Return on marketing investment has become a hot topic as marketers seek to prove the value of their activities and programs and strive to bolster their credibility in the C-suite. Today, marketers are using ROI for everything from justifying marketing budgets to measuring the performance of individual campaigns.
ROI has also become an important topic for marketing service providers. MSP's are routinely using case studies that include ROI calculations when pitching projects to prospective customers. In many cases, they will also provide post-campaign reports to clients that contain a calculation of the ROI produced by the campaign. Therefore, marketing ROI has become an important factor both for winning business from prospects and for winning additional work from existing customers.
In these circumstances, it's critical for MSP's to use accurate calculations of marketing ROI. One very quick way to lose credibility with a prospect or client is to present a flawed ROI calculation. Even if your immediate contact doesn't catch the error, it's likely that, sooner or later, someone in the customer organization will.
Given its increased use and popularity, you would think that the process for calculating marketing ROI is now well understood. Unfortunately, I still see far too many examples of marketing ROI that has been calculated incorrectly - in many cases by people who should know better.
One of the most common errors is the use of increased revenues (sales) rather than increased profits when calculating marketing ROI. You can see a detailed illustration of this problem here, but the essence of the issue is easy to describe.
The basic formula for calculating marketing ROI is:
ROI = (Gain from Marketing Investment - Cost of Marketing Investment) / Cost of Marketing Investment
For ROI purposes, Gain from Marketing Investment is the incremental gross profit (gross sales/revenues less cost of goods sold) produced by a marketing campaign or program. Using incremental sales or revenues in the ROI calculation distorts ROI because most marketing campaigns are designed to increase sales volume. And increases in sales volume are not free - there are always costs associated with producing and delivering the additional products or services. Therefore, incremental gross profit is the real meaure of the "gain" produced by most marketing investments.
Using sales/revenues rather than gross profits will usually produce ROI numbers that look fantastic. But the problem is, these ROI numbers are flat out wrong. Way wrong.
Using accurate ROI calculations isn't the only key to being a successful MSP, but it is an important factor in winning new business and building lasting client relationships.
Discussion
By Aaron Corson on Aug 05, 2010
In my opinion, this is bad advice for MSPs.
If MSPs were to calculate ROI based on gross profit, rather than revenue, there would be very few profitable marketing campaigns.
It's our job as MSPs to bring our clients a positive ROI based on sales/revenue. The profit our clients make on these sales is up to them.
In your example, response rate (5%), conversion rate (50%) and profit margin (50%... lol, what business gets a 50% profit margin, sign me up) are extremely inflated. Most campaigns will not see anywhere close to these numbers. With slight decreases to any of these figures, the campaign you show would be negative ROI. Based on a more realistic 2% response and 25% conversion rate, it is literally not possible for this example to be profitable. Does that mean it's not worth doing if it will drive significant revenue growth or future sales volume? Maybe it does in some cases, but shouldn't that be the business owners decision?
I think it's always good to be open and mention to your clients when you provide ROI calculations that they're based on revenue not profit. But let them decide if the amount of potential revenue the campaign generates is a good investment, don't do it for them or you will vary rarely be able to prove the value of your services.
It's hard enough to sell marketing services as it is.
By Stephen Eugene Adams on Aug 05, 2010
David,
Great point here. Another common mistake occurs when calculating the cost of the investment, especially for in-house marketing efforts. A lot of times, there is no allocation of labor to the cost especially when it comes to social media and in-house SEO efforts. These programs tend to look very good when the marketing investment cost is calculated close to being free.
By David Dodd on Aug 05, 2010
Stephen,
Thanks for your comment. I couldn't agree with your more. The idea that "social media marketing is free" is a common misconception. Executing a social media marketing program correctly requires significant time and talent. To get a true picture of the ROI of social media marketing activities, the cost of that time and talent must be captured.
By David Dodd on Aug 06, 2010
Aaron,
Thank you for your comment. With all respect, I disagree strongly with your position. By definition, ROI is a measure of the profit created by an investment. For example, if I purchase a share of stock for $1,000 and sell it one year later for $1,100, my ROI on that investment is 10% ($1,100 - $1,000) / $1,000, not 110% ($1,100 / $1,000). The same principle applies to calculating marketing ROI. What matters is incremental gross profit (or, as Dr. Joe wrote over at LinkedIn, incremental contribution margin), not incremental revenue.
By the way, the 50% margin figure used in my example referred to GROSS PROFIT, not bottom-line NET PROFIT. I agree with you that very few companies earn a net profit margin of 50%, but a gross margin of 50% is not all that unusual.
One final thought. There are many ways to measure the value created by a marketing activity, campaign, or program. Page views, click throughs, response rates, and revenue dollars generated can all be indicators of value in the right context. But none of these constitute ROI. Today, far too many marketers and MSP's are using "ROI" as a synonym for "value" or "results." That's not only wrong, it's sure to produce unmet expectations and lost credibility.
Thanks again for joining the discussion.
By Gordon Pritchard on Aug 06, 2010
If your ROI definition refers to the MSP's involvement then I agree with Aaron. MSP's do not have control over how their customer's create or define financial profitability. It is said that, despite billions of dollars in revenue, most Hollywood films never show a profit simply because of the tax implications. That being said, the MSP needs to understand what their customer expects as a meaningful, measurable, ROI from their marketing investment.
If your ROI definition refers to the customer of the MSP then I agree with you in the sense that the customer needs to define what the meaningful, measurable, ROI that they expect from their investment. That may or may not be defined simply as financial profit.
Discussion
Join the discussion Sign In or Become a Member, doing so is simple and free