s a little twist in this equation. It’s always brought up by a plumber, or a HVAC company, and that is, “Hey, I’m in a service business. How do I figure out my ad budget?” Because they don’t really have a cost of goods sold, and typically in that case, what we do is recommend that you markup the actual cost of the service that you’re providing, and the cost being, if you’re a plumbing shop, how much did you have to pay the plumber to go out and do the service call? The cost of goods becomes the cost of the service professionals that you’re using to accomplish the job. Just makes the equation a little bit more complicated, but it’s certainly doable.

Chris: But you have to make it something that you can attach a value to.

Dave: Yeah, because it’s cost of goods sold, so in this case, the cost of goods sold is the air conditioner technician, or the plumber, or the guy up on the roof.

Chris: Well, it looks like a great tool. There are no difficult menus, you don’t have to become a member to try this tool, or anything at adbudgetcalculator.com; and also has some help files – everything is right here, and it’s very, very simple to figure out, isn’t it?

Dave: It really is. This site gets a little bit of traffic, not a lot. I don’t tell people about it. My partners use it probably more than anyone else. They know about it, and when they sit down with a client, they’ll just pull it up and use it as a little tool during a meeting.

Chris: We’re talking about how to calculate an ad budget. We’ve gone through the ad budget calculator. What do you think for a business owner, someone who’s running a store, or even a service, what’s the most important thing they need to know about working out a budget?

Dave: If you don’t do the budget, Chris, you’re not going to know whether you’re spending too much or too little, and this gives you a nice, safe way to do that, because it’s based on what you ought to be able to spend based on your markup. The same number, anybody that uses a percentage, just a flat percentage, and says, “Spend 10% to 12% of your total sales for your ad budget…that’s stupid. That’s crazy. If you don’t have the markup to support it, if you’re only making 2% profit, there’s no way you can spend 10% on advertising. That’s just not going to work. That’s really the most important thing. I think what people need to do is sit down and work that out. Grab a sheet of paper and a pencil. We’ll put the formula here in the blog post, and a link out to the ad budget calculator so you can play with it yourself, and see what you think.

Ad Budget Calculator – Take 10% to 12% of your annual gross sales as “Total Cost of Exposure.” Multiply by your average mark-up above cost of goods sold. Deduct your annual cost of occupancy (rent, mortgage, etc.) and the remaining balance is your Ad Budget.

Chris: That was going to be my next question – if somebody remembers BrandingBlog.com, but not so much the other web address that we gave them. There’ll be a link there so they can get to it really easily.

Dave: We’ll link to it. It’ll be super easy.

Chris: The tools are going to help. The information’s going to help. And they can always check your blog to find out more information.

Dave: That’s right.

Chris: OK. Dave Young from BrandingBlog.com and Wizard of Ads Partner. Dave, thank you for joining us.

Dave: Thank you, Chris.

Chris: You’ve been listening to Branding Blog SoundBites with Wizard of Ads Partner Dave Young. For more information, visit Dave Young’s brandingblog.com. Please feel free to share this podcast by sending the link or the mp3 to someone who can benefit from the information. And thank you for listening to BrandingBlog SoundBites with Dave Young.