How Much Should You Really be Spending on Sales and Marketing?
There are a lot of expenses that a company takes on that can be easily recognized as a necessary expense. The cost of rent for a building or payments on equipment used. The cost of wholesale items or raw materials. All of these are tangible items that the business would not be able to operate without. The same goes for salaried and hourly employees, you can recognize the monetary and operational value of the specific expense. If a company is maximizing their profits, they are tracking and calculating every expense incurred and the revenue that is generated from said expenses; the value brought to the company. Even though there are plenty of tangible and visible expenses, what about those that are not as easily seen, something like a 5,000 sq. ft. warehouse?
This is when we dive into Sales and Marketing. You may be able to see the amount of people you are reaching with an Instagram promotion, but how much revenue are these efforts truly generating? Then you need to ask: are these Sales and Marketing expenses creating enough profit to be feasible? Sales and Marketing are both a necessary component of any successful business, there is no doubt about that. Although both are (typically) primary revenue-drivers in an organization, it’s necessary to know exactly how much revenue is being generated, whether by paid ads, direct marketing, or social media.
Once these expenses are accounted for, it is equally as necessary to determine how Sales and Marketing expenses compare to the revenue they are generating. Budgeting for expenses incurred for Sales and Marketing are not as easily recognized by companies, thus resulting in over-spending and the loss of unrealized potential with different channels. Similar to determining a good profit margin for a product, deciding on a calculated Sales and Marketing budget will maximize revenues.
The first step to determining a Sales and Marketing budget is to assess the individual channels that you are targeting. This can be anything from direct mail to social media. Separating Marketing expenses into their individual cost pool is important in being able to decide what is feasible and most importantly, profitable. For example, don’t combine all social media efforts into a singular cost pool because you many see a lot more benefit from one social network over another. If you advertise on different websites, make sure to separate which individual websites are attracting their respective number of users or potential customers. By doing this, you will be considering the cost of acquiring a new customer.
The Costs of Attracting a New Customer
Customer acquisition has a handful of variables that affect the cost such as Sales and Marketing employee salaries, as well as the direct expense of advertisements, both digital and physical. The success of some Sales and Marketing efforts are much easier to determine than others. When you are advertising through social media, you can see exact metrics on how you are attracting users. Whereas, if you are paying for a billboard or direct mailers, you may not be able to get exact figures for reach or interaction until customer acquisition is complete or are notified of the effect directly. Regardless, there are ways to calculate an estimation, or in some cases, an exact amount on how much revenue Sales and Marketing are generating. First you need to know how many customers came from each channel. Take a look at figure the below figure as an illustration:
We can calculate the average cost to acquire a new customer with this equation:
Knowing how much is spent on attracting and acquiring new customers is necessary to correctly determine the value of the marketing. Although useful figures, none of this information is relevant without recognizing the revenue from these customers. This will allow you to recognize the profitability and value from your Sales and Marketing efforts.
The Revenues of a New Customer
When determining how much revenue is generated by a single customer, a company first must consider how the revenue is incurred. It could be product by product, such as an apparel company or monthly payments, such as a service-oriented organization. Each of these are calculated differently because of the realized future gains when there is a business contract for an extended about of time. An example to this type of relationship would be a client-agency relationship, where an agency works for a client on a monthly revenue schedule. To calculate how much revenue will be generated, the time of said relationship must be recognized. According to Advertising Agency Statistics, the average tenure of a client-agency is approximately 3 years. For the sake of example continuity, revenues are low. Illustrated below is how total revenue of this type if relationship is calculated, And the equation used.
Now, where the magic lies in determining the best budget for Sales and Marketing is combining the figures found from the cost of marketing per customer, and total revenue from the customer. This allows to you find out how much was spent on acquiring a new customer, and how much revenue said customer generated. This can be calculated two ways, depending on the type of revenue channel. In the illustration below depicts determining the marketing cost to revenue ratio. Figure 5 represents a company selling single items and the costs are taken from the marketing costs shown above in Figure 3. These same calculations can be used with re-occurring revenue, shown in the above, “Time-Based Relationship”, Figure 4.
When the ratio is calculated, it is finally possible to see how successful and profitable your businesses efforts toward Sales and Marketing have been. In the figure directly above, there are three ratios, 4, 12, and 2.5. In these ratio examples, for every 4 dollars spent in Sales, there is one dollar spent in Marketing, yielding a 4:1 ratio, so forth. This is also known as a Sales and Marketing “Return on Investment” or ROI. Typically, a good Sales and Marketing ratio is 5:1. The 5:1 ratio falls in the middle of the bell curve and it is considered a strong ROI among businesses.
So, What Should I Do with This Information?
By knowing how to determine a strong Sales and Marketing ratio, the next step is to take a thorough evaluation of all your business Sales and Marketing channels to determine what is producing the highest ROI. Maybe there is an area that isn’t being maximized, and could result in reaching previously missed potential customers and increasing company revenues.
