All You Need to Know About Return on Investment (ROI)

How do you decide whether you’re current marketing strategy is really working? Do you gauge success based on whether your customer base increased? Or, do you look for increases in monthly sales? While those techniques are great for taking the pulse of your business, marketers have a better way of measuring effectiveness: return on investment.

Return on investment, or ROI, is a way to measure how much value is being created by your marketing activities. In order to do this, you have to know how much you’re spending and what the concrete results of your actions are. With the right elements, calculating ROI is easier than you may think.

Show Me The ROI
Show Me The ROI

Before you whip out your calculator, take a look at what you first need to have in place. The basic elements are:

– Defined marketing activity

A defined activity is one campaign. Whether you choose a print ad, a television commercial or pay-per-click advertisement, you need to know exactly how much money you spent on this single activity.

– Alignment with a measurable goal

A goal may be to simply increase website visits, sign up new clients or increase customer satisfaction. Or, you might want to see a certain percentage of your revenue increase. Marketers like to put these goals into a box called marketing metrics. What matters is that the goal is specific, realistic and that you have access to the data needed to measure it.

Why does it matter?

A business that uses a ROI approach to marketing has an advantage. By knowing which activities turn a higher profit with less dollars spent, advertising can be targeted where it will be most effective.

For example, a car manufacturer may define their marketing objectives as bringing more people into their showroom and increasing incentives to buy. Using the ROI formula, this company can definitely say that, “Using marketing campaign X, we had 800 people visit the showroom during the last quarter. Using marketing campaign Y we spent 10 percent more, but increased showroom visits by 200 people and sold 20 additional cars.”

A Monster of a Tale

A real life success story, Monster.com, began at a time when there was very little demand for online services. While the site was a brilliant concept, the founder had a few employers and not enough job seekers. After looking at the numbers, a decision was made to allocate marketing efforts towards gaining more job seekers, and hope that the employers would follow.

The process evolved into a commercial, aired in 1999 during the Super Bowl. The ad won numerous awards from well-known magazines, such as Adweek, Time and TV Guide. “When I Grow Up” is still regarded by many as one of the best commercials of all time.

The results were staggering. Within one day of the commercial airing, there were over two million job searches processed. This represented a 450 percent increase in business. Their approach, based on an ROI marketing model, has helped propel them into one of the world’s largest career web sites.

How to Calculate ROI

It’s easy to get confused about calculating ROI. If you spend $10,000 on a marketing campaign and earn $20,000, do you think you have a 100 percent ROI?

Return on investment is calculated by taking into account such factors as cost of goods and other expenses. In the above scenario, assuming a 50 percent profit margin, the ROI is actually 0 percent.

$50,000 (Revenue) – $25,000 (cost of goods sold) = $25,000 profit

$25,000 (profit) – $25,000 (investment in marketing)/ $25,000 investment= 0% ROI

Marketing Math

The biggest reason people make mistakes when calculating the return on investment is that they fail to input all the numbers. Which number you need depends on which metric you are analyzing. Here are specific examples of how ROI can be calculated:

Basic Marketing ROI

Total units sold – Price of each unit = Gross Revenue
Gross Revenue – Cost of good sold = Gross Profit

Gross Profit – investment
_________________________
investment

As an example, let’s say you spent $5,000 on a pay-per-click ad campaign that earned you 100 sales, and each sale was worth $300. You allocate 10 percent of your revenue to overhead costs.

Step 1: Calculate your gross revenue.

number of sales x amount of each sale (100 x $300) = $30,000 in gross revenue

Step 2: Find out the cost of goods for each sale.

The cost of goods is a separate figure you will need to know based on whatever product or service it is that you sold. If you’re unsure of what this number is, check with your accountant. For the sake of simplicity, we are going to use $100.

Step 3: Calculate the cost of goods sold.

number of sales x cost of goods sold (100 x $100) = $10,000 Cost of goods

Step 4: Calculate gross profit.

total cost of goods sold – gross revenue ($30,000 – $10,000) = $20,000 gross profit

Step 5: Calculate ROI.

gross profit – investment
_________________________
investment

Gross profit – investment ($20,000 – $5,000) = $15,000
Divide this figure by your total investment (15,000/5000)= 300

This campaign had a 300 percent return on investment.

Lifetime Value

If your goods or services result in repeat purchases from the same customers, you can also factor this into the ROI. The lifetime value is the amount of revenue than a single customer generates for your business over their consumer lifetime. You simply submit customer lifetime value for for gross profit in the top line of the equation.

customer lifetime value – investment
____________________________________
investment

You’ve probably heard the adage “work smarter, not harder?” ROI is a powerful tool to help you make profitable marketing decisions. You can stop using campaigns that cost more and earn less. Those resources can then be allocated to developing other campaigns.