by Jim Lenskold
Marketing ROI is one of the terms most commonly used to describe marketing success, sometimes referred to as the holy grail of performance metrics. The financial term Return on Investment itself has a clear definition. Yet there still lacks clarity in the definitions and measures of marketing ROI not only across industries and companies, but even within companies.
I was invited to collaborate with three professors from top universities on a paper to define Marketing ROI. It was both an honor and a great experience to work with these professors that are widely considered among the very best in marketing ROI and measurements. You might think that four like-minded experts would quickly sort through the basics and nail down the definition. Instead, the need for a clear definition became more apparent as we were challenged to come to agreement over many months.
Paul Farris (Darden), Dominique Hanssens (UCLA), Dave Reibstein (Wharton) and I published our definition and the framework to communicate this definition in the paper “Marketing Return on Investment: Seeking Clarity for Concept and Measure.” This article summarizes my personal perspective on the definitions and how some simple variations can help all companies overcome the key areas of confusion and complexity.
First of all, the definition of the ROI calculation must be consistent with the financial definition to maintain credibility with finance. The formula in its simplest form is below. In this format, a positive value results when the profit generated exceeds the cost invested – which is exactly what marketers need to know to manage and improve financial performance.
MROI = (Incremental Profit Generated by Marketing – Marketing Investment) / Marketing Investment
The challenge with establishing a definition for marketing ROI is actually not with the ROI calculation but with the inputs of marketing expense and the financial returns into that calculation. We addressed this by establishing several variations of Marketing ROI that account for differences in measurement precision and timing, along with the specific decision being evaluated. The measurement precision and timing determine how return “valuation” is defined while the decision being evaluated determines the “scope” and “range” of the marketing investment.
Consider the questions below and how these can easily shift how ROI is defined, measured and communicated.
Marketing Objective & Decision Evaluation
The answers to these questions will guide you to the right choice of the return valuation, scope and range that defines your marketing ROI. All variations can provide reliable insight to assess and improve ROI. A key conclusion from our paper was that communicating the approach is needed to establish clarity and credibility with executives and other stakeholders.
Let’s start with the most straightforward and common approach to the return valuation. When marketing measurements can capture the incremental sales generated, the ROI calculation is run using the marketing expense and the profits from incremental sales over a baseline of existing sales. When you consider the measurement timing, this Baseline-Lift valuation is the central point since some measures value marketing impact prior to a sales conversion and some measures assess future value beyond the sales lift. We established five valuations that are influenced by the timing around incremental sales lift as shown in Figure 1.
Measures of marketing lift on purchase funnel outcomes, such as increased engagement, preference or leads, can be projected forward to future profit in order to estimate ROI. By specifying this as a Funnel Conversion valuation, executives will understand that the profits are either not yet earned or that the measurement precision cannot reliably capture incremental sales.
A Comparable Cost valuation is used to guide marketing decisions that can generate impressions (or other forms of contacts) at lower costs. A good example of this is comparing the cost of generating earned impressions from social media or sponsorships against paid impressions from advertising media. The big assumption required to align this cost comparison to ROI is that all impressions have the same impact on sales and therefore, a lower cost will yield a higher ROI. The cost savings can be run as an ROI calculation (cost savings divided by the original marketing cost for the same number of impressions) although this differs from how finance would typically calculate ROI. I personally prefer to run ROI using the Funnel Conversion valuation for this type of decision, using a best estimate of sales conversion per impression to compare the lower cost marketing to the original marketing.
The other two valuations are inclusive of profits that follow the initial incremental sales. A Customer Equity valuation accounts for the value that a larger or better customer base will provide for future marketing. The Marketing Assets (or Equity) valuation includes the financial value that stronger brands will provide in terms of company valuation and future marketing effectiveness. Equity value in ROI measures can be tricky since additional investments are typically needed to convert this equity into actual profits. But those ROI measures are possible and desirable to reflect longer-term contributions from marketing.
It is important to note that the difference between the Baseline-Lift valuation and these equity valuations is not limited based on timing but on a direct outcome vs. the “potential” for future value. The Baseline-Lift valuation should account for incremental value for as long as that profit stream lasts. It can include future profit streams for multiple years if there is a reasonable assumption that these profits resulted from converting a new customer and do not require additional marketing expenses (such as the acquisition of a 401k customer).
The inputs into a Marketing ROI calculation must align to a specific marketing decision with an understanding of the context of that decision. The basic principle is to “make more money than you spend” or in business terms, generate enough profit to reach or exceed an ROI threshold (the goal). Marketers make decisions that range from determining the total marketing spend, to choosing which tactics to implement, to deciding the reach, target, offer and creative to maximize the impact of each tactic. The “scope” of the ROI measure simply states the specific marketing initiative being measured.
While the scope defines what is being measured, the “range” defines what that marketing spend represents in the context of other marketing. The terms we established to help communicate the measurement range are Total ROI, Incremental ROI and Marginal ROI.*
Total ROI represents the measure of independent marketing initiatives that stand on their own, whether the scope is a small single tactic campaign, an integrated multi-channel campaign or a major channel investment. The ROI is based on the total marketing investment and the return generated from that investment. This type of marketing ROI measure determines if that initiative is a good use of budget or if other alternatives can generate a better return.
Some decisions are based on modifying or enhancing a base level campaign, program or marketing mix, such as adding another tactic to an integrated campaign, or adding an offer to an existing marketing initiative. An Incremental ROI measure evaluates just the incremental decision separate from a base decision.
As we introduce the concept of incremental or marginal spend, it is critical to note that the objective is to maximize profits and not ROI. Better decisions are made when measures show these smaller increments of spend have good ROI instead – a fact that could be missed when looking at just the total. Figure 3 and 4 below demonstrate this.
In Figure 3, the addition of the marketing enhancement B (let’s say a second contact) to a marketing initiative A (the initial contact) increases profit but brings the Total ROI down from 80% to 60%. The Incremental ROI shows that the additional $50,000 brought in $70,000 in profit for a 20% ROI. If a company has an ROI threshold of 25%, the decision to add the second contact would not meet that objective. But in other cases where the Incremental ROI exceeds the threshold, the decrease in ROI would be acceptable.
Marginal ROI defines the range for measures that assess many continuous increments to find the most optimal. This is needed when marketing decisions are highly scalable, such as a media purchase. As Figure 4 above shows, the Marginal ROI identifies the optimal point of diminishing returns between X and Y where the threshold is optimized and is not achieved with the next increment of spend. This typically requires advanced models to deliver such precision.
* Note: In my book, I use Incremental ROI for both incremental and marginal since the concepts are the same. The split here emphasizes the different measurement techniques. I also split Total ROI into Independent ROI, the measure of any single initiative, and Aggregate ROI which is a broader total that can roll up a number of integrated marketing initiatives for more optimal decision-making.
In order to achieve the objective of creating a clear, consistent definition of marketing ROI, the marketing community has to come together. Here is my list of priority actions:
I consider the direction of the “Marketing Return on Investment: Seeking Clarity for Concept and Measure” paper to be a huge step forward. The return valuation, scope and return provide the details needed to effectively communicate the variation of Marketing ROI used to measure, assess and improve the financial contribution from marketing. This communicates what is measured and what is not. It aligns the measure to the decision being evaluated. With a well-defined marketing ROI definition in place, companies can build the MROI framework that will guide marketing performance and profitability to higher levels.
Download and read the complete paper for additional detail as well as case examples: Marketing ROI Defined – Full Paper.