E-commerce Insights: Multichannel Planning Is a Complex Endeavor
This perspective applies to list rentals and paid search keywords:
• require the portfolio to “work” in aggregate,
• allow your managers discretion in the portfolio, and
• inspect, occasionally, disaggregated performance by list or keyword.
To determine the trade-off curve between advertising and resulting sales, turn to historic data or construct controlled tests. Earmark 5 percent of your marketing budget for testing brand new opportunities. Budget another 5 percent to test “over-marketing” of existing channels: small selects from marginal lists, small ad spends on marginally converting keywords, mailing a bit below your cutoff to your buyer file, and so on. Modest, ongoing over-marketing lets you collect critical data on the shape of your advertising vs. sales trade-off curve.
The advertising-to-sales trade-off curve typically isn’t smooth. You either take a list or keyword, or you don’t. And it often has a very steep cliff. That means, once you’ve bought the good stuff, the quality plummets, and additional sales come at a huge ad cost.
For modeling purposes, it can be helpful to assume this trade-off curve is smooth for small changes. The “square root rule” takes this approach, stating that sales increase linearly with the square root of advertising. It’s a wrong assumption for large changes, but a useful approximation for small ones.
In brief, the square root function:
• shows decreasing returns to scale,
• is internally consistent, and
• offers theoretical properties.
At www.rimmkaufman.com/squarerootrule, I’ve placed an Excel spreadsheet which uses the square root rule to model the potential effect of slight increases or slight decreases in your advertising spend, as well as suggested the advertising level which optimizes contribution (see Figure 2 below).
One rule of thumb that emerges from the square root assumption is that marketers maximize their marketing contribution dollars by spending half of their effective margin on advertising. For example, a marketeter selling products with 45 percent cost of goods sold and 12 percent other variable expenses should aim for an advertising-to-sales ratio of (1⁄2) x (1 - .45 - .12), or 21.5 percent.