For More Accurate Marketing ROI, Think Incrementally

Return on investment (ROI) is a financial measure that managers use to guide major investment decisions.  For example, suppose that you are considering a business expansion opportunity that will require the purchase of new machinery and certain other investments.  To evaluate this potential expansion, you would discount all of the future profits and expenses related to the expansion and calculate a net present value for the expansion opportunity.  Then, you would use those net present values to compare the gain from the expansion investment with the cost of the expansion investment and calculate the projected ROI of the expansion project.

When we use ROI to evaluate prospective marketing investments, we need to adapt the traditional ROI analysis process a little, primarily because unlike most major capital investments, marketing investments can often be made in relatively small increments.  In other words, marketing investments are often not simple "go-no go" decisions.  In many cases, the more difficult questions relate to the size and scope of a potential marketing campaign or program.  How long should the campaign run?  How many prospects should be targeted, and how many times should they be contacted?

For example, suppose that you are considering a direct mail campaign to generate new sales leads for your B2B company.  You have identified three mailing lists that you could use in this campaign.  Each of these lists contains 1,500 names.  The first list (List 1) is a "house" list that includes prospects that your company has had some previous contact with.  Therefore, you believe that List 1 contains the best prospects and will probably produce the most new customers.  List 2 and List 3 are both outside lists that you can purchase, and based on past experience, you believe that List 2 will be more productive than List 3.  The question is:  Should your campaign target only the prospects in List 1, or those in List 1 and List 2, or those in all three lists.

The table below shows the estimated costs and the projected results of all three alternative versions of the campaign.  The top portion of the table shows the overall ROI calculations.  The lower portion of the table shows the incremental results as you move from the first option to the second and from the second to the third.

For this example, let's assume that your company requires that all proposed marketing investments show a projected ROI of at least 15 percent.

If you look at the overall ROI calculations shown above, you would probably recommend including all three mailing lists in the direct mail campaign.  Even though the projected ROI of 57.5 percent is lower than the other two options, it still far exceeds your company's ROI threshold of 15 percent.  The three-list option also generates the highest projected total return ($15,750) and the highest projected net return ($5,750).

However, if you look at the incremental analysis, you see a different story.  Here, you see that if you include List 3 in the campaign (as opposed to only List 1 and List 2), your company will incur $2,500 of additional costs, and you will increase your net return by $250.  This means that the incremental ROI generated by including List 3 in the campaign is only 10 percent.  Since this falls below your company's ROI threshold, you would probably recommend against including List 3 in the campaign.

This example illustrates how the incremental approach to analyzing marketing ROI can lead to more profitable marketing decisions by measuring the incremental value of each incremental investment.

Analyzing the ROI Formula - Part 3

This post concludes my discussion of the individual components of the formula used to calculate the return on investment (ROI) of marketing activities and programs.

The basic ROI formula is:

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

In earlier posts, I've discussed the Gain from Investment and the Cost of Investment components of the ROI formula.  Although it's not explicitly included in the formula, time is the third component of the calculation.

ROI is always measured over a specified period of time.  The goal is to select a time period that will enable you to capture an accurate view of the stream of profits and expenses that are attributable to a marketing investment.  A time period that is too short will cause the ROI to be understated, and this may cause you to not go forward with proposed marketing programs (or eliminate existing programs) that produce significant value over the long term.  If the time period used is too long, the accuracy of the ROI calculation may be diminished because of the uncertainty that is inevitably involved in forecasting profits and expenses for distant time periods.

When specifying the time period to be used in an ROI calculation, marketers need to focus on several issues.

• Over what period of time will the marketing campaign or program have an impact?  The time period used does not need to extend past the point where most (85%-90%) of the value and costs are captured.
• How much uncertainty exists regarding future value and expenses?  If the degree of uncertainty increases substantially over time, marketers should use a time period that permits reasonably accurate forecasts.
• What are the company's profit priorities?  Some companies rely on short-term cash flows to remain viable.  Such companies are naturally more interested in marketing programs that produce short-term results and, therefore, are more interested in short-term ROI.

To illustrate some of the issues that surround the selection of the correct time period for measuring ROI, let's look at two different situations.

Suppose that you are a retailer and you decide to send your existing customers a direct mail piece that includes a discount coupon.  Customers must present the coupon in order to receive the discount.  From past experience, you know that 95% of the coupons that are redeemed will be used within 90 days of the date of the mailing.  Therefore, it would be appropriate to measure the ROI of this marketing program over a period of 90 days.

