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Fun with ROI

Jim's Note:  Will the real ROI please stand up?  You were probably thinking about this one as you read the pervious page of the tutorial; knowing what you know now, what is the ROI of Ad #1 versus Ad #2?

ROI, or Return on Investment, is a concept from the financial world which is frequently applied to database or customer marketing.  What people seem to forget is ROI implies the concept of time, because "Return" happens over time.  So an ROI calculation really asks, "What was my return over time?"  And without looking at time, you can't calculate the "real ROI" of a campaign.

Think about a bank account.  The bank says if you put money in, they will pay 2% interest.  This is an yearly number; if you put in $100 and don't do anything else, you will have $102 in your account at the end of a year.  Your annual ROI is 2%.  At the end of 6 months, it's close to 1%.  So ROI depends on what time frame you are using for the calculation.

Let's go back to our example of Ad #1 and Ad #2, and look at some ROI numbers an calculations..

Ad campaigns #1 and #2 were pretty similar.  The ad units were the same and the CPM's were the same, but they ran on different sites and had different creative.  As a result, the response rates (click-throughs resulting in purchase) were different.  Here's what they look like at the end of their campaign runs:

Parameter Ad #1 Ad #2
a. Cost of Campaign $5,000 $5,000
b. People Clicking 2,000 1,000
c. Number of Buyers 185 230
d. Average Price $90 $70
e. Product Sales $16,650 $16,100
f. Product Margin 30% 30%
g. Net Margin (f x e) $4,995 $4,830
h. Campaign profit (g - a) -$5 -$170
i. Campaign ROI (h / a) 0% -3%

This is short-term ROI, right at the end of the campaign.  It's based on what customers first bought during and immediately after the campaign.  Ad #1 looks to be the clear winner; Ad #2 has a negative ROI (lost money).  But you're smarter than that now.  You know about Recency and LifeCycles.

Your first Recency tracking is 30 days later, and you find that 20% of the buyers from Ad #1 have made another purchase and 15% of the buyers from Ad #2 have made a purchase (these numbers are from our original example).  The rest of the numbers from the LifeCycle charts are included below.  Now what does the campaign ROI for Ad #1 and Ad #2 look like?

Parameter Ad #1 Ad #2
1 month Repeat Buyer % 20% 15%
2 month Repeat Buyer % 15% 13%
3 month Repeat Buyer % 12% 11%
4 month Repeat Buyer % 9% 13%
5 month Repeat Buyer % 6% 14%
6 month Repeat Buyer % 4% 16%
j. Total Repeat Buyer % 66% 82%
k. Original # of Buyers 185 230
l. New Purchases (j x k) 122 189
m. Average Price (d above) $90 $70
n. Product Sales (m x l) $10,989 $13,202
o. Product Margin 30% 30%
p. New Net Margin (o x n) $3,297 $3,961
q. Initial Margin (g above) $4,995 $4,830
r. 6 Month Margin (q + p) $8,292 $8,791
s. 6 Month Profit (r - a) $3,292 $3,791
t. 6 Month ROI (s / a) 66% 76%

Surprised?  These ad campaigns at 6 months have ROI numbers many times higher than they did at 30 days.  And, Ad #2 has emerged as the winner because at 6 months, it has passed Ad #1 in profits and ROI.  If you recall the LifeCycle chart, at the 6 month point, Ad #1 is going downhill fast while Ad #2 is still climbing.  Looks like the spread in profits and ROI is going to get even wider still over time.

Now, is this the best and most accurate way to determine the true ROI?  No, it's a "down and dirty" approximation of campaign ROI you can make on the spot, a "back of the napkin" kind of idea.  You're looking for trends and comparisons in order to get a feel for what's working.  But it is a heck of a lot better than just looking at conversion to first purchase though.

For this example, we don't know how many of the repeat customers may have made multiple purchases in a month - we only know they made "at least one".  And we're using "average price" from the original campaign; this has probably changed.  The point of this example is making comparisons between the future value of customers generated by different ad campaigns, and using these comparisons to make more money with your advertising.  Once you see important trends emerging, you can decide whether it's worth spending the time and resources to take ROI down to the last penny.

Could the customer LifeCycle for Ad #2 suddenly turn down and undercut the customer LifeCycle for Ad #1?  Sure, it's possible, but not likely.  This late in the LifeCycle, when a group of customers is moving in a certain direction, they tend to keep moving in the same direction.  

Good customers tend to remain that way (until they leave you) and poor quality customers tend to remain as they are.  That's one reason there is so much money wasted in customer marketing; marketers are not targeting using the LifeCycle, and as a result they're making untargeted offers at the wrong times to most customers.

Early in the LifeCycle, it can be difficult to tell if a customer will become profitable or not.  That's why it is so critical to track trends like this from the beginning; later on, it becomes less important as the customers tend to remain either profitable or unprofitable. 

There's no reason to guess though, is there?  You'll be tracking these LifeCycles, because that is what smart marketers do. 

Next in Tutorial: 8 Tips for Customer-Focused Marketing Promotions

Read advanced version of this topic
Extensive coverage of ROI tools, measurement techniques, and formulas for increased campaign profits are found in the Drilling Down book.


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