One Simple Metric You Need to Determine Marketing ROI
BY Victor Ho
Struggling to calculate return on a text campaign or Facebook investment? Just apply this single, simple equation.
When I was a consultant at McKinsey, we helped Fortune 500 companies optimize their marketing spend. With the help of statistics PhDs, we applied complex statistical models to customer data to identify small tweaks in marketing campaigns--to the tune of millions of dollars of incremental profits.
If you're a small business owner, you don't have the luxury of a PhD data scientist on your staff. Between opening and closing every day, managing inventory, and hiring and firing employees, you have a few hours every month to unearth insight from your spreadsheets and Quickbooks data. What should you be looking for? What insights can drive meaningful impact on your business?
But studying spreadsheets isn’t the only way to unearth marketing insights.
In order to multiply impact for your business, I want to introduce you to a different marketing ROI framework that’s much simpler than the classic equation taught in finance textbooks. Traditional finance ROI is defined as net profit from an investment minus investment cost divided by investment cost. However, this calculation is not easy to do in marketing because a fully loaded net profit from a marketing campaign is hard to ascertain.
So do what the big guys do. Most Fortune 500 marketing VPs look at the revenue to cost ratio: incremental revenue driven by a marketing campaign divided by the cost. It's a deceptively easy metric, but if you use it properly, I guarantee you’ll be able to make the bold marketing decisions you need to grow your business.
Recently, for example, one of our FiveStars merchants ran a text message campaign to their loyalty program members. It cost them six dollars to send the text to a few hundred of their current customers. Four percent of the recipients of the text came to the store and spent a total of $110. The revenue to cost ratio of this campaign was 18x. Was this a good result? Rule of thumb for most companies is that 5x is a decent return, and 10x is a home run. Considering that the restaurant only had to incur incremental costs for the food of about $30, and spent six dollars to get $80 in gross profit, this was a great result. We recommended that this merchant expand the size of loyalty program, and start running bi-weekly campaigns. Implementing these simple tactics and investing less than $600 could increase the restaurant’s revenue by over $10,000 per year.
Once you understand the revenue to cost ratio, it's easy to start ranking marketing decisions. Should I advertise in the newspaper? Should I pay to advertise on Facebook? Should I do a daily deal? All of these decisions can be put through this simple analysis to see if it's a good decision. You can estimate revenue to cost ratio up front, or you can try a campaign once and see if it passes your ROI hurdle.
Who needs a data scientist? Through testing, intuition, and smart application of the revenue to cost ratio, you can arrive to similar conclusions, and make decisions based on those conclusions, as any data scientist would.
VICTOR HO is the CEO and Co-Founder of FiveStars, a venture-backed startup building the first loyalty automation platform for local businesses. Previously, he was a consultant at McKinsey & Co. in New York, where he helped multiple Fortune 500 companies build and manage their loyalty and customer retention programs. Victor holds three degrees from the University of California, Berkeley, and is a Rubik’s cube enthusiast with a personal best of 45 seconds. @FiveStarsCard