Re: ROI formula

From: Jim Novo <jimnovo_at_sprintmail.com>
Date: Mon 28 Aug 2000 20:40:55 -0400

MONIQUE LITTLEJOHN <Monique.Littlejohn_at_webbase.com> WROTE:
> Here is the formula:
>
> ROI= (Impressions x Response) x conversion
> ROI$= ROI * Cost of product
>
> Suppose that you had a mailing list of 1000 past
> purchasers of your software and you wanted to pitch an
> upgrade of your software. Previously, you received a
> 15% response rate for upgrade message direct mail such
> as a postcard. Your sales team converted 5% of the
> respondents. The above formula gives you 7.5 sales.
> If your software sold for $199, your ROI$ would be
> $1,493 on this project.

An important thing to understand about database
marketing metrics is they can be defined differently by
different organizations. The critical issue is:
within the company, does everyone agree on the
definition? This is essential for "apples-to-apples"
communication internally and with marketing partners;
as long as everyone agrees, you can calculate ROI any
way you want.

A common definition of ROI (Return on Investment)
involves looking at the cost of a marketing campaign
relative to the profit generated. This approach comes
from the original definition of ROI as used by finance
people rather than marketing people.

A Return on Investment in financial circles has a very
specific meaning: How much did I invest, and what was
my Return on the Investment? This is the same "return"
concept used in the stock and bond markets, as in: "My
stock portfolio had a Return this year of 20%" (we
hope). If you invested $1000 on January 1, and on
December 31 you had $1,200, you generated a 20% ROI -
your Return on the Investment of the original $1000 is
$1200-$1000 = $200 / $1000 invested = 20% ROI.

One definition of ROI in marketing is viewed in the
same way. Let's say you're selling widgets with a
price of $100. 50% of this is margin, what's left over
after the cost of the product. It costs you another
10% of the $100 to take the order, pick, pack, ship,
and deal with returned widgets. So *profit* on a sale
is $40; the other 60% of the product price of $100 goes
to cost of the product and processing the sale.

You put $1000 into a campaign to try to sell these $100
widgets. You sell 30 of them at the *profit* of $40
each, for a total profit of $1200 on the campaign. But
this profit is before the cost of the campaign, so you
subtract this cost, $1200 - $1000 = $200. This is the
Return - $200 extra dollars came back to you on your
original marketing investment of $1000. Your Return on
this Investment is $200/$1000 = 20%. This is "simple
ROI", a straight calculation of Return without
factoring in the element of time.

Why does this matter?

Back in the finance department, where they have cash,
they can invest it. In computers, in software, in
people, or in bonds, or their own stock. If your
marketing programs can't generate a higher ROI than
say, very safe government bonds at 6% ROI, then the
company should not invest in the marketing programs.
The company as a whole is "better off" investing in the
bonds, or in people, software, buildings, or whatever
delivers a higher ROI.

I believe the original question was about ROI on a
banner campaign where no products were sold. (Right,
Jorge?) For the sake of simplicity, we'll say page
views cost nothing to generate and all we look at is
revenues.

There has to be a value metric around somewhere. If
you sell ads for $20 CPM, and you're 50% sold out,
you're at a net $10 CPM. Assuming 1 ad per page, each
page view is worth a penny in revenue at a $10 CPM.
How many page views did the campaign generate versus
the cost to generate them?

If you have some other more complex revenue generating
methods, try using Total Revenue / Unique visitors.
Divide total revenue over some period of time by the
uniques in that time period. Let's say you come up
with $1 per unique. How many uniques at a value of $1
did the campaign generate versus the cost?

The above approaches are more likely followed by mature
companies; they ignore the "land grab" mentality of the
early dotcoms. But it's what Wall Street means when
they say "Return on Investment"......

Jim Novo
Marketing Mercenary
jimnovo_at_sprintmail.com





Received on Mon Aug 28 2000 - 19:40:55 CDT