Now suppose that you are a software company that provides warehouse management software to business customers.  You decide to market the latest version of your software to prospective customers using an integrated direct mail and e-mail campaign.  Because warehouse management software has a long sales cycle, your marketing campaign will involve several direct mail pieces and several e-mails sent over a period of several months.  Companies that buy your software pay an initial licensing fee and monthly support fees.  From experience, you know that once a company buys your software, they will remain a customer for an average of seven years.  Therefore, in order to get an accurate measure of the ROI of your marketing campaign, you would need to measure ROI over a seven-year period.

One final point about the role of time in measuring marketing ROI is that both future profits and future expenses must be converted into present values.  This is accomplished by "discounting" both future profits and future expenses.  The discount rate is typically set at the company's cost of capital, which marketers usually obtain from the company's chief financial officer.

Analyzing the ROI Formula - Part 2

This post continues our discussion about measuring the performance of marketing, including the use of marketing return on investment (ROI).

As I have already noted, the basic ROI formula is:

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

Therefore, marketing ROI is calculated using two factors - the gain or incremental "profit" produced by a marketing campaign or program and the cost of that campaign or program.  My last post discussed the Gain from Investment component of the ROI formula.  This post will focus on the Cost of Investment component of the formula and discuss some of the issues this component presents when ROI is used to measure marketing.

Cost of Investment is the total cost of the marketing campaign or program whose ROI is being measured.  At first glance, this can appear to be an easy determination to make, and in some cases it will be.  For example, if you outsource all of the work required to develop and execute a particular marketing campaign, the investment in that campaign will be easy to identify.

In other cases, however, the issue becomes more complex.  For example, if creative elements are developed that will be used in multiple marketing campaigns or programs, how should these creative development expenses be assigned to the multiple marketing efforts?  What if you don't know how many times a creative element will be used?  Should the labor costs of marketing department staff personnel be treated as marketing overhead or assigned to specific marketing campaigns or programs?

The most important principle to use when assigning expenses to specific marketing campaigns or programs is that cost assignments should always be based on real-world cause-and-effect relationships.  In other words, the marketing campaign or function whose ROI is being measured must be the "cause" of the cost or expense.

As noted earlier, this principle can be fairly easy to apply in some cases, such as when expenses are incurred to pay outside contractors (agencies, designers, printers, etc.) for specific work on a specific project.  Internal marketing department expenses can be more difficult to address.  For example, if you employ graphic designers, it is appropriate to assign their labor-related costs to the projects they work on.  On the other hand, it may not be possible to assign the labor costs of higher-level marketing managers who perform more general marketing activities.  Often, these costs cannot be logically assigned to specific marketing campaigns and should be treated as overhead expenses.

Assigning costs to marketing campaigns and programs can become relatively complex, and marketers may need to obtain help from financial professionals in performing these assignments.  Assigning costs accurately is essential to producing accurate ROI calculations.

Analyzing the ROI Formula - Part 1

This is the third in a series of articles about measuring the performance of marketing, including the use of marketing return on investment (ROI).  In my last post, I described the basic concept of ROI and discussed how ROI has been used to measure many types of business performance.  Beginning with this post, I'll discuss each component of the basic ROI formula and explore some the the issues that each component presents when ROI is used to measure marketing.

The basic ROI formula is:

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

So, the ROI formula contains three components:

• Gain from Investment
• Cost of Investment
• Time - Although the formula doesn't expressly contain a "time" value, ROI is always measured for a defined period of time.

This post will focus on the Gain from Investment component of the formula, and this component presents two basic issues.  First, how should Gain from Investment be defined?  And second, how should ROI be calculated when the Gain from Investment is produced by more than one marketing campaign or program?

For ROI purposes, the best definition of Gain from Investment is the incremental contribution margin produced by the marketing function or by a marketing campaign or program.  One of the biggest mistakes that I still see some marketers make is to use incremental sales (revenues) to calculate marketing ROI.

To understand why this mistake distorts ROI, remember that most marketing programs are designed to increase sales volume either by acquiring new customers or by increasing sales to existing customers.  But increases in sales volume are not free - there is always an associated cost of producing and delivering the additional products or services.  Therefore, if incremental sales are used to measure ROI, the ROI will be overstated.

Using contribution margin solves this problem by taking costs into account.  Contribution margin is defined as sales minus variable costs.  Variable costs are costs that the company will not incur if the additional sales are not made.  Therefore, incremental contribution margin is a measure of the "net new revenues" produced by a marketing program.

The second major issue presented by the Gain from Investment component of the ROI formula is how to address situations where the Gain may have been produced by more than one marketing campaign or program.  This situation is not at all uncommon in B2B companies where each prospect may be "touched" by several marketing programs over the course of his/her buying cycle. 

Some companies deal with issue by assigning all of the incremental contribution margin earned from a prospect to the marketing program that generated the first "inquiry" from that prospect.  Others assign all of the incremental margin to the program that "touched" the prospect last (just before the purchase).  It should be obvious that this first touch/last touch approach will often produce a distorted picture of marketing ROI if a prospect has had several interactions with your company.

