Calculating Your Marketing ROI

Ideally, marketing should generate much more sales margin than the actual cost of the marketing. Here are proven ways to do that and see positive signs.

Calculating Your Marketing ROI

Knowing you ROI can help you reallocate valuable budget to use for things that have a higher return. (Photo: iStock)

Over years of providing marketing consulting to businesses, and now as a Chief Marketing Officer of a $8.5B software company, the primary marketing question is always “Is my marketing actually making me money?”  The general rule is to spend 2 to 5 percent of your revenue on marketing in retail, but this ranges greatly with some industries spending as much as 40 percent. 

In the early 1900s, marketing pioneer John Wanamaker coined the phase, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” The metaphor is actually worse today with the enormous increase in the number of marketing channels such as social, video and multiple commerce channels on top of the legacy direct mail, billboards, radio and television. Most senior business leaders are noting that less than 20 percent of advertising is effective with all the blind investment spent on new unproven channels, but how would the average retailer know which channel, message, offer, timing or creative format is working? 

It is easier than you would think, however, there is math and some accounting involved. Doing the hard work and digging into this marketing math can identify nearly every underperforming marketing program from your budget. This can also reallocate valuable budget to use for things that have a higher return. The general idea is to assure the margin made on the sales attributed to marketing covers the expense of marketing. Ideally, marketing should generate much more sales margin than the actual cost of the marketing. 

Building a Baseline

The first step is calculating the overall company return on marketing investment. The next steps involve systematically calculating the same return for each marketing channel such as email, social, events, etc. Finally, each individual marketing promotion within each channel should have the same ratios calculated … even down to that questionable doorbuster email deal on Black Friday, and each individual email, social campaign, direct mail, digital ad, referral advertising and radio advertisement.

Many companies do not track individual campaigns down to this level, however, every company should be able to easily calculate ratios at an overall and per channel basis. If that is not possible, all marketing spend should be questioned until marketing tracking performance such as Google Analytics, sales conversions of referrals, email, social, digital advertising campaigns and POS offer redemption tracking can be added.

Calculating ratios down to the individual campaign level helps to understand what is not working and where deeper investment in successful programs is needed. Generally the “return” is calculated with ROAS (Return on Ad Spend), ACOS (Ad Cost of Sales), and COGS (Cost of Goods Sold) ratios.

Most companies only look at the old accounting standard of COGS, however a poor COGS ratio could be reflective of high non-marketing sales cost, utilities, shipping or operations expenses, and does not isolate marketing expense performance. The financial accounting COGS ratio goes beyond just marketing costs and typically includes all direct and indirect costs to determine the true cost of goods. Obviously, COGS is not granular enough to understand whether your marketing is working or whether your promotions are profitable, so marketers need to look to other marketing specific ratios for answers.

Each ratio has a different meaning and use. ROAS is the term most widely used in the industry for general marketing spend performance with advertising agencies, broadcast and digital media, but it works equally well with any marketing channel. ACOS is a term most used in the online PPC (Pay per Click) referral and commission models such as Amazon.

ROAS is Gross Sales Revenue divided by Advertising Cost which delivers “Return” hopefully in the form of a positive number that indicates the expected return on a marketing investment. Typically ROAS is expressed as a multiplier or as a percentage but should always be a number greater than the amount of margin made on a sale. Example - A $100K campaign generates $1M sales. $1M/$100K = 10. Spend $1 get $10, or 1,000 percent ROAS. 

Another spin off metric is MOAS (Gross Margin on Ad Spend) which is more meaningful in retail with lower margin products to assure you are covering the cost of marketing. Example - A $100K campaign generates $200K margin. $200K/$100K = 2. Spend $1 get $2 in margin, or 200 percent MOAS.  This has been my most used set of marketing ratios and is always the fastest to use by a marketing team. The recommendation is to assure your advertisers and team are clear on minimum acceptable ROAS for all campaigns and promotions.

ACOS is the same as the ROAS ratio but is flipped with marketing expressed as a cost of acquiring the sale. With online PPC and referral-based sales commission models, promoters/sellers are paid a percentage based on the total revenue.  Example - $1M in Amazon sales cost $100K. $100K/$1M = 10 percent ACOS. If you have an average margin of only 7 percent, this is a very bad promotional method even as a lead generation program. 

