Increased Profits, Not Higher Sales, Determine Marketing ROI

Return on marketing investment has become a hot topic as marketers seek to prove the value of their activities and programs and strive to bolster their credibility in the C-suite.  Today, marketers are using ROI for everything from justifying marketing budgets to measuring the performance of individual campaigns.

Given its increased use and popularity, you would think that the process for calculating marketing ROI is now well understood.  Unfortunately, I still see far too many examples of marketing ROI that has been calculated incorrectly - in many cases by people who should know better.

One of the most common errors is the use of increased revenues (sales) rather than increased profits when calculating marketing ROI.  To illustrate this error, take a look at the following table.  I based this table on an example ROI calculation that appears on the Website of a well-known national provider of direct mail services.  I won't name the company because they are only one of many companies that use this methodology.

In this example, Return On Investment (ROI) was calculated by dividing Total revenue ($1,250) by Total cost of the mailing ($550), resulting in an ROI for the mailing of 227%.

That ROI number looks fantastic, but the problem is, it's flat out wrong.  Way wrong.

The basic formula for calculating ROI is:

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

For ROI purposes, Gain from Investment is the incremental gross profit (gross sales/revenues less cost of goods sold) produced by a marketing campaign or program.  Using incremental sales or revenues in the ROI calculation distorts ROI because most marketing campaigns are designed to increase sales volume.  And increases in sales volume are not free - there are always costs associated with producing and delivering the additional products or services.  Therefore, incremental gross profit is the real meaure of the "gain" produced by most marketing investments.

So, the first problem with the methodology used in the example is that it bases ROI on incremental revenues rather than on incremental gross profits.  If the cost of goods sold of the products covered by the example is 50% of the products' selling price, the incremental gross profit produced by the direct mail program would be $625 (total revenue of $1,250 X 50%).  Using incremental gross profit causes the ROI to drop from 227% to just under 114% ($625 / $550).  That's a more accurate ROI calculation than the one used in the original example, and it's still an impressive number, but it's also still wrong.

To calculate marketing ROI correctly, you must subtract the cost of the marketing investment from the incremental gross profit produced by the investment and then divide by the cost of the investment.

So, the real ROI produced by the example direct mail project would be calculated as follows:

ROI = (Incremental Gross Profit-Total Cost of the Mailing) / Total Cost of the Mailing
ROI = ($625 - $550) / $550
ROI = $75 / $550
ROI = 14%

It should be clear from this discussion that inaccurate calculations of marketing ROI can lead to unprofitable marketing decisions and can also undermine marketers' credibility with senior company leaders.  Would you want to tell your CEO that a marketing campaign has an ROI of 227% when the real ROI is 14%?  The moral of the story:  If you're going to calculate ROI, it's wise to calculate it correctly.

Have you seen instances where inaccurate calculations of marketing ROI have led to flawed marketing decisions?

How MSP's Can Take Advantage of B2B Marketing Automation - Part 1

The use of marketing automation technologies by B2B companies is growing rapidly, and the growth is likely to continue for the foreseeable future.  Marketing service providers who serve B2B companies need to be aware of this trend because it changes the way B2B companies approach marketing and the kinds of marketing services they will require - and be willing to pay for.  To fully realize the benefits of marketing automation, B2B companies will need to define marketing and sales processes more precisely, and they will need to implement new marketing techniques. Marketing service providers who can help B2B companies make these changes stand to win new clients and boost revenues.


The best way to identify the kinds of marketing services that are likely to see increased demand is to identify the tasks that B2B companies must perform in order to take full advantage of marketing automation systems. There are eight major tasks that are essential to implementing and successfully using marketing automation technologies. Most of these tasks provide the foundation for new marketing techniques that many B2B companies have not previously used. Therefore, many B2B firms – especially small and mid-size companies – will need assistance to perform some or all of these tasks, and that’s what creates the opportunity for savvy marketing service providers. I’ll describe two of these major tasks in this post, and I’ll cover the others in my next few posts.

Creating an Ideal Customer Profile – This task is right out of Marketing 101, and it should be a core component of every company’s marketing process, whether or not marketing automation is involved. An ideal customer profile is simply a description of the kinds of companies that make the best customers and, by extension, the most attractive prospects. The ideal customer is usually described in terms of “firmographics” such as industry classification, company size, and geographic location. The ideal customer profile is used to shape lead generation programs, and it is one major component of the lead scoring system that will be set up as part of the marketing automation implementation.

Obviously, a marketing service provider cannot decide what a client’s ideal customer profile should be. The role of the MSP is to lead the client through a process that is designed to ensure that all the right questions are asked and that all the appropriate factors are considered.

Developing Buyer Personas – Most B2B buying decisions are made (or significantly influenced) by a group of people rather than by one individual. This is true even in relatively small companies. Research firm MarketingSherpa says that in companies having between 100 and 500 employees, the average number of people involved in buying decisions is 6.8. This buying group is usually composed of individuals who have different points of view regarding a proposed purchase. For example, a “user buyer” will usually have different priorities than a “technical buyer” or an “economic buyer.” To market to these buyers effectively, a company must develop marketing content that addresses the specific needs of each type of buyer in the buying group. The basis for developing such content is buyer personas.

A buyer persona is a biographical sketch of a typical buyer. It is more than a job title. Buyer personas are written in narrative form, and they are written as if the archetypical buyer is a real human being. A company needs to create a persona for each type of buyer who significantly influences the purchase decision. Marketing automation systems enable companies to create and execute marketing programs that are customized for each type of buyer, but the starting point for leveraging this functionality is the creation of buyer personas.

To develop a complete buyer persona, marketers must answer several questions about each type of buyer. Here are some examples:

•What are the buyer’s major business objectives and job responsibilities?
•What strategies and tactics does the buyer use to achieve his objectives and fulfill his responsibilities?
•What measures are used to evaluate the buyer’s job performance?
•What issues and problems keep the buyer awake a night?
•How old is the typical buyer? [Age range is OK]
•Is the buyer typically male or female?
•What is the typical buyer’s educational background?
•What sources does the buyer turn to for information?
•How would the buyer describe the issues he or she is facing?

As with the ideal customer profile, an MSP cannot build buyer personas “for” a client, but the MSP can lead the client through the process of developing buyer personas that will drive relevant and effective marketing.

In my next post, I’ll cover two more tasks relating to marketing automation that MSP’s can help B2B marketers perform.

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.