Understanding and Measuring the ROI of Your MarketingThursday May 28th, 2015
This article will lay out a top level understanding and method for you get a quick estimate of how your investment in marketing is paying off, and to show how difficult it is to get a finite, accurate answer.
Every dollar counts when running a small business. So, naturally we want to know that each dollar is well spent. There are few instances when this pursuit gets as murky as with marketing and growth initiatives. Even with all of the data accessible to us with digital marketing, it still feels impossible to really figure out what’s working and what isn’t.
A Quick, “Back of the Napkin” Approach
This article is meant to lay out a top level understanding and help you get a quick estimate of how your marketing is working across different channels. I want to keep it simple. I’m sure you can find a very long, dense thesis on the topic elsewhere. Or I’d be glad to help for a modest monthly fee.
How to Calculate ROI
At its simplest, Return on Investment is just that, how much money you’ve made off of an initiative, less how much money you’ve put into the initiative.
We want to have a scalable conversation, though, so that if I put more money in, I can figure out how much I will get back. So for that we use a ratio or percent.
Easy enough. If I put in $100 and make $200 back, then I have 100% return on investment. If my efforts were perfectly scalable, I could put in $1 million and get $2 million back. I’m rich!
Unfortunately, nothing is quite that easy. For instance, when calculating the investment, you could include things like opportunity or hourly costs for your time, or general administrative costs for the office that you do the work in.
More importantly though, calculating only the immediate return can give you a very broken picture and lead to the wrong decisions.
Lifetime Customer Value
This is where lifetime customer value comes in. How much is each customer actually worth to you, beyond their first, easily trackable transaction?
There are several ways to look at this, but the two main factors are how much they spend over time and how many other customers they bring to your business. Let’s look at lifetime spend. The simplest way is to just find the average lifetime spend of all of your current customers.
This leaves a lot out of course. What if you have different products or services that cost different amounts? What about extreme outliers? What about growth and changes in the history of your business? What if your business is only one month old?!
A better way is to look at your average cost per transaction, the average (or estimated) frequency of transactions and the average or estimated lifespan of a customer relationship.
Again, this is overly simplified and leaves out very important details like the cost of goods sold and the eventual profit margin. Still, it illustrates the point that if you only look at that first $100 when calculating the ROI of your marketing, you would be making a grave mistake.
Theoretically then, if you can get your cost per new customer below the profit margin on that $6,000 LCV, you might as well go borrow $1 million and throw it all into marketing. I say theoretically of course, because this is seldom actually 100% true in practice, but it is exactly the kind of thing an investor would look for before deciding to invest in your business.
Connecting the Dots
So, you count up the new customers from your marketing initiatives, calculate the LCV and compare it to what you’ve invested.
That’s a -20% ROI on marketing! Stop the presses! Cancel your campaigns! Right?! Well, slow down for a minute and let’s consider a few other things:
What percentage of those 100 customers are likely to directly refer another customer? If it’s more than 25%, then you probably want to continue your campaigns. Or even better, what can you do to make it more than 25%?
Sales Funnel Conversion
In order to get those 100 customers, how many leads or potential customers went through the sales funnel? 1,000? 2,000? If only 5%-10% of your leads are converting to sales, is it because they are the wrong leads, or because of hurdles in your sales funnel? Increasing this conversion throughput is like pulling money out of thin air. If your conversion rate was 7.5% instead of 5% you’re looking at 50% more customers and a dramatically different outcome.
Aside from direct referral new business, will those 100 new customers go around spreading the word about your brand? Can they be convinced to carry a bag with your logo? What monetary value do you place on brand awareness? (Hint: with a little bit of data you could calculate an estimate working backwards from LCV and cost per lead).
Purchasing Cycle & Timeline
How long is the decision making process for your product? Do you expect someone to see it and purchase it on the same visit to your site, or will they spend months researching before finally pulling the trigger? In the case of a new car, for instance, it could be years before someone’s brand awareness pays off with a purchase. Does your sample size take this into account?
Calculating ROI of Marketing is Hard
My purpose behind this exercise is two-fold. First, to show that having some understanding of how your marketing dollars affect your business is incredibly important and totally achievable. Even the most rudimentary, loose calculations have some decision making value. You’ll also never get to a more accurate, complex calculation without starting with a simple one.
Second though, I wanted to give a taste of how getting a perfect picture of ROI in terms of marketing is very difficult, maybe even impossible. Any single approach you take to the question of ROI should be taken with a grain of salt, and an understanding that there is information that can’t possibly be covered in every scenario. Really, how would you calculate the value of a recognizable brand? It’s certainly not an exact science.
Just because it’s impossible though, doesn’t mean it isn’t important to try.