The post generated some Twitter discussion upon which I’ve been reflecting.
I tweeted: “I think a key point is that ROI is highest with low-hanging fruit. ROI decreases once you get beyond that. You’d want a higher relative ROI from two choices for incremental spend, but overall ROI likely falls. Goal is to maximize profit, not ROI.”
Andrew Willshire made a similar point in a different thread (Sept 27, 2020): “Significantly, ROI is often used as the metric of choice as though you should seek to maximise it, whereas that would result in under-investment and misallocation of budget. Much better to optimise on incremental revenue, but that’s often overlooked.”
“What was the financial return (incremental profit) as a percentage of the campaign cost (ROI)?” – p.157, Marketing and the Bottom Line by Tim Ambler (2000).
Michael Taylor tweeted: “I think maybe I just don’t understand the semantics, but to me it’s simple. You want to make more money than you spend, so deduct spend from revenue and divide that by spend. That’s ROI. You can calculate short term ROI or forecast long term ROI. No idea what could replace it.”
Hmm. I’d say Revenue is not your return. Profit is.
For an investor, ROI = (Current Value of Investment − Cost of Investment) / Cost of Investment. You buy a stock for $25, it doubles to $50, so ROI = 100%. The numerator is your capital gain, which is analogous to profit.
But in a marketing context, the costs are not just the cost of the advertising spend. You’d need to subtract Cost of Goods Sold (and/or other variable costs) to get the profit generated by your advertising spend. So, ROI = (Revenue – COGS – advertising spend) / advertising spend.
Similarly, Ambler defines ROI as “the net profit return (R) divided by the advertising investment (I).”
Michael Taylor tweeted: “Also if all you have are low ROI opportunities maybe you should cut costs and spend that elsewhere or return it to shareholders. There’s an opportunity cost to money and if you’re only giving me 5% on my money I’d want it back to invest in a company that can grow faster.”
It’s a good point, but if you are reporting ROI based on revenue generated rather profit generated, you are overstating ROI.
To demonstrate the point, let’s say you spent $250,000 to generate $1 million in revenue with a 20% contribution margin. Calculating ROI on a revenue basis would be ($1,000,000 – $250,000) / $250,000 = 300%. Hurray! But on a profit basis ($1,000,000 – $800,000 – $250,000) / $250,000 = -20%. You’re losing money.
If you have a high margin product and you are using ROI to compare the relative efficiency of multiple executions, it may be fine to use revenue rather the profit in your numerator – as long as your metric is consistent for apples-to-apples comparisons, and as long as you understand what it means.
Alastair Thomson tweeted: “The difficulty comes in the practical application where short term cost savings are easy to ‘prove’ a positive RoI on, but longer term (often more valuable) initiatives have less provable R’s and I’s, so in practice often get shelved…
But the issue comes from a bias towards short term cost cuts which is often present in environments where RoI is the prime focus. That’s because it’s really easy to generate short term RoI if you don’t care about the long term health of the business.”
Long-term ROI in a marketing context brings up the difficulty of attribution. Which investment are you attributing to a sale? Is there a cumulative effect of multiple investments over a period of years? This gets messy.
Bruce Clark posted a slide.
I found this Return on Marketing Investment formula on BrandFinance.com: “ROMI = Incremental financial contribution generated by marketing / Marketing spend.” This gets more complicated, but it boils down the measuring the profitability of marketing spend. They note that “return” could refer to Total Return on all spending, Incremental Return on a specified additional spending increment (“This is most useful for analysing a go/no-go decision”), or Marginal Return on the ‘last dollar’ of marketing spend.
How Not to Plan: 66 Ways to Screw it Up (2018) by Les Binet and Sarah Carter: “As you spend more on advertising, it often gets more effective (sales and profits generated go up), but less efficient (ROI goes down)… ROI…is a measure of efficiency, not effectiveness.”
ROI is Dead. Now Bury It. (2003) paper by Tim Ambler.
Managing the Marketing Metrics Portfolio. (2011) paper by Bruce Clark and Tim Ambler.
Marketing and the Bottom Line. (2000) book by Tim Ambler.