Return on investment is a black and white mathematical calculation – so why is it so difficult for organizations to determine ROI for marketing and advertising dollars?
Though calculating ROI can be challenging, it doesn’t mean it’s impossible. Helping businesses owners and marketing executives understand and improve ROI is a core component of our business, and we’ve developed a few guiding principles to help remove some of the pain and frustration from this process.
Here’s a list of some pointers:
Understand your margins.
It may sound simple, but many times companies don’t clearly understand the profit margin on their products and services. If you don’t understand your margins, your ability to calculate ROI is virtually impossible.
Every product company should know exactly what their margin is on each product. If you sell jackets for $100 at a 25% margin, then you profit $25 per jacket sold.
Likewise, a service company should know their margin on a billable hourly rate. If you charge $100/hr for a service that actually costs you $75 to perform, you are also running on a 25% margin.
Once you’ve got a firm grip on your margins, you are ready to proceed to the next tip.
Understand how to tie marketing dollars back to sales.
Once you understand your margins, you know what you can afford to spend in marketing to generate a new customer. At a 25% margin, every $1 spent needs to generate $4 in gross sales in order to break even. Ideally, you’ll want to generate $6, $10, or $20 in gross sales from every $1 spent in marketing!
Now the challenge becomes understanding exactly what sales were created by what efforts. Sales can be created in any number of ways:
- Some sales are created as a direct result of marketing (saw your ad, immediately bought)
- Some sales are influenced as result of marketing (saw your ad, shopped around, came back and bought from you a month later)
- Some sales simply cannot be tracked or understood completely (referred by a friend, live close by your store, etc.)
Tracking direct sales.
In the digital landscape, tracking sales that are directly created from marketing dollars is fairly black and white. Tools like Google Analytics will show exactly where each sale came from (if you are an ecommerce business), or exactly where each lead came from (if you are a service business). If you don’t have this technology in place, or aren’t using them to their full potential, you need to call someone (like CM!) to help with this.
See revenue per channel in Google Analytics:
Tracking influenced sales.
Understanding what sales are being influenced by marketing spend becomes a bit more complex. Modern tracking software gives us the ability to monitor “conversion paths” – meaning that we can see the entire customer journey that someone has gone through prior to making a purchase.
Let’s take another look at the jacket example:
A potential customer may do a Google search for “black dress coats”, clicks on your PPC ad and arrives at your website. They look around, and ultimately leave the site and continue with their day. The next day they do the search again, they are enticed by the same ad, they click again and come back to the site. They add the coat to their cart this time, but ultimately do not purchase.
The next week, they can’t stop thinking about that coat. The do a Google search for your brand name, and click on your organic listing. While checking out, they get realized they are late for work and have to run.
Later at work (on their lunch break of course), they are browsing Facebook and see your brands post. Remembering that they didn’t complete the purchase from earlier, they click through to your website and finally buy the coat they’ve been looking for.
With the right tracking in place, this entire process can be monitored and reported on.
Top Conversion Paths report outline these 4 encounters with your brand:
Sales that can’t be tracked.
As good as technology is as this, there will always be certain channels of marketing that are nearly impossible to track completely. Dollars spent on building you brand, participating in community events, attending conferences and trade shows, etc. can be very difficult to tie back directly to sales.
Even some components of digital marketing pay dividends that are hard to understand:
- Someone sees your banner ad, takes an interest, but doesn’t click through to your website.
- Someone sees your social posts, reads them but doesn’t engage.
- Someone comes to your website, doesn’t make a purchase, but has now been exposed to your brand and remembers your name.
My recommendation here is to understand your truly trackable marketing so well that you can afford to invest a percentage of your budget into serendipitous marketing. (more on this in a bit)
So how do I Calculate ROI?
For the company who sells jackets:
The company does $5M in sales a year, and the annual marketing budget is $200,000.
80% of the budget ($160,000) is spent on channels that can be tracked very well. At a $5 cost per customer acquired, this investment creates $3.2M in gross sales.
20% of this ($40,000) is spent on less trackable channels. Subtracting out revenue generated from trackable channels, there’s $1.8M in gross sales unaccounted for. It’s likely the case that the $40,000 spend contributed in some way to this, though we can’t be certain exactly how much.
At a 25% margin, they’ve made $800,000 in gross profit from the $3.2M in tracked sales.
Subtract the marketing investment of $160,000, and they’ve actually created a profit of $640,000.
The net profit is 4 times the size of the initial investment, so ROI for tracked marketing is 400%.
So how do we account for the $40,000 spent on less trackable channels? There’s two options:
- You can calculate ROI from a “worst case scenario” perspective. Assume your $40,000 created zero in sales, and add this expense to the $160,000 spend on tracked marketing. So instead of $160,000 creating $3.2M in gross sales, assume that it actually took $200,000 to create $3.2M.
$3.2M at a 25% margin is $800,000 gross profit, minus $200,000 in marketing = $600,000 in net profit.
Spending $200,000 to create $600,000 in net profit is an ROI of 300%.
- You can make a conservative estimate on customer acquisition cost for less trackable marketing. If it cost $5 to acquire a customer through tracked channels, let’s assume it cost $20 through non-trackable channels (4 times the cost).
With a spend of $40,000, we can attribute $200,000 in gross sales and $50,000 in gross profit. Subtract the cost of marketing, and you are left with $10,000 in net profit.
The ROI of this $40,000 investment would be 25%.
If we combined this with the ROI generated from trackable sales, then we can say that the spend of $200,000 created $3.4M in gross sales ($3.2M from tracked, $200,000 from non-tracked).
$3.4M at a 25% margin is $850,000 in gross profit, minus $200,000 in marketing = $650,000 in net profit.
Spending $200,000 to create $650,000 in net profit is an ROI of 325%.
Additional value created: The lifetime value of a customer.
The calculations above assume that we are creating one-time sales with each marketing dollar spent. In reality, many of these new customers will become repeat customers. A percentage of those repeat customers will become brand loyalists, and will encourage their friends to purchase the same jacket.
How do we quantify this effect?
I’ll leave that for another post, but figuring out the lifetime value can add a ton of extra insight into your ROI calculation. Many companies will actually lose money acquiring the first transaction, because they expect to ultimately earn a larger profit through repeat business from the same customer.
In my view, if you can at least show a reasonable profit on the first transaction, lifetime customer value is icing on the cake!
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