Pick a term that is bandied about the most but understood the least and chances are it will be ROI, return on investment. Many marketers are asked by senior stakeholders what their ROI is, how to calculate marketing ROI, or whether their ROI is trending in the right direction.
Before we go any farther, let’s define ROI clearly.
ROI is a financial term with a financial formula. There is no substitute for it and there are no ways to weasel around it that don’t make us look like fools. Expressions like “return on awareness”, “return on engagement”, and “return on conversation” are largely invented terms by people who don’t know how to calculate ROI.
ROI is not the ultimate measure of marketing performance. ROI is an objective metric (an endgame metric that tells you if you’ve reached your goals) only if cost containment is a priority for your marketing. If you are in a growth mode with an objective of capturing significant market share and net profit is not a strategic priority (such as many startups), ROI can actually be a hindrance to your marketing efforts because over-focus on it will prevent you from taking short-term losses in exchange for long-term potential gains.
What is ROI?
Simply put, it is the following formula:
(Income Earned from Marketing Efforts — Marketing Expenses) / Marketing Expenses = ROI
That is ROI. It’s a deceptively simple formula. The reason why it’s so deceptively simple is that there are a lot of components in each of the two areas.
Determining income earned from marketing efforts requires the use of a good CRM that allows you to track what marketing methods actually result in sales, and what the revenue of those sales is. For example, let’s say you sell chewing gum. To the best of your ability, you need to be able to track exactly how much gum you’ve sold to consumers at what price, by marketing channel. The last part is the catch. It’s easy to figure out how much gum you’ve sold, but much harder to figure out what marketing channel drove those sales. Online is relatively simple — using tools like Google Analytics to track checkouts at a virtual store makes that fairly straightforward. Offline is trickier and requires things like surveying and statistical sampling in order to accurately assess why someone bought a pack of gum.
Income can be even trickier to determine if it’s decoupled from marketing, as is often the case with wholesalers and resellers. If you manufacture alkaline batteries like Duracell or Energizer, there’s a good chance you use a distributor or reseller like a Walmart or Target to resell your goods. As a result, your marketing efforts to build your brand are decoupled from the actual transactions because someone else is handling the sales — and as a result, all of your brand-building effort may be for naught if a reseller fails to display your products effectively. One of the few methods that gets around this problem to some degree is coupon redemption. If a manufacturer issues a coupon, they can get an actual idea of a channel’s income generation potential by tracking how many coupons were issued vs. how many were redeemed from that channel.
The expense side of marketing is also fraught with danger, especially in fields like social media. Almost no one tracks the single largest expense in social media: time. Time is not free. Time has never been free. How much you spend in any marketing channel isn’t just a question of money leaving your bank account or corporate credit card, but time spent as money.
How to Calculate Marketing ROI
Here’s an example of determining time spent as money. Let’s say you’re in marketing and you earn $50,000 per year. The effective number of working hours you have per year is 52 weeks x 40 hours per week, or 2,080 hours. Your effective hourly pay, then, is $24.04 per hour. For every hour you spend on Pinterest, Facebook, Instagram, etc., you are effectively investing $24.04 of time as money in that marketing channel. Suddenly, channels like social media get very expensive.
So let’s put the two sides, income and expense, together in an example so that you can see what marketing ROI looks like.
Let’s say you decided to advertise using Google’s Adwords pay per click advertising. Let’s say you spent $500 in cash and 5 hours of your time (at a $50,000/year salary) to get Adwords up and running, and in turn, you earned $1,000 in sales of, let’s say citrus-scented headphones.
Do the preparation math:
- Income: $1,000
- Expense (cash): $500
- Expense (non-cash): $24.04 x 5 = $120.20
- Total Expense: $620.20
The ROI formula is Income — Expense / Expense, so $1,000 — $620.20 / $620.20 = 61.24%.
This is an excellent ROI. It states that for every dollar spent, you earned the dollar back plus 61.24 cents. Any business would be very pleased with that ROI and would likely ask you to invest a little more time and a lot more money if that result remains consistent.
Let’s try another example for the same person at the same company. Let’s say you’ve decided that Facebook is the hottest thing since sliced bread and you’re going to avoid outlaying cash on your Facebook efforts. You set up a Fan Page for your citrus-scented headphones, take 80 hours to set it up, administer it, manage the community, do outreach, etc. but you spend no money on it and you manage to sell $1,000 worth of those strange headphones. You’re feeling good about yourself — this social media stuff works, right?
Do the preparation math:
- Income: $1,000
- Expense (cash): $0
- Expense (non-cash): $24.04 x 80 = $1,923.20
- Total Expense: $1,923.20
The ROI formula shows $1,000 — $1,923.20 / $1,923.20 = -48% ROI. Uh oh. When you account for time spent as money, Facebook (in this example) is a money-loser. For every dollar of time you invest in it, you’re losing 48 cents.
What to Do With ROI Calculations
This is where it’s decision time for you as a marketer.
Remember, if cost containment isn’t a primary goal, ROI isn’t the correct metric to be focusing on. If you’ve made the conscious and strategic decision to take a financial loss (in cash and time spent as money) in order to grow a long term opportunity, then this ROI of Facebook for citrus-scented headphones may be acceptable. However, if cost containment is a primary goal for your marketing department, you have to make the decision whether to adjust your Facebook strategy or cut it out and stop your losses.
Ultimately, ROI is just one way to measure marketing’s performance, but it’s one of the least well-understood ways of doing so. By walking through this calculation, you’ll realize just how difficult it is to calculate with great precision and how meticulous you must be in your tracking methods in order to capture even moderately good quality data. If you can do that effectively, ROI is yours to analyze, but if you can’t because of organizational structure or operational issues, then you’ll need to forego the use of ROI as a marketing metric.
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Originally published at Christopher S. Penn Blog.