Return on investment. These three little words have never packed such a big, powerful punch as they do in today’s marketing environment. How much of a punch? IBM’s recent chief marketing officer study found almost two-thirds of CMOs think ROI will be the primary measure of their marketing effectiveness by 2015.
With ROI in the driver’s seat as the definitive measure of success in marketing, the pressure is on marketing leaders to make sure it’s measured accurately. What are the best ways of doing so? While ROI calculations can be as unique and diverse as the companies that use them, generally speaking there are a couple of options: basic and advanced.
Here’s how to calculate both options, along with the pros and cons of each.
For starters, there’s the basic method. The components of any solid ROI calculation should include revenue generated by the campaign, profit margin and the costs of executing the campaign. While profit margin can be difficult for organizations to quantify because it incorporates the cost of operations, it is necessary to generate an accurate ROI.
Keep in mind that revenue generated “by the campaign” means that the campaign has been designed with a way to capture responses in the form of transactional dollars.
In its most basic form, the calculation looks like this:
Campaign Revenue X Profit Margin
ROI = ———————————————–
Cost of Campaign
The basic ROI calculation is a solid metric for getting a quick directional read on campaign performance. Simply seeing a positive number is better than seeing a negative number. The basic calculation is also good for simple comparisons–“Campaign A is doing better than Campaign B,” or “We showed improvement this month over last month.”
This elementary-level calculation is also good for pilot campaigns and first-time efforts, since these are often launched with one-time start-up costs or temporary extraordinary expenses that would not be present once project efficiencies are captured after the program is rolled out.
While this is a good place to start and keeps things fairly simple, the basic ROI calculation lacks several key components. It does not factor in all of the costs associated with the campaign, or control groups. Both are needed to determine the true revenue generated by a campaign. Enter the advanced version.
Advanced ROI calculations incorporate all of the costs associated with having a marketing department–salaries, benefits, space, computers, software, their proportionate share of the heat and electricity bills, etc., plus all of the campaign costs. Tally all of these items and enter that as the bottom line “cost of campaign” figure.
In the advanced version, it’s also important to factor in dollars generated and purchases generated from the target group and control group. Was the average purchase dollar amount higher from the target group than the control group for those customers who purchased? Did the target group purchase at a higher rate than the control group?
If the average purchases generated is the same between the control group and the target group, the only thing to consider is the difference in the average dollars generated. Likewise, if the average dollar amount is the same, the only thing to consider is the difference in average purchases generated. The answer to at least one of these questions has to be yes, otherwise the campaign financials will be upside down.
Let’s assume the answer to both questions is yes. Determine the number of transactions from the target group that would have taken place anyway using average purchases generated in the control group. Multiply that number by the average purchase amount from the control group, since it’s lower than the average purchase amount from the target group. Then, subtract that number from the total target group revenue to reach accurate campaign revenue. The equation looks like this:
Campaign Revenue = Total Target Group Revenue – (Average Control Purchase Amount X Number of Transactions that would have occurred anyway)
This advanced version of ROI factors out the transactions that would have occurred anyway, leaving in the incremental revenue gain due to the higher average transaction amount of the target group. To take it even further, a marketer can apply statistical tests of significance against the target and control group differences.
While the IBM study reports that 56 percent of CMOs feel insufficiently prepared to manage the increasing importance of ROI, savvy CMOs who understand financial and statistical analysis are adding significant value to their marketing campaigns, departments and companies. They’re applying knowledge and tools to drill down to the truly important numbers that inform marketing campaigns and continue to improve ROI.