Calculating ROI (Return on Investment)
Jim's Intro: An important thing to understand about database marketing
metrics is they can be defined differently by different people. The critical issue is: within the company, does
everyone agree on the definition?
A common definition of ROI (Return on Investment) involves looking at the
cost of a marketing campaign relative to the profit generated. This
approach comes from the original definition of ROI as used by finance
people rather than marketing people.
A Return on Investment in financial circles has a very specific meaning:
How much did I invest, and what was my Return on the Investment?
This is the same "return" concept used in the stock and bond
markets, as in: "My stock portfolio had a Return of
invested $1000 on January 1, and on December 31 you had $1,200, you generated a 20% ROI - your Return on the
Investment of the original $1000 is $1200 - $1000 = $200 /
$1000 invested = 20% ROI on an annual basis (excluding transaction costs).
The definition of ROI in marketing should be defined in the same
way. Let's say you're selling widgets with a price of $100. 50% of this
$100 is margin, what's left over after the cost of
the product. It costs you another 10% of the $100 to take
the order, pick, pack, ship, and deal with returned widgets. So profit on a sale is $40; the other 60% of the product
price of $100 goes to cost of the product and processing the sale through
You put $1000 into a campaign to try to sell these $100
widgets. You sell 30 of them at the profit of $40 each,
for a total profit of $1200 on the campaign. But this
profit is before the cost of the campaign, so you subtract
this cost, $1200 - $1000 = $200. This is the Return - $200
extra dollars came back to you on your original marketing
investment of $1000. Your Return on this Investment is
$200/$1000 = 20%. This is "simple ROI", a straight
calculation of Return without factoring in the element of time.
Why does this matter?
Back in the finance department, where they have cash, they
can invest it. In computers, in software, in people, or in
bonds, or their own stock. If your marketing programs can't generate a higher ROI than say, very safe government bonds
at 6% annual ROI, then the company should not invest in the marketing programs. The company as a whole is "better off"
investing in the bonds, or in people, software, buildings,
or whatever delivers a higher ROI for the company.
How do you calculate ROI on a banner campaign on a site where no products
the sake of simplicity, we'll say page views cost nothing to
generate and all we look at is revenues from ads on the site.
There has to be a value metric around somewhere. If you
sell ads for $20 CPM, and you're 50% sold out, you're at a net $10 CPM. Assuming 1 ad per page, each page view is
worth a penny in revenue ($10/1000) at a $10 CPM. How many page views
did the banner campaign generate versus the advertising cost to generate them?
If you spent more than a penny to generate a page view, you lost money -
If you have some other more complex revenue generating
methods, try using Total Revenue / Unique visitors. Divide
total revenue over some period of time by the unique visitors in
that time period. Let's say you come up with $1 per unique. How many uniques at a value of $1 did the
banner campaign generate
versus the advertising cost? If it cost less than $1 to generate
each unique visitor, you made money. If it cost $.80 to generate
each unique, you ROI is:
$1 - $.80 = $.20; $.20/$.80 = 25% ROI
There's more to campaign ROI than just the "front-end"
revenue generated versus the ad spend. What about the future value
of the customer, repeat behavior? You can get a good idea of how to
measure this residual value by taking the tutorial Comparing
the Future Value of Customer Groups.
The above examples ignore any other costs to the organization. To be
more accurate, you would want to at least figure in operational
costs. One way to approximate would be to take total operations cost
for any period and divide by the number of unique visitors served in the
same period. Let's say in a month you serve 1 million uniques and
your operating costs were $100,000. That's an average of $.10 per
unique. So true ROI for the campaign would have to include the cost
of servicing the incremental uniques you generated.
Let's say you spent $80,000 in the campaign. It generated 100,000
uniques, which generated $100,000 in revenues ($1 per unique). But
the cost of serving each unique is $.10, so you have to net this cost out:
100,000 uniques x $.10 = $10,000 cost
$100,000 revenue - $10,000 cost = $90,000
$90,000 net - $80,000 campaign = $10,000
$10,000 / $80,000 = 12.5% ROI
Now, do people really think this way? Sure, offline. Online,
the cost of serving incremental page views may be next to nothing.
But there is some cost - they have to designed, stored, and bandwidth used
to serve them. The point is, this model doesn't "scale to the
sky" without additional costs. At some point as you grow, you
have to buy more servers, storage, bandwidth, and so forth. And hire
people to service all of it. So to calculate the true ROI of a
campaign, any additional costs must be taken into account. Costs
frequently overlooked might include design, agency fees, answering phone
calls, clearing credit cards, and so forth. In remote shopping,
these costs can be huge, such as to pick, pack, and ship. They must
be included in the overall calculation to measure true campaign ROI.
One way to handle this is to get agreement on a
"flow-through" number with the finance department (if you have
one). What percentage of each dollar in revenue actually "flows
through" to the bottom line, to cash flow, or to EBITDA? For
example, in the cellular business the number that matters to Wall Street
is called EBITDA Margin, and it can range from 25% to 45%, depending on
the growth stage of the company. If at your cellular company it's
30%, then any $1 you generate in revenue has to cost less than $.30 to
generate or you lose money, since 30% is all that "flows
through" on each revenue dollar.
The above approaches are more likely followed by mature
companies; they ignore the "land grab" mentality of the
early dotcoms. But it's what Wall Street means when they
say "Return on Investment", and the way Wall Street thinks
usually matters in the long run.
The Drilling Down book shows you how to predict the ROI of marketing
campaigns based on simple financial models you can build with an Excel
spreadsheet. You can use these models to drive revenues higher while
reducing marketing costs.
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