π How to create a marketing budget
Corey Haines | Swipe Files
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Which came first: the chicken or the egg? Marketers suffer a similar dilemma. Which came first: the goal or the budget? The truth is that you can back into a budget from a goal or you can create a reasonable goal from a budget. "We can create budget for anything as long as we can prove the ROI" is an excuse. It's lazy and unacceptable. Budgeting on a project-by-project basis slows down progress, discourages experimentation and big swings, and boxes marketers into thinking small and too conservatively. You need concrete methods to create both goals and budgets. There are two foolproof methods for creating a marketing budget:
Method #1: 5-40% of annual revenue With this method, you start with the budget and then end with the goal. The budget is essentially determined by how much revenue can be devoted to marketing comfortably, which then ultimately determines the goal. Unlike other methods, the goal is the last piece of the puzzle and is largely determined for you. If a business is already established and focused on profits, it may only want to devote 5% of revenue to marketing to preserve enough profit to distribute to shareholders. For example, if the business is doing $1M ARR, the annual marketing budget would then be $50,000. And if the cost of acquiring a customer is $100 on average, then they can expect to acquire 500 new customers. And if the ARPC is $50, then they can expect to add $300k to ARR. Finally, if the churn rate is 15% annually, then they can expect to add 85% of $300k, which is $255k to ARR, with an end of year goal of $1.255M ARR. If you've raised a good amount of money and you've got ambitious goals you need to hit, you might spend as much as 40% of ARR to aggressively deploy the funds you've raised. Method #2: [(New ARR / (ARPC x 12)) x CAC] / annual retention rate With this method, you start with the goal and end with the budget. The budget is essentially determined by reverse-engineering the relationship between the goal and the customer acquisition unit economics. This formula took quite a few iterations and a lot of Excel to come up with, but itβs a foolproof way to propose a budget that you can be confident talking about how you came to that number. This method is best for when your SaaS is just starting up or anticipating outside sources of capital, where you need to find the money to hit ambitious goals. Once you've reached $1M ARR, VCs will generally want to see you triple revenue for two consecutive years and then double revenue for at least three consecutive years. Some call it the "3 3 2 2 2 Rule." For example, if youβve just raised a Series A at $1M ARR, here are your goals laid out for you:
But to each their own. You may want to grow by 50% or 5,000%, it doesnβt matter to the formula. Letβs break down the formula piece by piece and use the example of doubling from $1M ARR to $2M ARR. [(New ARR / (ARPC x 12)) x CAC] / annual retention rate β [(1,000,000 / (ARPC x 12)) x CAC] / annual retention rate Next, you have to calculate how much ARR each new customer represents on average. To do so, you would multiply the average monthly revenue per customer by 12 to get the first-year revenue of each customer. Letβs assume ARPC is $50, generating $600 in ARR. [(1,000,000 / (ARPC x 12)) x CAC] / annual retention rate β [(1,000,000 / 600) x CAC] / annual retention rate Now we know that you need to acquire 1,667 additional customers. Next, multiply it by the average cost of acquiring each customer. Letβs assume CAC is $100. [1,667 x CAC] / annual retention rate β [1,667 x 100] / annual retention rate This effectively gives us the marketing budget since we know how much itβs likely going to cost to acquire the number of additional customers we need to add $1M ARR. But we also need to account for churn and the extra bit of customers we need to make up for so that we donβt fall short. So we divide by the annual retention rate. Letβs assume retention is 85%. 166,700 / annual retention rate β 166,700 / .85 = ~196,118 Now we have a final marketing budget of ~$196k which can be rounded up to $200k or whatever the nearest additional increment is. When someone asks how you got to this number, you can walk them step by step through this formula to explain your thinking. The key to this approach is building in buffer to your CAC estimations. CAC is the main dependency. If CAC is 50% higher than originally estimated, itβll have cascading effects and youβll be at risk of missing your revenue goals by 50%. Yikes! Itβs far better to overestimate CAC than to underestimate. Plus, you need room to experiment, be wrong, and still have budget to make up the difference in other experiments that get you to your goal. As a good rule of thumb, tack on an additional 10-20% to your marketing budget and label it βexperimental budget.β I know that's a lot to digest, but it's simpler than it sounds. I find talking it through to be helpful to understand it from first principles. But once you create a spreadsheet formula or use a tool like Summit, you're just plugging in numbers. βCorey
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