Marketing Budgets: How to set one and how to avoid the number one trap that leads to underperforming marketing activity

In this blog we are going to cover the methodologies B2B organisations can employ to set their headline marketing budget, we are not going to cover how and where you are going to deploy the budget once set. If you want support with this feel free to get in touch with us and we can walk you through how to approach this element of the planning process.

For organisations trading B2B and indeed many other types of business, there are three main methods of arriving at an annual marketing budget and in our humble opinion only two of them are right, yet the third is the route employed by the vast majority of organisations.

1. Revenue linked
2. Unit economics-based
3. Activity-based

Let’s explore each one in turn, starting off with the most commonly employed - activity-based budgeting:

In many organisations, the marketing team is perceived as a cost centre, a place where money is spent, not made, a place of hope and continual reinvention that somehow never quite delivers. A place that when times are hard and a big sales result is needed is overlooked in favour of their sharp-suited sales colleagues down the hall.

Why is this? Well there are lots of reasons, but a big one is resources, because of this cost centre mentality that exists in so many organisations, marketing teams suffer from constant under investment not just in activity, but also in people. When those hard times roll around it isn’t marketers that get hired.

I have always felt that this leads to marketing teams asking for the budget they think they will get signed-off and not the budget that they need to succeed and thus perpetuates this cycle of underperformance. These budgets tend to be based on incrementality over the previous year and rooted in the activity they want to deploy and not the commercial impact they need to generate.

Breaking this cycle is difficult and in many organisations, is not something that is possible to do from within the marketing team, unless a new CMO has the backing to really shake things up. In reality, this change in approach and the associated change in budgets needs to come from the c-suite, because to generate the step change required to generate commercial impacts there is only one way the marketing budget needs to go and it’s not down.

So how do you set a budget to plan to? Well there are two methods and it will depend on the nature of your business as to which one is the best fit and in many cases one can be used to validate the other. As a simple delineation revenue linked budgeting is a good place to start for product-based businesses that don’t rely heavily on recurring revenue and unit economics is a good place to start for ‘as-a-service’ style businesses.

Revenue-based budgeting:

There is a beautiful simplicity to revenue-based budgeting, it’s as simple as the marketing budget = x% of total revenue. The trick is knowing what that percentage is and for your average marketing team, used to activity-based budgeting, the answer will probably shock you. 

According to recent studies by Deloitte, Gartner and others like the US Federation of small businesses an average of around 11% of revenue is invested in marketing, with the range going from around 5% right the way up to 18%. Where you should sit in this range depends on a number of factors.

What you sell: Typically B2B product businesses invest less than their services based counterparts, with 10% of revenue being typical, compared to 15% for B2B services organisations. 

Sector: The level of competitiveness and the revenue potential of the industry have a significant bearing. Education spends the most at 19.4% of revenue and the energy sector the least at 4%, with B2B consulting services at around 13% and software a fraction behind this at 12%.

Growth aspirations: The speed at which you want to achieve a result will then have either an inflationary or deflationary effect on the percentages detailed above. As a rule of thumb, growth aspirations above 10% will increase the percentage and those down in single figures will reduce it.

Where the simplicity of this approach goes away is that it is also interlinked with pricing and targeting, simply increasing the percentage you spend on marketing without moving anything else is likely to do nothing more than erode margin and that won’t do the rep of marketing any good!

For businesses that have recurring revenue at their core and a focus on the number of customers they acquire each year, such as SAAS businesses then we would suggest using a model that is more results-focused than the revenue linking.

Unit Economics

The unit economics model focuses on the cost of acquisition and the value this represents to the business. It is rooted in 6 key metrics:

• CAC - Customer Acquisition Cost
• LTV - Lifetime Value (average gross margin per customer/churn rate)
• LTV:CAC - How much money you will make per customer as a ratio to acquisition cost
• Payback period - The average time to recover your CAC 
• Churn - the number or percentage of customers lost per time period
• Customer Lifespan - How long a customer stays with your on average (use 4 years if you are a young business)

When calculating CAC, ensure that you fully load the cost with headcount, software and all the other things easily swept under the rug! Ensure you are accounting for all fixed and variable acquisition costs - basically divide your marketing budget by the number of new customers you win.

Once you have identified all of your key metrics and have your LTV:CAC ratio established then you need to understand the efficacy of your marketing. The LTV:CAC ratio can be evaluated in 2 ways - payback and ROI. 

To establish your ROI metric you need to look at how many multiples of CAC is being generated over the lifespan of the customer. Typically in a SaaS business somewhere between 3:1 and 5:1 is considered optimal. Too low and you aren’t getting a strong enough return and your activity needs to be optimised, too high (6:1 and above say) then you can and should allocate more resources to marketing activity to grow market share.

The other measurement metric that is worth evaluating is payback period. Many investors will look for CAC to be recouped within 3-4 months, but the conventional wisdom is that anything under 9 months is well optimised and scalable as an activity.

Lovely evaluation tool, but how does this apply to budgeting I hear you say? Well if you have established what good looks like then budgeting out of the commercial targets for the year ahead becomes very straightforward.

Lets look at an example  

We want to achieve revenue growth of £12m next year from net new business, which represents 12% growth YoY, to build revenue to £112m. Our average deal size is £1m, so we need acquire 12 new customers. If we have established a 4 year customer lifespan period and we work at a 70% gross margin, then the LTV per new customer is £2.8m.

Last year we spent £5m on marketing and acquired 10 new customers, so CAC was £500k. Forecasting this year would make our CAC:LTV ration 500k:2.8m, which is a payback period of 8.5 months, which means our marketing is relatively efficient and thus provides a good basis for scaling into next year, although there is definitely scope for some improvement in efficiency.

To grow our customer base by 12 next year we need to plan to spend £6m on marketing (£500k x 12), which is a little over 5% of revenue. On this basis our plans look to be lacking a little bit of ambition, but are probably fine for an established business planning for steady growth.

Where this calculation falls down is when a company has previously done very little marketing and has relied on a sales team for growth and thus have no metrics to scale from. If this is you then simply use the established LTV figure based on your current gross margins and churn rate to generate a monthly contribution figure and multiply this by 9 as a good predicted marketing CAC. This can then of course be multiplied by the number of new customers you need to acquire. Years 2 and 3 will be more robust as your strategy matures, but if the number reads across well to an appropriate percentage of revenue then you should be good to proceed.

The bottom line  

Ultimately activity-based budgeting leads to a cost-saving mentality where spend is linked to activities and not outcomes. The unfortunate byproduct of this diligent cost-saving is effectively planned underperformance, a budget that was never fit for purpose. By starting with a number that is robustly linked to prior performance and scaled up, we can be sure that we have laid the foundations for success.