Understanding Return on Investment (ROI)
in Strategic Marketing
See also: Pricing Strategies
Return on investment (known as ROI for short) is one of the most common metrics (measures) used in business. At its simplest, it measures profit per unit of investment (money put into the business). It can therefore be used as an overall measure of the business, or for specific investments. These might include examples such as buying shares in another business, or the cost of a marketing campaign.
This page describes the overall concept of return on investment in business, and then discusses how it can be used for marketing activity in particular.
What is Return on Investment (ROI)?
Classically, return on investment is the difference between the current value of your investment, and the cost of it at the point of purchase, expressed as a percentage.
As a formula, this can be written:
| Return on investment = 100 × | current value of investment – cost of investment |
| cost of investment |
However, this formula has some limitations.
In particular, it assumes that you invested in an asset, and can therefore sell it for a fixed sum (the current value). This is not always realistic in business, when a large part of your investment may be in people or activity.
It also takes no account of time, so it is hard to compare investments over different time periods.
Non-financial aspects of return on investment
Return on investment has been criticised for only considering the financial aspects of an investment, and not the societal gain. For example, investments in sustainable technology may have an upfront cost and a long pay-off time. However, there may be immediate societal benefits such as lower carbon emissions, and these also need to be considered.
There is more about this in our page on Understanding Sustainability.
The formula for calculating ROI can therefore be adapted to suit the business. For example, you could calculate profit (takings minus costs) as a percentage of cost, or incorporate non-financial benefits.
Return on Investment in Marketing
Marketing is a key area of business. It is defined as any activity designed to acquire and then keep customers. Examples of marketing activity include advertising, relationship-building campaigns, emails to customers, and sharing content online.
Most of these activities are fairly nebulous in their effect, especially when you are using several at once—as almost always happens. It is extremely hard to tell whether a potential customer has been led to act by seeing an advertisement or reading something online, or had simply reached the point where they wished to make a purchase.
Measuring return on investment in marketing is therefore challenging.
However, it is extremely important to try to measure return on marketing investment, for several reasons:
To be able to justify marketing spend, and especially any new investment;
To decide how best to spend marketing money;
To compare marketing efficiency with competitors; and
To check that the business is performing efficiently, and getting best value for money.
Calculating Return on Marketing Investment
The basic formula for calculating return on marketing investment is fairly simple, and based on the formula for return on investment.
| Return on marketing investment = | Financial gain as a result of marketing investment |
− Cost of marketing investment |
| Cost of marketing investment | ||
However, in practice there are a number of issues associated. These include:
1. What costs to include in the calculation
It is generally recommended to include all the costs associated with any marketing activity.
This might therefore include agency costs to produce advertisements, any paid advertising, plus all associated employee time. For example, a social media campaign with all content produced in-house would look very cheap compared with a paid advertising campaign produced by an agency. However, once you take all the staff time into account, you get a much more useful comparison.
If your company routinely includes a ‘cost of capital’ figure in return on investment calculations, you should also include the opportunity cost. This means estimating the value that you could have gained from spending the money on something else.
2. How to estimate the financial gain attributable to the marketing investment
This means the difference in profits that is the result of the campaign or activity.
The first step here is to estimate the baseline profit: the amount that you would have made without the campaign. Even this is not trivial (see box).
WARNING! Baseline sales is not a static figure
Your baseline sales or profits figure needs to take account of any underlying trends in the figure, including seasonal variation. For example:
If your sales are currently increasing by an average of 2% each month, you need to subtract that from the growth seen during the campaign.
If your sales are currently decreasing, any positive change—including a slower rate of decrease—may be positive.
If you always see higher sales at this time of year, this higher level needs to be subtracted from the figures seen during the campaign.
You also need to remember that the figures for previous years or months may also show the effect of marketing activity. You could therefore subtract the effect of those activities before looking at your baseline—or you could say that you need to see an additional effect.
The next part of the challenge is to estimate the time lag before you expect to see results.
Some marketing campaigns may have immediate effects. However, others, especially for major purchases, or in business-to-business environments, may take much longer to show an effect.
It is no good looking at sales figures in the three months after the campaign or activity if your customers’ average time to purchase is actually two years.
This is a huge challenge for many companies, because they are budgeting on a year-by-year basis. However, it is essential to manage it effectively, and not focus solely on the short-term aspects of marketing spend.
One of the most difficult aspects is to attribute sales to particular aspects of a campaign, or of ongoing marketing activity. Some companies use ‘last touch’ attribution, where a purchase is simply attributed to the last contact with the company. However, customers have often seen multiple advertisements or pieces of content before deciding to buy. Their decision is very unlikely to be solely the result of the last contact with the company. Others use ‘first touch’, but again, this may not have been the decision point.
Should you use marketing attribution software?
There are now algorithms available to help with marketing attribution, especially from online activity. They can look at numerous contact points, and allocate weight to them based on subsequent activity.
These algorithms can be extremely useful—but only if you have very good data, and you use that to make the right assumptions.
The process of gathering data is often extremely time-consuming, and many companies find that it is not worthwhile.
For more about the process of gathering the right data, you may like to read our page on Gathering Information for Competitive Intelligence.
Alternative Measures of Return on Marketing Investment
Some companies use alternative measures of return on investment, to better reflect the goals of the marketing activity.
For example, marketing may aim to increase brand awareness, or encourage people to click through from a social media site to the company’s own website.
You can therefore measure improved brand awareness through market research, or ‘clicks per pound’. This gives a much more immediate measure of the effect of the marketing activity.
However, you need to remember that these effects, though interesting, do not necessarily mean increased sales.
Customers can be clicking through, and then not doing anything further—and brand awareness may not always be positive.
Ultimately, the effect of marketing should be to drive sales—so an increase in sales is necessary to show marketing effectiveness. In other words, return on marketing effectiveness always needs to consider sales figures at some stage.