Marketing || ROI || Refresher
Companies spend a lot on marketing communications. In fact, global spending on media is expected to reach $2.1 trillion in 2019, up from $1.6 trillion in 2014. But is all that money well spent? And more fundamentally, does marketing actually work?
Quick – Summary.
Companies spend a lot on marketing communications. But is all that money well spent? Marketing ROI (mROI) helps companies measure the return on investment. For marketers (and other executives), there are several benefits associated with using this measurement, including justifying marketing spend; deciding what to spend on, comparing marketing efficiency with competitors; and holding themselves accountable. It’s not an easy metric to measure, because it can be tough to determine how much incremental financial value a marketing program adds. It can also be difficult to figure out which incremental profits are attributable to which programs. Measuring the lag time associated with most marketing spending is another common challenge. Despite these challenges, measuring mROI is worth it. Ideally, your marketing program is not only affecting sales and profits this year but is also strengthening your brand equity and customer relationships over time.
What is Marketing ROI, and How Do Companies Use It?
Marketing ROI is exactly what it sounds like: a way of measuring the return on investment from the amount a company spends on marketing. Avery explains that it is also referred to by its acronym, MROI, or as return on marketing investment (ROMI). It can be used to assess the return of a specific marketing program or the firm’s overall marketing mix.
For marketers (and other executives), there are several benefits associated with using this measurement, including:
How Do You Calculate MROI?
Marketing ROI is a straightforward return-on-investment calculation. In its simplest form, it looks like this:
The goal, as with any ROI calculation, is to end up with a positive number, and ideally as high a number as possible. Some companies establish a threshold for MROI that takes into account its risk tolerance and cost of capital, below which they are hesitant to make investments. “If a program doesn’t promise to deliver at or above that level, they are unlikely to invest,” Avery explains. And if you end up with a negative ROI, the project is harder to justify on financial terms.
What Are the Challenges of Calculating MROI?
While the calculation looks straightforward, there are a lot of complexities to actually using it.
The cost of the marketing investment is pretty concrete. “Usually we know how much we’re going to spend,” Avery says, but it’s often difficult to decide which expenditures to include. For example, do you include just the cost of the media, or do you also include the investment of staff time to create the ad? “The MROI of social media activity often looks very high if you only count financial resources, but if you look at the human resources required to develop content and respond to consumers’ posts 24/7, the number goes down,” she says. “In principle, managers should try to estimate the full cost of the marketing activity, including creative development, media spend, and customer-facing staff time.” Since marketing expenditures tie up capital, managers may also wish to include the opportunity costs associated with this spending, taking into account the company’s cost of capital in their calculations.
That challenge, however, pales in comparison with the difficulty of measuring incremental financial value. To do this, you need to establish your sales baseline. What would our sales and profits have been if we didn’t spend on this marketing program? “The baseline is hard to establish in a dynamic marketing environment,” Avery says. Usually, companies look at their historical data and project them into the future. But even that can be complex, she says: “Last year’s sales line had a bunch of marketing behind it. It’s hard to strip out everything that would give you a pure baseline.” Some firms use A/B testing to assess the incremental lift that a marketing program gives, with the B group serving as the no-marketing control case, Avery explains. “But sometimes, the incremental financial value attributable to marketing derives from its ability to increase customer loyalty and reduce customer churn. In this case, managers need to measure how much profit was retained that would have been lost without the marketing program.”
Measuring the lag time associated with most marketing spending is another common challenge. If you spend $1 today, it might take three years for the marketing to “work” and for the consumer to make a purchase, especially with products, like cars, that are purchased less frequently. “It’s often tough to link spend to purchase,” Avery says. “Time lags can also complicate the MROI formula, which needs to be adjusted to account for the risks of a changing environment and the time value of money.”
It can also be difficult to figure out which incremental profits are attributable to which programs. “Most companies are using a mix of programs to persuade consumers,” Avery says, making it tough to parse which are having the largest impact on profit. It’s sometimes simpler in digital marketing, she points out: “Say I run an ad — they click or don’t click; they buy or don’t buy.” To overcome this attribution challenge, many marketers credit the sale to the last touchpoint, whether that’s a search ad, a coupon, or something else. “But consumer behavior may be the result of 30 years or more of marketing,” Avery says. “Google search ads look like they have a high ROI, but they are often building on and benefiting from many other forms of marketing.”
Avery points out that several companies now sell marketing mix software, which uses complex algorithms to help managers disentangle the attribution problem. “Algorithms are fabulous as long as they are based on good assumptions and good data,” Avery says, but most managers find that collecting data needed to make good assumptions can be the most difficult part of the process.
What Mistakes Do Companies Make When Using MROI?
One of the downsides of marketing ROI is that it is easy to only recognize the incremental profits in short-term sales and underestimate the long-term benefits that marketing brings to brand value.
This “can be particularly challenging for executives who might be impatient to see a return. A CFO might just see marketing expenses walking out the door and not a corresponding build-up of cash flows and assets,” Avery explains. As a result, CFOs and CMOs are often at odds. “CFOs are under tremendous pressure to deliver quarterly earnings, and may not be patient for the longer-term effects of marketing to take hold. You’re asking them to believe in forwarding movement in a progression through a customer’s purchase journey, and that can take a long time,” she says. But marketing does more for a company than generate profits in the short term; it also builds lasting value and drives future profits.
This is where the concept of customer lifetime value can be useful. By calculating how much one customer is worth in comparison with others, marketers can show a CFO (and other skeptics) the impact of marketing spend over the course of the company’s ongoing relationship with that customer. Avery says that some companies also build in “proxy measurements,” such as brand awareness, brand liking, and brand knowledge, that help demonstrate that marketing dollars are helping customers move along the decision journey even if they’re not making purchases now.
The key is to remember that while marketing expenditures hit the P&L immediately, every dollar you spend today is building your brand as an asset for the future, Avery explains. So, ideally, your marketing program is not only affecting sales and profits this year but also strengthening your brand equity and customer relationships over time.
As always, feel free to reach out to one of our experts to get a one-on-one consultation to help jump start your marketing efforts for the year!