ROI: Today’s Most Misunderstood Marketing Metric
By Daniel Kehrer
Here's a thought not much discussed much among marketers: ROI might not be the right way to measure the impact of your marketing. In part, that's because we routinely misunderstand and misuse ROI in all manner of ways.
This is how and why.
Invoking ROI to gauge marketing impact can severely distort the true value that marketing is delivering for your organization. Sure, it's hard to have a marketing measurement conversation without ROI coming up. It is, after all, one of today's most used marketing metrics. ROI calculations are a handy yardstick to show top management how marketing measures up.
But is "return on investment" really an accurate way to measure marketing effectiveness? Sadly – and perhaps even shockingly to some – the answer is often no.
The concept is certainly honorable. Marketing should show a return on the investments it makes – just like any other department. Linking marketing to financial performance and business results is absolutely critical.
It's just that most people who use ROI in a marketing context probably aren't using it correctly, or really mean something else, says Dominique Hanssens, professor of marketing at UCLA Anderson School of Management and a globally renowned marketing scientist.
ROI's roots, he points out, are in evaluating one-time capital projects. "But is marketing a one-time capital project?" asks Hanssens. Clearly not.
We regularly talk about marketing "investments" which sound likes a good thing. We want everyone to view marketing's budget as something that will pay dividends. But – technically speaking – marketing outlays are still an expense, no matter what we choose to call them. In CFO-speak, marketing costs are a P&L item, not a balance sheet item.
As a result, notes Hanssens, marketers rarely mean ROI when they say ROI. Nevertheless, "plain" ROI can certainly be an important interim metric for marketers. But it falls well short of helping us understand marketing's contribution to business goals, or how those contributions can be improved.
In part, that's because ROI is too limited. To truly gauge and improve marketing effectiveness, for example, we must factor in the strategic intent of all marketing investments a company makes. ROI doesn't really do that.
The Rub Over ROI
We'd all love to quantify marketing performance with a single number. But ROI is a ratio, and ratios are not what matter most here. What does really matter? Net cash flows, says Hanssens. Performance measures such as net profit, for example, are derived by subtracting various costs from revenue. ROI is different. You get it by dividing net revenue by cost.
How, then, can marketers compare ROI on different marketing investments, such as a television ad campaign versus a paid search campaign? As it turns out, you can only make an accurate ROI comparison if the spending amounts are the same. ROI, you see, changes at different spending levels. It is not only a function of the medium, but also of the investment in that medium.
And it's also critical to know that maximum ROI does not necessarily produce maximum profit. Oops! Blame the concept of diminishing returns. Many marketers might think that the highest ROI corresponds to the best spending level. Unfortunately, that's not so.
Because of the diminishing returns effect (among other things), ROI can rise while the rate of sales growth drops.
After a certain investment level, marketing effectiveness declines. But that doesn't mean you stop investing. Profits may still rise, albeit not as fast.
Should you stop spending when ROI drops, even if you continue to produce bigger profits? Most likely not. The point at which you'd stop or make a change depends on the return of the last incremental amount spent, not the overall ROI. This "incrementality" is a key ingredient that many marketers miss – here and in other measurement areas such as attribution.
This introduces what's known as "return on marginal investment" – or ROMI. And "marginal" return as compared an average return is what can make all the difference for accurately interpreting results and making decisions on future spending.
So if you must use a return measure to gauge marketing effectiveness, ROMI may be better. The only thing you really need to know is whether ROMI is positive or negative. Or, put another way, are you underspending in a given category...overspending...or getting it "just right" (where ROMI is zero)? And the determining lever is how much you spend.
Tracking Complex Interactions
An impressive ROI attached to a specific activity probably means little or nothing if broader marketing goals aren't being met. Focusing solely on dollars-in ("I") compared to dollars-out ("R") ignores a complex web of interactions that happen in between.
Only by analyzing as many of those intermediate processes as possible can we gain useful insights into what's working and what's not, and alter allocations to achieve better results.
The core takeaway bears repeating: If you're satisfied with only for a seductively simple measure such as ROI, you may severely distort the true value that marketing is delivering for your organization.
Source
"ROI: Today's Most Misunderstood Marketing Metric." ANA Data Analytics Center, 9/27/17.