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You're (Probably) Budgeting Incorrectly

Many marketers are familiar with baking in LTV at a granular level, diminishing returns and seasonality, but still fail to ‘payback optimize’ their approach.

It's mid-August, which might sound like an inopportune time to discuss budgets, yet at many mid to large size organizations, budgeting discussions are right around the corner.

How an organization approaches its budget is often defined by their company stage.

Organizations often go through a few phases of budgeting maturity:

Infancy:  Business constrained primarily by cash flow and fundraising.  Investments gated by cash, even when proven profitable on a near-term window.  Product-market fit might not be nailed, so the concept of LTV is limited.  Budgeting is generally ad-hoc and cash flow is managed carefully.

Growth Stage/Adolescence:  Companies have cash flow.  There is an understanding of LTV (hopefully at a granular level) and the luxury to optimize on to some point on the LTV curve.  At this stage, primary organizational cash constraints are more tied to planning than infancy-stage constraints.  Loose annual budgeting processes.  Organization can be opportunistic with select investments.

Mature:  Defined annual budgeting processes and goals.  Cashflow generally not a constraint, but organizational alignment, expectation management and finance signoff is often necessary to make incremental investments.

This often demands organizations marry top down assumptions with bottoms up channel level models developed by the marketing team.

The process usually looks something like this:

  • Top down targets set from leadership, usually hero metrics such as revenue, customers, and/or CAC
  • Marketing develops scenarios within these constraints, demonstrating opportunities at different investment levels & LTV/CAC levels
  • Negotiation occur, and budgets are landed by month within tolerable full-year CAC levels

Many marketers are familiar with baking in LTV at a granular level, diminishing returns and seasonality, but still fail to ‘payback optimize’ their approach.

Most mature organizations fail to properly consider the ability of 'payback window' optimization to extend from infancy organizations (where such optimization is a matter of organizational survival) to growth and mature stage organizations.  A dollar of revenue today is generally valued far more than tomorrow's.

Let's look at a scenario where a company with a $200 3 year LTV realizes half that value in year one, and in that first twelve months the $100 is divided as follows:

For the sake of simplicity we'll assume linear elasticity:  30% more in spend drives 30% more volume.  When we re-flight budgets to maximize in-year cashflow at the same total CAC, we gain that 30% back in revenue.  Even if moderate marginal returns curves are assumed, the 'payback optimized' budget drives double-digits more in-year revenue.

In addition to helping an organization drive maximize in-year revenue, there are other benefits to such an approach:

  • Companies beginning their fiscal year in January can take advantage of Q1 media rate lull, compounding the benefits of a higher tolerable CPA.
  • Derisks total year budget plans by front loading value, reserving optionality to be opportunistic in back-half spend if needed.
  • Better ties media to in-year impact, directly positioning marketing as demand driver vs. cost-center.

Don't like leaving opportunity on the table in Q4?  That's fine, accept a slightly higher full-year CPA and spend to the target average in Q4.

Averages are evil, and getting caught up in total annual averages and flighting spend and demand based on historical patterns leaves money on the table.  

Instead, a thoughtful partnership with finance and one's leadership team will allow for more productive partnership and ultimately stronger business outcomes, or at least stronger reported outcomes.  

If not already doing so, think about incorporating payback optimization into your budgeting process.  Chances are your CFO will thank you.

About the Author

Mark Fiske

Operating Partner focused on digital & marketing strategies at H.I.G. Growth Partners. Helping growth-stage organizations scale for 15+ years. Focused on developing pragmatic, scalable solutions.

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