Thursday, December 25, 2008

Back to Basics: Calculating ROI

Most of the marketing positions I've held have required me to demonstrate how my department's activities have produced a significant return on investment (ROI). I've learned that this seemingly simple concept is not as cut and dry as it might appear - even if we leave social media marketing and perhaps even traditional advertising out of the equation. Yet demonstrating the value of marketing activities has always been how I've proved that what I am doing is worthwhile.

Jim Novo, author of Drilling Down, makes the point that because there are so many ways of calculating ROI, the best way to calculate ROI is to use an equation that your company (ie your Board or CEO or CFO) finds relevant. How true. (You can read Novo's full article here.) Perhaps this should be step one in any quest for demonstrating accountability in the marketing department - determine what metrics the big bosses want to see.

In the earlier parts of my career, I did just that. When I calculated ROI, I took into account only the cost of acquisition and the resulting profit of a campaign (this was all that my "big bosses" wanted to see from me for a long time). As I progressed and became the manager of a department, however, I had to account for additional factors including the cost of staff salaries (my "big bosses" became even bigger bosses - CEOs and the Board and the like). My understanding of ROI changed as a result, and has continued to change with increasing responsibility and "higher" perspectives. The "higher up" I go, and the more I reflect, the more and more factors I believe I need to take into account. The more I learn about measurement, the more I believe that the results of the calculations I have relied upon only give me a glipse into the effectiveness of my marketing activities, and therefore how limited I have been in my ability to substantiate the value of marketing activities that relate to longer-term profitability goals.

The type of ROI calculation I am most familiar with - ie profit/cost of acquisition, is what Novo refers to as "simple ROI". As Novo points out, although this type of calculation is important, the results demonstrate only "front-end profit." These results ignore other important factors like the effect on the brand, customer loyalty and repeat purchases. According to Novo, these are all factors that can be measured, too, but the calculations are somewhat more complex. I'll delve into these areas in due course in this blog. I have always known that these factors were missing, but to date I have been unable to really find adequate methods for quantifying marketing's contribution to these areas.

In regards to web metrics, Novo suggests a very interesting model. It seems rather straightforward. In order to calculate the ROI of push campaigns where information is gathered through a company's website, especially where the campaigns are complex, Novo suggests that we might examine the revenue over any given period divided by the number of, let's say, unique visitors to the company website to determine how much each unique visitor is "worth". For example, if my revenues over one week are $1000, and I have had 100 unique visitors to my site, then by this calculation, each unique visitor is worth $100 to me.

I think this is a useful calculation, but I'm not sure I'm satisfied with assuming that my revenue is directly related to the number of uniques to my site. I think there are too many factors at play for this to be an accurate measurement. Still, I think that demonstrating the relationship between increases in uniques and increases in revenue are definitely worth looking into. If these were plotted in a graph over several months, or preferably, over several years, this would yield a benchmark for the ideal number of unique visitors to help stimulate revenue. I find this intriguing. I think this might be the case for a number of different methods of measurement - they are incomplete on their own, but taken with other relevant metrics they become more useful.

In fact, the more I come to understand about measuring the effectiveness of marketing activity, the more I believe that any marketer worth her salt needs to create a system of interconnected metrics to attempt to show progress towards company goals. Granted, this picture will always be incomplete because we cannot measure absolutely every effect for want of time, however if we choose a variety of the most important metrics, we will surely arrive at a more complete picture... and that complete picture may just save our marketing budgets (or our jobs), and I am convinced will absolutely allow us to speak from a stronger position when the big bosses want to see measurable results.

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