BOOK A DEMO
Metrics

Marketing insight


ROI is not a measure of effectiveness



Written by Mats Rönne

Mats Rönne

Mats Rönne is a partner of Penetrace. He is a senior marketing advisor with a career in international brand development and marketing communications. He has held a variety of senior roles and positions for both B2B and B2C companies and has had global responsibility for brands like Electrolux, Ericsson and Skanska.

Both Swedish and Norwegian are in many ways expressive and multifaceted languages, but they do have their limitations. The word ‘effektiv’ is one example, where the lack of clarity and particularly the inability to distinguish between the English words ‘effective’ and ‘efficient’ leads to bad marketing decisions.

‘Effective’ is about producing results – how well something delivers the desired effect.

‘Efficient’ is about how we utilize our resources in creating the desired result. But if you fail to attain the desired effect, the question of resource utilization becomes more of a theoretical notion, as in “We didn’t quite reach the moon, but at least we saved a lot of fuel on the way there”.

Another way to demonstrate the difference between effectiveness and efficiency: Being effective is about doing the right things, while being efficient is about doing things right.

 

ROI – an inadequate metric

As a case in point, what is perhaps the most important week for those of us who like to dive deep into the effects of marketing is called Effectiveness Week, not Efficiency Week. The event focuses on how marketing communications create effects – in terms of measures like increased profits, a stronger brand and higher willingness to pay. All three are examples of key measures that ought to be high on every marketer’s agenda.

Instead, we tend to (much too often) end up discussing marketing ROI – or even worse, campaign ROI. This is like the analogy of the streetlight’s significance to the drunk: Its main purpose is not to provide illumination but something to hold onto. A distinct advantage of ROI is its tangibility: a concrete number easily understood by a CFO.

Or perhaps not? The question of ROI as a metric for marketing efforts is so riddled with issues and questions that the CFO probably would have hefty objections to it – if he or she knew what it is based on. How about these:

 

1. Vague definitions

From a mathematical perspective, ROI is an equation where the business outcome over a certain time period is divided by the investments – “what did I get?”, divided by “what did it cost?” However, this leads us to three factors that we need to define:

A. What is included in the outcome?
Only the advertised product or service, the entire product range in the category, or all sales for the brand? And are we to measure total sales, margins, increased sales – or something else?

B. What is included in the cost?
Only the campaign, in terms of media and production costs, or aspects like packaging and web as well? How should the costs of product development be accounted for? And what about all the previous efforts that have been made to build the brand – which part of these are we supposed to factor in, and at what rate?

C. What is the time period – and what do we compare it with?
Is it just the campaign period, or do we extend it another few weeks/months after the activities?

 

2) Explanatory flaws

The biggest explanatory variable in order to understand sales fluctuations within practically every retail category is weather. Thus, if we want high ROI on our campaign, we should be active only when the weather is favourable to our category. And preferably only when our competitors’ marketing communication efforts are low, as SOV (Share of Voice) is another important success factor. And there are others, such as distribution issues, pricing, product development, and sales efforts.

Another key flaw is that we only focus on the last link in the client’s decision chain, ignoring all steps that lie before. One example of this is search engine marketing (SEM), where we usually see a significant rise in the number of searches during a period of high media activity. However, this does not mean that the SEM activities have become more effective, but rather that the increased media exposure have generated more attention and interest for the brand.

 

3) Ignores baseline sales

In most categories and industries, activity-driven sales constitutes only a small part of total sales. The bulk of the revenue, often up to 70–75% or higher, results from what is called baseline sales, i.e. sales that originate based on the brand already being well established in the market, both mentally and physically, regardless of whether or not you are currently doing advertising or any other communication efforts.

If you are going to measure campaign ROI, your starting point ought to be zero-based budgeting, i.e. how much did sales (and profits) increase beyond the expected baseline sales level, and what activities and investments were deployed to achieve this?

 

4) Creates sub-optimisation

The most serious flaw in focusing too much (solely) on campaign ROI is that it can potentially hurt the overall business. A simple calculation illustrates this issue: If there are sales lag effects in the category, doing and investing as little as possible during the designated campaign period will improve campaign ROI. The lag effects divided by investments that are close to (or equal to) zero will produce an enormous ROI during the campaign period. But hardly the desired effects – and definitively not the desired development over time for the company.

Yet another sub-optimisation issue: It is more profitable (higher efficiency) to target clients that intend to buy the brand anyway, than those further away from their purchase decision. The previous group will produce a higher return in terms of high conversion and quick sales, but it hardly produces the desired development over time.

The fact is, as the studies by Les Binet and Peter Field demonstrate, that focusing on ROI as a key metric has a low correlation with the desired development of the company’s overall financial metrics. And in many cases there is even a negative correlation – that is to say, by focusing on short-term campaign ROI you risk worsening the company’s financial position, both short and long term.

 

What is the alternative?

After all, campaign ROI is, at face value, a simple and easily understood metric. A better option is to think based on the following structure:

1. What does our business dynamics look like? What does it currently take, in terms of awareness, site visits, RFPs and similar, to achieve today’s sales? If we are to increase sales and profits, what do our goals for this look like, split up into for instance:

  • The number of new customers, in total or within different groups/segments
  • The average value of each order for different customer groups
  • The number of orders per customer per year, or during the customer life cycle

2. How will marketing impact the customer journey and sales development? Where in the value chain are the biggest challenges? Where can marketing have the strongest impact?

3. How do we measure and report metrics for these areas? Which ones are activity based, and thus typically easily measured? And which are knowledge/attitude based, which often requires a little more effort to both measure and understand?

4. How do these metrics evolve over time? How can we test, compare, and evaluate different efforts – with one another and with different control groups? And how can we ensure that we learn and gain insights from each effort?

If you expand on the reasoning above with your CFO, and the rest of your executive team, you are more likely to focus on effectiveness rather than on efficiency only. Quite simply because you will be able to see eye to eye on the value that marketing brings. And then there is likely to be real ROI for you.

 

Free checklist

Marketing insight