Some companies attempt to eliminate this distortion by allocating the Gain to all of the marketing programs that "touched" the prospect.  But what percentage of the Gain do you assign to each program?  Allocating the Gain equally to all of the marketing programs may not reflect which of the programs were truly influential in the purchase decision and which ones weren't.  Unless you have some way of knowing how much influence each program actually had in driving the purchase decision, the allocations are arbitrary, and the resulting ROI measurement is likely to be inaccurate.

This allocation issue presents one of the most serious challenges in measuring marketing ROI accurately, especially when we attempt to measure marketing ROI at a very grandular level.  The difficulty of using ROI in this way suggests that there may be a better approach, and I'll have more to say about that in a later post.

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.

Measuring Marketing Takes More Than ROI

Over the next several days, I'll be posting articles here about measuring the performance of marketing, including the use of marketing return on investment, or MROI.

This may not be one of the sexiest marketing topics out there, but it has become an extremely important one.  For the past several years, CEO's and CFO's have been demanding greater financial accountability from the marketing function, and they are now pressing marketers to prove the value of marketing activities and programs.  Many years ago, John Wanamaker is reported to have said, "Half the money I spend on advertising is wasted; the problem is, I don't know which half."  CEO's and CFO's expect better from marketers today.

I'm also writing about this topic because, even though there is a large volume of literature about how to measure the performance of marketing, there are many misconceptions floating around, even about some of the most basic principles.  For example, you can find many marketing campaign "ROI calculators" in use today that calculate ROI based on revenues or sales instead of profits (in one of its various forms).  If a marketer presents one of these kinds of "ROI calculations" to a CFO, his/her credibility can be undermined.

Another issue is that in recent years, MROI has become the "gold standard" for measuring not only the overall performance of the marketing function, but also the performance of individual marketing activities.  Some experts argue that this approach is both possible and essential.  But, like any metric, MROI has limitations, and we need to understand those limitations in order to use the metric in the right ways, for the right purposes.

In my next few posts, I'll start by explaining the basic idea of ROI, and I'll describe how ROI has been used to measure business performance.  Then, I'll look at the components of the ROI formula and describe how each of the components should be defined and calculated and what issues that may present.

And finally, I'll argue that, while MROI is an important metric, we need a more holistic approach to get a comprehensive view of marketing performance, especially in B2B companies with complex marketing/sales processes and longer revenue cycles.

Four Ways to Jumpstart Content Development

Successful B2B marketing depends largely on the quality of marketing content.  To break through the marketing clutter that fills the environment and create real engagement with potential buyers, you need relevant and compelling content that helps buyers address important business challenges.

Although this "new" approach to marketing is quickly becoming a competitive necessity, it's not an easy transition for many companies to make.  The volume of content needed can seem to be overwhelming.

For example, suppose that you sell to only one type of company.  Your buying group typically contains three individuals so you have three buyer personas to address.  Your buyers usually move through a four-stage buying process, and you believe you will need to interact with each buyer at least three times during each stage of the buying process.  This means you'll need at least 36 "pieces" of marketing content to fuel your marketing effort (3 personas X 4 buying stages X 3 interactions per buying stage).

The good news is that getting started with content marketing is usually the most difficult step.  Once your initial base of content is created, the job becomes more manageable.  So, is there any way to make getting started easier?  These four tactics will enable you to jumpstart your content development.

Narrow Your Focus

If you sell to more than one type of business, pick your largest, most profitable, or most attractive customer segment and start by developing a full set of content materials for that segment.  You can add content for other types of customers later.  When it comes to content marketing, you are better off having the content you need to take some of your prospects all the way through the buying cycle than having content that will take all of your prospects only part of the way through the buying cycle.

Use Existing Marketing Materials

OK, I'll admit that most of your existing marketing materials probably aren't suitable for the kind of customer-focused marketing you need to be doing today.  I include this tactic for two reasons.  First, at the right time in the buying cycle, your potential buyers will want and need to learn about your company and your products, and your existing marketing materials should be able to perform this function.  Second, even if your existing materials aren't suitable in their current form, you may be able to make some of them suitable by making relatively minor changes.  At least you won't be starting from scratch.

Follow the "Rule of Five"

The rule of five says that whenever you develop a significant content asset, you should try to create at least four "smaller" content pieces from the original asset.  For example, say you write a white paper.  You then use the content in the white paper to create one or two short articles and two or three blog posts.

Outsource the First Wave

Even if you follow the first three suggestions, you may still find that you don't have the time or internal resources to create the content you need as fast as you need it.  If that's the case, you should consider outsourcing some or all of the content development work.  Once the initial wave of content is developed, you may find that you can build on that foundation to create the additional content you need.