April 2007 Archives

When Good Metrics Go Bad

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The goal of marketers is usually to increase revenue, so we create metrics that help us do that.

Metrics are those numbers that "per" -- like "cost per lead" and "page views per day."

Marketing Metrics Are Everywhere
Product profitability and product sales affect marketing ROI
There are metrics everywhere in the marketing/sales process from awareness to closing an order and servicing the customer.

We strive for increasing our clickthrough rate on e-mails, newsletters, banner ads, paid search ads, and wherever we can measure clicks.

We look for ways to increase the "open rate" for everything from e-mails and envelopes to prospects' minds.

Why? Because these metrics are highly correlated to revenue, which is what we've all been taught is our goal.

Keeping Marketing Metrics Profitable

However, there are times when increased sales causes decreased profits.

This can happen when marketers are successful in getting customers to buy a "loss-leader" product. This type of product is sometimes added to the product line for a strategic reason, such as to show the market that the company is a one-stop place to buy that category of products.

Another type of problem product is one that is profitable but not as profitable as similar products sold by the company. These sometimes start out as custom products made for a special customer, then they're added to the catalog because someone says, "We've already got the molds and jigs."

No matter how these products found their way into the product line, they can cause profit problems when marketing (and sales) succeeds at increasing revenue to improve their metrics.

While increasing revenue is good, increasing profits is better because that increases shareholder value. So, be sure the products you're promoting are profitable or support a non-financial marketing strategy.

Customer Tracking

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The key to determining the ROI of individual marketing campaigns is tracking customer behavior in response to those marketing activities.

Ideally, you want to track every customer at every touchpoint so you can determine the response to each marketing activity -- ads, mailings, etc. Companies that sell directly to customers have the best opportunity to track their customers' behavior. When you are in direct contact with a customer it's possible to know when and how every contact occurred.

But most companies sell through their distribution channel, which makes it very hard to know how each buyer was influenced by marketing and sales activities. Also, companies that use offline advertising and public relations to promote products have a hard time knowing the impact of their ads and stories on each customer.

Traditional offline media has always presented a challenge for marketers wanting to measure the value of their marketing, but direct marketing techniques can be used to track many customers. For example, people who respond to an ad immediately can be tracked using unique toll-free telephone numbers or URLs .

But we know that exposure to a company's prior ads helped a prospective customer move toward taking action. So how do we measure those exposures?

Sometimes you can determine if a customer was in the audience that was exposed to your earlier ads.

But when you can't get media exposure data for individual customers, you can apply reach and frequency math to the demographic segment the customer is in to estimate ad exposure.

This technique isn't just for consumer companies. Reach and frequency techniques can work for B-to-B marketers, too.

Many trade publications can tell you how much overlap they have with other publications in their market. Once you know the total subscriber base in your market segment you can calculate an estimate of how many of your ads were seen by each customer in that segment.

All customer tracking techniques take work to capture data, consolidate it into customer profiles, and apply sound analytical techniques. However, when marketing resources are tight this is the best way to have the highest ROI possible.

Cash Flow is Profit

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My previous post on cash flow from marketing activities didn't explain which flows of cash it referred to.

Some people who talk about increasing marketing ROI are referring to increasing sales revenue. So, they're happy when they generate $2 in sales for every $1 in marketing expense. But is this a high marketing ROI when compared with a company's other investments, or is it low, or just average?

Marketing typically generates $1-$4 of sales revenue for every marketing dollar spent, so a $2 return is typical, but that still doesn't answer the question of how marketing compares with the rest of the company.

The cash flow I was referring to is the cash that's left over after paying all costs of making the product, serving the customer, and each customer's portion of the operating expenses.

In other words, an increase in net cash flow means an increase in profit - not sales revenue.

So, let's take a look at how that 2-to-1 return of sales revenue to marketing expense can compare with a company's other Investments

Here's how sales revenue is allocated at companies like IBM and P&G:

Revenue 100%
Cost of Goods Sold -55%
Gross Profit 45%
Expenses -35%
Profit 10%

Based on marketing generating $2 of revenue per marketing dollar spent, the company will receive $0.20 - which is a return of 20%.

So, the next time your CFO questions the return on marketing, have your marketing ROI ready. It's very likely that your ROI is higher than the investments in the rest of the company!

Why Marketers Must be Better

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A lot has been written about increasing the ROI of various marketing activities. But, one thing is usually missing from those articles and sales pitches -- explaining just how to calculate that higher marketing ROI that they talk about.

The reason they don't want to talk about how to measure marketing ROI is that it's very hard to do. But being hard is no reason to skip the rigor of actually measuring the bottom line benefit of marketing.

The reason that it's hard to measure the ROI of marketing is that unlike many financial transactions, marketing is made up of a series of non-financial "transactions" that end in a financial transaction. Yet, the purchase wouldn't have been made without all the marketing activities that occurred over the prior weeks or months.

A typical financial transaction would be to buy something today, earn the extra cash flow that it generates, then sell it in a few years.

This chart illustrates the initial outflow and the inflows over the next four years from this transaction.

Return on investment from cash flows each year plus a profit on the sale of the asset.

Microsoft Excel calculates the return on this investment as 5% per year. If the cost of capital is anything under 5% this is a good investment.

But marketing investments are not this clear in how they contribute to cash flow. And, marketing investments usually don't result in an asset that you can count on selling in the future.

Here is what that same investment -- and same 5% annual return -- looks like when the only benefit is increased cash flow.

Return on investment from only cash flows each year.
Since there is no asset to sell (like a building or equipment) the cash flows each year need to be much higher to pay back the investment -- plus generate an extra 5% per year of additional cash.

This means that marketing activities need to perform much better than tangible assets just to generate the same net cash to the business.

The key to using ROI to improve marketing decisions is to have accurate data on the cost to obtain each customer and how much each customer contributes to the company's bottom line.

My objective here is two-fold. First is to provide the tools and techniques needed to quantify both of these. The second is to share analytical methods that can improve the effectiveness of our marketing decisions.

A new beginning again

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After using a traditional content management system for years to create articles on Allen.com I decided it was time to start a blog.

I'll be sharing short observations on marketing and encouraging the conversations that are hard to have using a traditional CMS.

So... let the conversations begin.

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