The Basic Idea of Return on Investment

As I wrote earlier, return on investment has become the "gold standard" for measuring the performance of marketing.  Return on investment is now used to measure both the performance of the overall marketing function and the performance of individual marketing activities and programs.

In addition to measuring past performance, marketers are using ROI estimates and forecasts to make decisions about future marketing programs and to allocate marketing budgets.  Therefore, ROI is playing a significant role in determining how marketing wll be done.

The basic idea of ROI is easy to understand.  Investopedia.com defines return on investment as:  "A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of investments.  To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the return is expressed as a percentage or a ratio."

The basic ROI formula is:

ROI = (Gain from Investment-Cost of Investment) / Cost of Investment

For example, suppose that you purchase 100 shares of stock for $10 per share.  One year later, you sell the stock for $11 per share.  Your annual ROI for this investment would be 10%, calculated as follows:

ROI = ($1,100 - $1,000) / $1,000
           $100 / $1,000
           10%

ROI has been used to measure the performance of companies and business units for over eighty years.  ROI estimates have also been used to evaluate major capital investments for decades.  More recently, ROI has been used to measure the benefits provided by everything from process improvement projects to employee training programs.  All things considered, ROI (or one of the variations of ROI) has become the most prevalent measure of financial performance used in business today.

It's only natural, therefore, to use ROI to evaluate the performance of marketing activities and programs.  CEO's and CFO's are rightfully demanding proof that their "investments" in marketing are producing real financial benefits, and they view ROI as a proven method for measuring those benefits.

So, if you're a marketer today, you need to be ready to measure and/or estimate the ROI of your activities and programs, or you need to be prepared to show why a different metric should be used in lieu of ROI.

In my next post, I'll take a closer look at the "return" component of the ROI formula and explore some of the issues that arise when ROI is used to measure marketing.