Calculating Return on Marketing Investments

Now you can splash those ads without fear! (courtesy of Entrepreneur magazine)

“Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” – John Wanamaker (1838-1922)

Sadly, this age-old problem is still faced by many CEOs and CFOs in an organisation. 

Marketing = Business Expense

Traditionally, marketing and publicity are viewed as business costs.

Look at any company’s profit and loss statement. There, you will find advertising and publicity expenses in the list of expenses, together with other “administrative” overheads like staff salaries, rentals, utilities, office stationery and so on.

It doesn’t matter what you do as part of your marketing strategy. Every marketing line item – brand development, public relations, events, company profiling activities, or advertising and promotions – is considered an expense.

To the financial controller, all marketing costs are considered overheads. Therefore, the best way to achieve superior corporate performance would be to trim these costs right?

Well, I certainly beg to differ.

Introducing Return On Marketing Investment (ROMI)

Marketing, branding, public relations – and now social media relations – are critical activities that can determine the life (and death) of an organisation or firm.

Without the means to attract, satisfy, and retain customers on a sustainable basis, companies will ultimately perish.

In today’s hyper-competitive white-hot consumer marketplace, the old notion of “build them and they will come” is well and truly over.

How do we then account for the funds channeled to such activities?

This is where the Return On Marketing Investment or ROMI comes in.

Popularised by Guy R. Powell amongst other authors, Return On Marketing (ROM) or ROMI looks at how one’s marketing investments can generate incremental value to an organisation.

Put it another way, for every dollar invested, what are the additional sales and profits generated for that dollar in marketing, advertising or PR?

There are several basic components to ROMI as follows, which can be distributed and broken down on a campaign by campaign basis:

Incremental Sales

If you decide to pump in $100,000 for an advertising and PR campaign, and that in term results in an additional $300,000 in incremental (not total) sales, the ROMI factor would be considered 3 (ie $300,000/$100,000).

In other words:

Return On Marketing Investment (ROMI) factor = Incremental sales/ Incremental advertising and PR costs

Incremental Profit Margin

To work out the marginal contribution to the profitability of the organisation, you need to derive the additional costs incurred by this increase in sales. These would include raw material costs, wages, logistics, operations and other expenses.

Collectively, these are termed as VARIABLE COSTS.

Incremental costs = Variable cost per unit x Number of incremental units sold

From there, you can work out the marginal contribution as follows:

Marginal contribution = Incremental sales – incremental costs

If detailed variable costs are unavailable, you may be able to estimate the above by simply using your company’s average profit margin as a gauge, ie

Marginal contribution = Contribution margin (ie what the profit margins are like for similar products/services) x Incremental sales

You can think of a marginal contribution as the additional bottomline revenue or profits that you can gain from investing in the campaign.

Net Profit from Campaign

To derive the net profit from your marketing campaign, you can simply deduct the cost of the campaign from its marginal contribution.

In other words,

Incremental net profit = Marginal contribution – campaign costs

This measure is very effective in determining exactly how well your marketing campaign has done after deducting or netting away the usual costs of sales.

Return On Campaign Investment

Finally, ROMI has a link to the effectiveness of one’s financial investments, which can be calculated through how the additional net profit generated is perceived as a percentage of the campaign cost.

This can be calculated as follows:

ROMI = [Incremental net profit / campaign cost] x 100%

To ROMI or not to ROMI?

While ROMI as a management decision tool may help marketers to financially justify the costs of their campaigns, it may lead to an over-emphasis on short-term profitability as opposed to building long-term brand and reputation value.

Moreover, not all marketing activities can be treated as investments that yield a financial return.

Many so-called “marketing” or “PR” activities do not have a direct link to a sales activity. Examples include organising a press conference to announce the launch of a new corporate initiative, refreshing one’s corporate identity, or organising a briefing to one’s distributors or vendors.

However, such activities are important as they help to build the long-term reputation, trust, and affinity of the organisation amongst its various stakeholders.

Despite its shortcomings however, ROMI is still useful as a way for organisations to measure the effectiveness of their marketing expenses.

By shifting marketing away from being treated as an evil expense to a valuable investment, ROMI helps marketers to justify their budgets and to show why spending more on marketing (as opposed to trimming it) may actually be a better thing in bad times than in good.