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.
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.
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.