Advertising is only expensive if it doesn’t work
Most entrepreneurs do not know the correct formula to calculate the cost of advertising.
Marketing Math. That’s what I call it! For some reason, most entrepreneurs cannot calculate the cost of advertising — or to put it another way — they cannot calculate their advertising ROI. This article can help you with the marketing math.
Traditional advertising is not cheap, unless it works the way it should. But I have found that most entrepreneurs cannot grasp the mathematics required to measure advertising ROI (return on investment). Here is an example. A manufacturer of coffee mugs makes an advertising buy to stimulate sales (which should be the goal for every advertising purchase). The advertising buy was for an even one-thousand dollars. The entrepreneur sells each coffee mug for $10, and has a gross profit margin from each mug of $5.
Most believe when the entrepreneur sells 100 mugs, that the advertising buy was worth it—that it had a positive ROI. The thinking is that if the entrepreneur sold 100 mugs at $10 each, that it paid for the advertising buy (100 X $10 = $1,000). This is the math that most entrepreneurs will perform, and the advertising salesperson will encourage you to complete the math with these figures. However, this is not marketing math.
Marketing math requires the entrepreneur to do a few more calculations to measure advertising ROI. There are three things that you must do:
- Calculate the break even point for the advertising buy
- Measure current sales prior to the advertising buy; and
- Measure additional (incremental) sales as the result of the advertising.
Here is how it’s done:
To calculate the BEP (break even point) on your advertising, you must divide the advertising buy by your gross profit margin. In our coffee cup example, the gross profit margin is $5 per cup; therefore, $1000 ÷ $5 = 200. The entrepreneur must sell two-hundred additional coffee cups just to pay for this advertising buy. This is where step 2 and step 3 come into the calculation.
Step 2 requires you to measure your current sales without advertising support, and step 3 requires you to measure advertising-supported sales. For example, if the entrepreneur currently sells 500 coffee mugs per month, the entrepreneur will have to sell 700 coffee mugs in the month that the adverting is run. Adding step 1 (200 additional mugs) and step 2 (500 current mugs) makes 700 total mugs to pay for the advertising. Therefore, the entrepreneur will have to sell 700 coffee mugs just to break even on the advertising buy. If the entrepreneur sells 701 coffee mugs, the advertising buy has a positive ROI of $5.
Marketing math is not that hard to complete, yet most entrepreneurs fail to make these series of calculations. Most of the entrepreneurs that I counsel simply believe that “advertising pays” and that you “have to spend money to make money.” Once you figure out your marketing math, you may discover that advertising does not pay after all.
Paul J. Werner is a Michigan State University Extension Educator from L’Anse, Michigan. You can obtain free business counseling by registering with the MSU Product Center. Werner has many years experience in small business ownership and entrepreneurship. He and his wife currently own two small businesses in the Upper Peninsula of Michigan.