5 Hidden Dangers in Annual Budgets for Marketing

Ah, the smell of the end of the Fiscal Year! Budget Planning for Marketing is in the air and the smell of burning remaining budgets lingers, backed by the sound of inter-departmental standoffs.

It doesn’t have to be like that.

Annual Budgeting is a time-honored process, but I’d argue that in today’s world annual budgets for marketing do more harm than good. Flexible budgeting based on hitting financial KPIs and working within cash-flow limits is a much better way to go.  So roll up your sleeves and get that coffee, because today we’re talking about the five main reasons Annual Budgeting can harm your marketing program!

1. Cost vs. Profit

Annual budgeting attempts to control costs while managing resources for the continued profitable execution of the business. Unfortunately, the two common tools for reviewing financial performance, the P&L (past-looking) and pro forma (forward looking) are poorly equipped to understand marketing’s direct contribution to bottom-line growth as they both separate cause (investment in marketing) from effect (profit realized from marketing).  This is solely because marketing has always been treated as a fixed cost, along with salaries and rent. But quantitative marketing, and particularly quantitative digital marketing has changed that.  Done right, data-driven marketing creates a clear and predictable relationship between investment and return, often optimizing to financial KPI’s such as Contribution Margin (post-marketing gross profit) that, if scaled, will improve the profitability of the company. Annual budgets, by definition, cap the potential upside of profitable opportunities that might exceed the estimates of the company at the time of budgeting.

The Better Way: Utilize strict measurements on the generation of profit from marketing where marketing is expected to increase Contribution Margin over time (how much time is predictable, but is based on sales/evaluation cycles and will vary widely by company). Combine these with cash flow controls so as not to overspend in advance of revenue. For example, in a SaaS company we might be able to predictably increase future Monthly Recurring Revenue (MRR) in an acceptable payback period with a greater ad spend, but monthly spend would still be capped as a percentage of current MRR for cash management reasons.

2. Limits on Course Correction

Budgets are a plan for the future, but the more detailed they are, the more difficult it will be to change course, even in the face of compelling evidence that you should do so. Budgets are often difficult to change on purpose, as the control inherent in the budget planning process is one way that leadership executes the course for the company.

The problem is that detailed knowledge of opportunities doesn’t live at the top of the organization, it often lives deep inside, at the levels of tactical decision making. As opportunities surface, the entire budget planning process, people, and leadership control needs to be challenged even to make a minor change. It sounds crazy, but is extremely common to hear “We know we should make this change and doing so will increase profit, but it just isn’t in the budget.”

In a recent example, one of our clients realized that they had given us the wrong remarketing budget and that they had no more budget for the remainder of the fiscal year. And even though we have clear data illustrating the profitable results of the investment in remarketing, the line managers decided they would rather forfeit that profit than challenge the budget process. This does not help their company’s bottom line.

The Better Way: Put money behind goals with limits on expenditures. Educate line managers on P&L level financial KPIs and enable them to move resources to improve those financial KPIs within cash flow limits. This often means addressing local optima, KPIs that don’t correlate well with financial outcomes but are intended as measures of performance separate from revenue and profit. In marketing, most traditional measures (Bounce Rate, Time-on-Site, etc,) are local optima. Local optima are blinders to good prioritization of activities that improve the business and should be viewed with caution.

3. Arbitrary Channel Blindness

Marketing is complex. Actually, that isn’t nearly as true as the fact that the human interaction with marketing is complex. Yet internally we fall in love with single-source attribution to evaluate marketing channels. Nothing feels better than knowing that this one customer came from this single source. It makes us confident in crediting programs and teams, and makes it easy to allocate budgets.

Of course, it’s dead wrong.

We know from our own behaviors that people engage in interactions with marketing campaigns that are far more complex than our tracking can fully capture. We see ads in multiple locations over a period of time. We are remarketed to. We see an ad, don’t click on it, and then later do a brand search. We switch devices before engaging with a web site. We’re human and so are our customers.

Single source reporting creates a false sense of security, and like the CEO who exclaimed, “This Brand traffic is great! Let’s move all our budget to that!” it often masks cause and effect within the complexity of real human behavior. (If it is not clear what the issue is with that comment, please reach out to me.)

Budgets, of course, make this worse the more granular they get. In addition to making my last point worse in that they can limit course corrections to better performing areas, channel budgets reinforce the false view that channels act independently of one another, and that all channels act in similar fashion with similar functions.

The Better Way: Have your financial KPIs be holistic, evaluating black/white success only when looking at the whole picture of paid, unpaid, earned, unearned customer acquisition. The channel numbers are directional and need to be evaluated carefully. Your Cost-Per-Acquisition numbers in Search and Social shouldn’t be the same, as Social typically drives 5x to 10x more out-of-channel activity that breaks source tracking. Data needs to be used to its fullest extent, but with thoughtfulness, experimentation, and a constant understanding that data collection is limited with regard to user intent. When changes need to be made, or experiments run, the budgets should easily and flexibly accommodate those changes.

4. Slow Learning

In the Mad Men days of traditional media, learning about campaign performance was slow, when it could be measured at all. Annual budgeting caused no significant harm, because annual budgets often aligned with annual media buying.  In a world where success was often obtained by the most demographically-correct eyeballs for the lowest price, demographic targeting and price negotiation were everything.

No wonder people had time for all those martini lunches!

Modern digital advertising is a world of constant measurement and constant experimentation. The limits of the budget process in slowing change and limiting complex understanding have one extremely dangerous but often overlooked effect: They slow learning. Gains in digital media are often discovered through testing (certainly this is the financially responsible approach), so how many test cycles you engage in is one control over success. A process that by nature limits the speed of testing can have a highly detrimental effect on performance that is likely completely invisible to those engaged in the budgeting process.

The Better Way: Create the freedom for testing within the budgeting process. 10% of the marketing budget that is solely for experimentation and is not held to financial KPIs will pay off dramatically in rapidly finding ways to scale profits.

5. Incorrect Time-Frames for Budget Evaluation

Fundamentally, annual budgets operate at an arbitrary time frame that is out of sync with marketing decisions that need to be made in a financially optimized, highly data-driven campaign. Quarterly budgets are not much better but will be closer to the learning cycles in most campaigns.

While the longer the budgeting cycle, the worse the problem is, the fundamental problem is that line-item budgeting for marketing is an inherently bad practice. In a world of 24/7 live auctions, shifting competition, constant learning and improvement, budgets are sub-optimal.

The Better Way: There is a better way, and many organizations already do it this way. Financial KPIs tied to cash flow-based caps given to engaged teams with line-level decision making work far better than a classic budgeting process. The best, most nimble companies we work with work off of pro formas that are not set in stone but that are live working documents, recast constantly based on evolving data.

When done right, digital marketing contains an amazing set of tools for the predictable scaling of profits. What is required is for companies to support the financial practices that allow this to happen as quickly as possible, provide financial transparency and clear financial KPIs to their marketing teams, challenge their teams to be thoughtful about complex data and behaviors, and stand back. Maybe it is simple after all.