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Measuring ROI: Did the Resource Allocation Work?

The goal of marketing analytics is to determine the effectiveness of a company’s various marketing strategies (such as its marketing mix). For each strategy, the company is looking to assess its return on investment (ROI).

Financial ROI is equal to profit over investment value. This is a yearly rate that is comparable to rate of return. Marketing ROI, on the other hand, is equal to profits related to marketing measures divided by the value of the marketing investment—which is actually money risked, not invested (Equation 2):

Determining ROI is simple arithmetic; however, estimating and defining the effects of ROI is difficult. Imagine that Powerful Powertools spends $2 million on search engine marketing in 2012 and generates $10 million in incremental sales that year with marketing contribution margins of 50%. The company would determine its marketing ROI as follows (Equation 3):

A marketing manager or chief financial officer (CFO) would have therefore determined that his or her return is 150% on the marketing investment. But the manager will likely still have questions. Will the investment in 2012 also pay dividends in 2013 (for example, should some new customer acquisitions in 2013 be attributed to the investment in 2012)? How was incremental gross margin determined? What is the baseline without the search engine marketing? Will doubling the investment to $4 million double the returns to $20 million in incremental sales, or are there diminishing returns to marketing? What are the longer-term effects, and what is the CLV of the customers acquired through this campaign? The goal of analytics is to accommodate these nuances of marketing’s influence on sales so that the estimate of incremental sales is an accurate reflection of reality.

One major decision regarding marketing ROI concerns the choice of average versus marginal ROI. Average ROI represents the returns for any given level of marketing investment. If an executive is interested in how total returns to marketing spending have changed over the previous two years, average ROI is the right measure. Marginal ROI, on the other hand, is the return for an additional dollar spent on marketing relative to existing investment levels. The choice between marginal and average ROI relies to a large extent on whether a marketing measure may yield diminishing returns. For linear models, average and incremental returns are the same because regardless of the current level of spending, the returns will be identical (Figure 1-6). As shown in Figure 1-7, however, the current level of investment matters when calculating incremental returns in the presence of diminishing returns.

Figure 1-6

Figure 1-6 A linear sales response curve

Source: Created by case writer.

Figure 1-7

Figure 1-7 Sales response curve with diminishing returns

Source: Created by case writer.

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