There are different methods to determining a promotional budget that firms typically use.

What Is Advertising Appropriation?

Advertising appropriation—also referred to as an advertising budget—is the portion of a total marketing budget that a company allocates for advertising over a specific time. The advertising appropriation policy for a company may be based on any number of approaches.

For example, some companies will budget an amount for advertising that is a fixed percentage of sales. Other companies may base their ad spending on what the competition spends. Whatever method a company uses to determine its advertising appropriation, it must attempt to balance the money spent against the additional revenue the company actually achieves through its advertising efforts.

Key Takeaways

• Advertising appropriation refers to the portion of the total marketing budget a company spends on advertising over a specific time.
• Companies can use direct marketing methods to track the response rates of their advertising campaigns and help them pinpoint an optimal level for ad spending.
• Companies can use a variety of methods for setting an advertising budget, such as the competitive parity method, the adaptive control method, and the percentage of sales method.
• A company with a new product or service will generally need to spend more money on advertising in order to generate brand awareness.
• In a very competitive marketplace, a company may need to increase its advertising appropriation in order to get the consumer's attention and stand out from the crowd.

Understanding Advertising Appropriation

In practice, it's not always easy for a company to determine the amount of money it should allocate for its advertising budget. This is because of the lack of a definite relationship, in many cases, between the amount spent on advertising and the company's sales and profitability. For this reason, many companies have opted for direct marketing, which allows them direct communication and distribution of their advertising to their target audience.

The U.S. Small Business Administration (SBA) recommends as a general rule that small businesses with $5 million or less in annual revenues should budget 7% to 8% of their revenues on marketing.

Rather than relying on a third party—such as mass media television or radio ads—direct marketers deliver their sales promotions through direct mail, email, social media, texting, and various other methods.

Direct marketing appeals to many companies because it is easier to track the response rate of their advertising campaigns and quickly see if the money spent on advertising results in growing sales and revenue. In turn, this information helps companies decide whether to increase or decrease advertising appropriation depending on the effectiveness of the marketing campaign.

Types of Advertising Appropriation Methods

While direct marketing data can help a company pinpoint the right amount to spend on advertising, this is most effective if the company has already run a campaign and generated sales results to analyze.

In cases in which a company has not yet run a direct marketing campaign or has decided against using direct marketing altogether, there are other methods it can use for determining an advertising budget.

Affordable Method

This advertising budgeting method is based on what a company thinks it can afford to spend on marketing. Because it's not based on a specific goal or any underlying data, the affordable method can be unreliable, leading to too much or too little being spent relative to returns.

Adaptive Control Method

A company using an adaptive control method will use market research to estimate the sales volume and profitability based on different ad budgets. They will use test markets to compare advertising spending levels that are either higher or lower than the current spending level. The company then uses these results to adjust its advertising budget.

Competitive Parity Method

This method bases the advertising budget on what a company expects its competitors to spend. It operates under the assumption that competing firms have similar marketing goals and execute them rationally. Thus, if a rival is spending approximately 5% of net sales on advertising, the company will set its advertising budget to match its rival.

While it may be seemingly easy to execute this spending strategy, the downside is one of "the blind leading the blind." It assumes the competitor has engaged in some form of market research or analysis to achieve the optimal advertising budget, which may or may not be the case.

Return on Investment Method

The return on investment (ROI) method is a strategy that devises a promotional budget by balancing the amount of advertising to the profits generated from advertising. To be successful, this method depends on the company's ability to correlate profits to specific advertising efforts.

The company can implement tracking methods (such as tracking codes) that will help it see which ad campaigns are the best at generating profits. The company can then appropriate more advertising funds to those efforts.

Percentage of Sales Method

A company that uses the percentage of sales method dedicates a fixed percentage of past sales revenue to advertising. Small businesses often use this method because it is simple to implement. The business owner will decide on the fixed percentage (generally between 2% to 5% of the previous year's sales) and then allocate that amount to the advertising budget.

Another variation of this method is to use anticipated sales for the upcoming year. Mature companies that have years of data regarding profit trends will use anticipated sales as this allows them to adjust the percentage up or down depending on the most recent sales estimates.

Special Considerations

A number of factors may influence how advertising appropriation is figured. For example, a product or company with a high market share may require a smaller advertising budget than an upstart competitor. Similarly, a new product requires higher spending to build brand awareness and buzz; a mature product may not.

A company may inadvertently reduce its advertising effectiveness if potential customers see too many ads for the same product or service. In this case, the company may decide to reduce ad runs. A company in a very competitive market may require more advertising and greater advertising appropriation to get the consumer's attention.

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