Most owners would be shocked at how many businesses are giving away more than they are making on these PPC referral, digital paid media, social and general marketing programs. Notably every different marketing channel will behave differently with different costs and acceptable returns. Any promotions that are not making a multiplier of the margin should be immediately modified or cut from the budget. One of the keys is to assure the marketing program costs used for the ratios also include all costs including potentially hidden costs into those return ratios.

Hidden Marketing Costs

This is the “What are we missing?” discussion that occurs when marketing is reporting positive marketing return and improving sales while revenue is tanking.

Sneaky costs that are often overlooked can be hidden within marketing infrastructure costs and can dramatically change the profitability and return ratios. These include license costs of marketing software, cloud marketing solutions, social media management platforms, various marketing pay by month services, creative and advertising agency service costs, advertising agency/consulting fees and sms and email delivery costs.

Many of those costs are legitimate, however they still need to be evaluated and incorporated into the marketing return analysis. It is important to include the full management, services and licensing costs of the solutions when calculating ROAS and ACOS metrics.

While working with a larger retailer, I discovered a great example of hidden costs. The email program on the surface had a high rate of return and the owner even bragged that they just send more emails if sales are low. The email program had a $0.35 CPM email send cost. CPM is Cost per Mille - Mille is Latin for thousand and in this case email costs were $0.35 per 1,000 emails sent. The program generated yearly sales of $7M with $700K of margin on 234M yearly emails sent. The numbers seem great when looking at only a yearly send cost of $81,900. 

The hidden cost of the solution buried in advertising agencies fees included a $100K yearly software license, $750K in agency creative costs and $250K in advertising agency services related to building the content and running the yearly campaigns for the company — a grand total of about $1.2M cost for a $700K margin return in sales.

The worst part was the program cost scaled with the total number of emails sent returning an average of $0.58 of margin for every $1 they spent on the program - opps, sending more meant losing more money. The above agency has written a bad contract tied to email send volume. Unfortunately this is a very common problem and also leads into my next point on trusting agencies.

Over the years, there are very few advertising agencies I trust mainly due to too much experience identifying agency inflating costs, skimming and billing on non-performed work. I found one agency who could not account for about $3 million in billing a year … and that went back five years in the records I looked at. Some of that was intentional and some were related to really sloppy billing. 

When working with advertising agencies, my advice is to trust no one and complete unannounced audits frequently. Most agencies work on a Cost Plus (percent fee over cost), Commission (percent of overall costs), or Fee basis (flat fee based on the overall scope of work). Agencies must be audited regularly to assure the Cost that impacts the Cost Plus and Commission rates is not getting overinflated or boosted. Although overbilling to purchases of higher priced ads to maximize commissions is common, agency problems are not always malicious. 

What is often discovered are well meaning agencies not looped into target ROAS or ACOS ratios and they are just blindly delivering a customer’s request despite the final solution being completely unprofitable. For those good agencies and even the bad, establishing clear expectations on overall total billed fees as they relate to your target budgets and ratios can correct problems and save a significant amount of marketing spend.

Inactive marketing solutions are another almost invisible recurring monthly cost that can add up. Marketing teams are rather infamous for buying and trying a lot of hot and new marking solutions — a small unnoticed marketing service gets added to send a quick text after purchase, another to send a text when an order is ready for pickup, yet another to automatically respond to social posts, etc.

A common occurrence in even small companies is the continual monthly billing of small sub-$200 services billed to a department head or owner’s credit card. Most  people assume those small unassuming charges are legitimate marketing system costs, however many times I find these solutions are no longer used and are still being billed. In one company we eliminated more than $2 million of unused services across dozens charges that would have otherwise gone unnoticed.

A little marketing math, a few ratios that can be easily calculated and some discussions with the billing and finance leaders can usually identify a significant amount of marketing spend that is ineffective, overbilled, un-used. Hopefully along the way you find a few ideas that work great and need a bit more investment.

About the Author

In addition to being a sporting industry writer for more than a decade, Tony Arnold is an awarded Chief Marketing Officer and marketing strategy thought leader with more than 20 years of database marketing experience in global Fortune level corporations such as Sears, IBM, Berkshire Hathaway and HP. Over his career, Arnold was an Inc. Magazine Web Strategy Award Winner, launched the second e-commerce site in history, developed the largest retail CRM system processing 25 billion customer contacts yearly and has developed, created and managed strategies that have generated approximately $75 billion in revenue over his career. 


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