ROI has been the bugaboo of marketing for almost as long as marketing existed. But, marketing ROI isn’t all it’s cracked up to be!
What is ROI?
ROI – return on investment – comes from financial management. It is used to assess whether a particular investment generates enough revenue to be worth the investment.
Commonly, ROI is used to evaluate decisions where the investment returns a discrete amount of revenue. Examples are:
- Make vs buy – where a firm evaluates whether it makes more sense (financially) to make their own components or products versus buying them ready-made from a company. Dell owes its initial success to a decision to buy computer components as surplus from manufacturers then install custom selections into a case and ship it to customers who ordered online.
- Buy a new machine – if a machine makes costs Y and costs Z to operate/ hour, you’d use an equation that looks like this to give you the number of parts you need to sell to cover your desired ROI:
Y + R (desired ROI)
SP (selling price) – Z
- Hire new production employees — the assumption is that each employee can make X products in Y hours, so hiring more employees results in a finite number of new products.
- And, many more.
You’d then compare the number of parts needed with the number of parts the machine can make before it breaks down. You might increase precision by adding any salvage value of the machine and using NPV (net present value) to change your ROI calculation based on inflation.
The calculations are pretty complicated, but the results are easy for managers to digest. They’re clear-cut and don’t require any imagination or true decision-making — they’re either positive or negative. End of discussion.
Of course, there are a number of assumptions buried in this equation:
- The selling price will hold indefinitely
- Demand for the product will continue at levels equal to or better than the number of units required by the equation
- The cost of maintaining/ operating the machine doesn’t vary — inputs don’t increase costs
But, here’s the rub — finance people pretty much ignore the first 2, and evaluating the last one is a crapshoot. That said, making decisions based on ROI for these types of business options are fairly straightforward.
If this, then that.
Problems with marketing ROI
The biggest problem with marketing ROI is people don’t respond immediately or reliably.
Despite this, a Google search on marketing ROI generated over 45 million results.
Yet, more folks are beginning to question the validity of ROI for making marketing decisions, like Digital Doughnut.
When I used to work for a direct marketing consulting firm, we’d estimate ROI assuming a 1%, 2%, and 5% response rate. But, it’s a total crapshoot as to whether we’d reach those rates or even exceed them. Even if we had experience working on projects for the client, there’d be wide swings in response rates between campaigns — some performing spectacularly, some not so hot.
Marketing doesn’t follow the — if this then that — philosophy
So, why should you base marketing decisions on marketing ROI?
Don’t believe me.
Marketing has multiple priorities that don’t involve sales
Take a look at this infographic (see the entire infographic below) based on Social Media Examiner and Forrester data (from 2014, but the data is still pretty on point).
Notice, the top business priority for CMOs is building brand awareness (nearly 40%) — the starting point in generating sales. In fact, only about 15% of marketers craft marketing campaigns with the goal of generating leads or sales.
This points to the challenge of effectively measuring marketing ROI.
Also, how can you evaluate the value of a marketing campaign to a firm or brand when you have multiple priorities that don’t involve making sales?
Putting $1 into building brand awareness doesn’t result in a finite return and it doesn’t result in an immediate return.
Customers use brand awareness to determine if a product is “right for them”, but they might not actually buy the product until they have a need.
For instance, doing new car advertising (regardless of online or offline) may show results in months or years when a prospect reached needs to buy a new car.
Marketing ROI is a function of effective transition from one stage to another
Customers don’t just drop like manna from heaven — or result from performing a series of actions with materials on a machine.
Instead, they must move through a conversion funnel such as the one on the left.
Some prospects might move through the funnel quickly, others might take some time. At each stage in the funnel, consumers might drop out — failing to move on toward conversion. Some lost consumers might jump back into the funnel at some point. Hence, the funnel is really much more complicated than it appears in this image.
Only once consumers move successfully through the conversion funnel do they show up in the company’s coffers as a sale.
Does that mean all the marketing activities it took to move the consumer from awareness through conversion were wasted?
I think not!
I’ve listed just some of the many marketing activities necessary to generate revenue. Take any one, like market research, and drop it from your marketing plan and you’ll likely see a decline in revenue. Yet, by itself, the ROI of market research is 0.
The same is true of customer service. Reduce expenses on customer service and you’ll likely see a decline in revenue.
I remember a certain big-box electronics firm that thought they might increase ROI by making returns more difficult. On paper, that makes excellent sense — fewer returns = more sales.
The firm quickly discovered that customers preferred to shop from competitors with more liberal return policies. Thus, this seemingly brilliant decision caused the decline of revenue to the point where this major retailer is now defunct.
Some marketers now consider firms using theories from evolutionary biology and chaos theory — marketing actions might result in unintended consequences.
An alternative to marketing ROI
I’m not advocating that we go back to the dark ages when we spent money on marketing without any inclination as to what worked and what didn’t work. In words attributed to Wanamaker:
Half the money I spend on advertising is wasted; the trouble is I don’t know which half
What I advocate is creating custom algorithms (predictive analytics) based on your own marketing activities and the results achieved from these activities. There’s also a bit of multi-attribution modeling inherent in this method.
Here’s what I propose:
- Set marketing goals in terms of both revenue and factors contributing to revenue, such as clicks, shares, likes, reach, awareness, brand image, etc.
- Calculate the costs of marketing activities associated with achieving these goals.
- Assign a value to activities that don’t directly contribute to achieving a goal, such as market research.
- Use Google Analytics with goal setting to understand what activities contribute to achieving goals
- Evaluate content and channels to determine which help you achieve your goals
- Calculate the change in performance based on marketing activities
- Create a custom algorithm where the change in revenue is a function of inputs (marketing activities) and outputs (expenses associated with activities)
- Increase your budget for those activities with the highest Beta and decrease the budget for those with low Betas or which didn’t figure in the model
- Repeat on a routine basis
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