(Recently, I had the opportunity to write a guest post for the ADAM Software blog. ADAM is a provider of marketing execution software that encompasses digital asset management, product content management, catalog automation, video content management, and more. This article is a slightly edited version of my guest post.)
The ROI of marketing technology has received a good bit of recent attention. Ralph Windsor wrote two articles on the topic, one for Digital Asset Management News, and another for CMS Wire. Both articles discussed several flaws in the methods frequently used to estimate the ROI of digital asset management projects. Mr. Windsor didn't pull any punches, describing the ROI estimates provided by consultants, analysts, and vendors as, ". . . at best wrong and, more often than not, a complete work of fiction."
ROI has been the "gold standard" for measuring financial performance for decades. It first gained prominence in the 1920's after DuPont made ROI the ultimate metric in a comprehensive financial management system for companies and business units. More recently, ROI has been widely used to evaluate prospective investments, including investments in marketing technologies.
ROI can be useful for evaluating marketing technology investments, but like any tool, ROI must be used appropriately. Managers must understand what information is needed to produce an accurate ROI calculation, and they must also understand what an ROI calculation does and does not reveal.
The basic ROI formula is: (Gain from Investment - Cost of Investment) / Cost of Investment
This deceptively simple formula masks several important issues that managers must keep in mind when using ROI to evaluate prospective investments in marketing technology solutions. Here are three of the more significant issues.
Garbage In, Garbage Out
ROI is a calculated value, and as with any mathematical calculation, the "answer" will only be as accurate as the inputs you use in the formula. When you calculate the ROI for a prospective investment, you're required to input the economic value of future benefits. Developing accurate estimates of these values can be a difficult undertaking, but if your estimates aren't reasonably accurate, the ROI you calculate will be completely out of touch with reality.
One way to alleviate some of this difficulty is to reduce the scope of your analysis. Instead of attempting to calculate a complete ROI for a proposed investment, your objective is to determine whether a prospective investment will produce enough benefits to make it acceptable to your company.
The key to this approach is something called the ROI Threshold. This is the minimum ROI that your company requires investments to produce. The ROI Threshold is typically equal to your company's cost of capital, or perhaps the cost of capital plus a risk premium. The cost of capital calculation can be fairly complex, but you can usually obtain the value from your company's chief financial officer.
Once you have the ROI Threshold, you can easily determine what level of benefits an investment must produce to meet the threshold hurdle. For example, suppose that your ROI Threshold is 15%, and you are evaluating a project with a cost of $200,000. You would calculate the required level of benefits as follows:
ROI = (Gain from Investment - Cost of Investment) / Cost of Investment
15% = (Gain from Investment - $200,000) / $200,000
$30,000 = Gain from Investment - $200,000
$230,000 = Gain from Investment
In this scenario, if you can identify benefits with a total value of $230,000, the project will meet your company's ROI Threshold, and you should be willing to move forward.
This approach can alleviate some of the difficulties of ROI analysis because some benefits are easier to quantify than others. When using this approach, you only need to quantify benefits until you meet the threshold level.
ROI Doesn't Consider Risks
The basic ROI formula does not factor in the risks associated with a proposed investment. The acquisition of a new marketing technology solution almost always requires the implementation of new business processes, and it also requires new learning by employees. Therefore, marketing technology projects always carry some risks, even when the actual functionality of the technology is not in question. In most cases, the most significant risk is that the project will not produce the expected level of benefits.
One way to account for the risks that are inherent in any significant technology project is to value benefits using both "best case" and "worst case" assumptions. You then perform an ROI calculation for each set of benefit values. This results in two estimated ROI values that establish the boundaries within which the actual ROI is likely to fall.
ROI Measures Efficiency, Not Impact
ROI is a measure of financial efficiency. It compares the financial benefits that an investment produces (or will produce) with the amount of capital the investment consumes (or will consume). ROI is not directly concerned with the absolute impact that an investment will have on company profitability.
For example, suppose that you are evaluating two prospective technology projects. Project A has an estimated ROI of 25%, and Project B has an estimated ROI of 15%. Using ROI alone, you would choose Project A over Project B. However, suppose that Project B will produce net benefits of $300,000, while Project A is expected to produce net benefits of only $75,000. Under these facts, you might well choose Project B despite the lower ROI because of the larger impact it will have on company profitability.
ROI is a useful tool for evaluating potential investments in marketing technology solutions. It is widely accepted by CEO's and CFO's, and because it provides a common framework for describing financial performance, ROI is particularly helpful for comparing disparate types of potential investments. However, ROI (even assuming that it is calculated accurately) does not provide all of the information you need to make sound investment decisions, especially when those decisions involve complex projects whose success depends on multiple factors.