Tuesday, 24 August 2010

Fallacy of the ROI Marketing Metric

In the world of marketing metrics ROI (Return on Investment) is the corporate speak holy grail. Job adverts and marketing plans talk about measuring ROI or maximising ROI in an effort to track the effectiveness of marketing. A lot of this is an effort to make marketing more financially accountable and show the worth of all that marketing budget to senior management.

Yet the ROI metric itself is fundamentally flawed and should not be used. 

Here's why:

Marketing ROI is measured by dividing the return (profit before marketing) by the marketing investment (marketing budget invested in a particular brand or campaign). So for instance if the profit gained on a launch of a new paperclip is £1,000,000 and we spent £200,000 on our marketing campaign to launch that paperclip, the ROI is £1,000,000 divided by £200,000 or a factor of 5.

If we could achieve the same return of £1,000,000 and spend only £160,000 then our ROI would be higher at 6.25.

So far so good - you can see how marketing managers, campaigns and methodologies could usefully be compared and measured using such a metric and benchmarking carried out between industries and competitors.

But ROI doesn't actually make your business more profitable - it's a statistic not a measure of actual net return, the actual profit that is so important.

Here's why ROI doesn't work as a metric: 

Say with our first example we could have spent £250,000 on marketing instead of £200,000, and that this then yielded returns of £1,200,000 instead of £1,000,000. Our ROI is now only 4.8 rather than 5, so obviously the campaign is doing worse? Well no actually because the net return has gone up from £800,000 to £950,000, we are now making £150,000 more profit, so this campaign is actually performing better, although the ROI metric would tell us that it isn't.

It is surprising that ROI is bandied about so much as a holy grail of marketing metrics when it is so obviously and fundamentally flawed. I am indebted to Tim Ambler's book Marketing and the Bottom Line for opening my eyes to this fallacy. If you want a more robust way of benchmarking then you need to look at other metrics such as DCF (Discounted Cash Flow).
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