In An Audience of One, the book by Jamie Turner and Chuck Moxley that has been called “One of the Most Important Marketing Books of the Past Decade” by a former Global Group Head at The Coca-Cola Company, there’s an in-depth chapter on how to calculate the ROI of a marketing campaign.
If you’re interested in exploring how to use one-to-one marketing to hyper-target and personalize your ads and then to follow the prospect through the sales funnel (all while protecting the prospect’s privacy), then you might want to check out the book which is being used for classes at prestigious universities around the nation.
Or, if you’d like to read an adapted sample from the book that provides a guide on how to calculate the ROI of a marketing campaign, then continue reading below. This is an excerpt from the book that will give you a sense of what the book is about and what makes it so special.
How to Calculate the ROI of a Marketing Campaign
Here’s one of the great things about the world we live in – it’s entirely possible to measure the return-on-investment (ROI) of your 1:1 marketing campaign.
If you’re thinking, “Well, of course I’m going to do that,” remember this – that wasn’t always easy to do.
In fact, back in the Mad Men days of the 1950s and 1960s, the idea of genuinely measuring the ROI of an ad campaign was a pipe dream. If you tried to correlate a bump up in revenues to a campaign you ran, you would quickly find there were a lot of other people claiming rights to the sales bump – the sales team, the PR agency, the retailers, or even the new whiz kid in the finance department.
During that era, measuring the ROI of a mass marketing campaign was nearly impossible (unless you ran a direct mail campaign, in which case you were able to measure the results, but for our purposes here, we’re talking about traditional TV, radio, print, and outdoor campaigns).
The good news is that it’s now possible to connect the dots between a 1:1 marketing campaign and the revenue (or, more importantly, the profit) that the campaign generated.
This chapter is designed to start with relatively simple calculations and then get more and more complex calculations as we go along.
With that in mind, we’ve divided the chapter into two sections. In the first section, we’re going to show you a relatively easy way to calculate the return on your investment. You’ll need to know some basic math for that calculation, but it’s well within your abilities.
In the second section, we’re going to dive into some more advanced calculations. These are also within your abilities, but you’ll need to put your thinking cap on. We’ll discuss something called Lifetime Value (LTV) and then use the LTV calculation to help you calculate your ROI in that section. Both of those concepts will help you do a more accurate ROI calculation.
So … let’s do this, shall we?
The Easy (But Imperfect) Way to Calculate Your ROI
The easiest way to calculate the ROI of a marketing campaign is to take the sales growth, subtract the marketing cost, and then divide by the marketing cost.
In plain English, that means you find out how much your sales increased in dollars during your campaign. Then you take that figure and subtract the amount you spent on the campaign. And then you take that answer and divide it by the amount you spent on the campaign.
By doing the calculation this way, you’ll be able to get a simple, back-of-the-envelope understanding of whether or not your marketing campaign grew your revenue. Here’s what the formula looks like:
(Sales Growth – Marketing Cost) / Marketing Cost = Simplified ROI
In this example, if sales grew by $1,000 during the month of March and the marketing campaign cost $100 during the month of March, then the simple ROI is 900%.
(($1,000 – $100) / $100) = 900%
That calculation is pretty straightforward, but it makes a big assumption – that the total month-over-month sales growth is directly attributable to the marketing campaign.
But sometimes sales are growing organically on their own. For example, if sales are growing by 4% per month over the past 12 months, then your ROI calculation for the marketing campaign should strip out 4% from the sales growth.
Here’s how the formula looks when you strip out the 4% organic sales growth:
(Sales Growth – Average Organic Sales Growth – Marketing Cost) / Marketing Cost = ROI
So, let’s do an example using the formula above. Let’s say that your company averages 4% growth per month and you run a $10,000 campaign during the month of March. The sales growth for that month is $15,000. Remember, 4% of that growth is organic, so you have to strip out the 4% (which is $600).
($15,000 – $600 – $10,000) / $10,000 = 44%
A 44% return on your marketing investment is pretty substantial. For your business, your results will probably be much lower, but by showing you the formula above, you’ll be able to do a relatively easy calculation that will give you a pretty clear understanding of your marketing ROI.
(Article continues after the … wait for it … advertisement below.)
A More Complex but More Accurate Way to Calculate Your ROI
Before we go on to the more complex calculation, there are a few things to remember about any marketing investment. For starters, the impact of your marketing campaign builds over time.
Let’s say you’ve invented a new energy drink and you start advertising on January 1st. The first ads you run in January are going to have much less impact than the ads you run in July because the ads in July will be building on the awareness from the previous 6 months.
In similar fashion, the ads you run in December will have more impact than the ones you ran for the previous 12 months for the very same reason.
We know the CEO of a Paris-based Software-as-a-Service (SaaS) company that started to experience rapid growth after being in business for 8 years. The growth was phenomenal, so we called the CEO to find out what he was doing to experience such a rapid rise in sales. Since they were a metrics-based company that closely tracked the ROI of their paid search, online display, and paid social media campaigns, we were eager to hear about the company’s return-on-investment.
“I still lose money on every campaign we run,” the CEO told us.
We were a little taken aback by that, so we kept listening.
“We track the campaigns closely and follow the customer as they go from initial click through final purchase,” he said. “When we do that, we’re still in negative ROI territory. But we’re also aware that each customer we gain refers us to their friends and associates, so there’s added value to the sale that’s not in the calculation. We also only use the first-year revenue gained in the calculation. We don’t include the revenue from the customer in year two, year three, and so on.”
That’s a great example of why there are some grey areas in any marketing ROI calculation that you do – there are variables and nuances that aren’t always captured by a mathematical formula.
So, now that we’ve addressed that, let’s move on to the more advanced way to calculate marketing ROI. As mentioned, the advanced calculation includes concepts like Lifetime Value and a few other things, so let’s dive into that calculation right now.
We’ll start with a simplified version of LTV and then move on to the ROI calculation. Here’s the formula for a simplified version of LTV:
The price of your product/service
x how many times your customer buys it in a year
x how many years they’ll be a customer
= Simplified LTV
As an example, let’s say the average price for a Comcast subscription in Kansas City is $100 per month. You would expect 12 repeat purchases every year. And the average customer stays with you for 3 years.
So, the simplified LTV in the Comcast version is:
$100 x 12 per year x 3 years, which equals $3,600.
But that formula for LTV uses revenue instead of profit for the calculation. That’s okay for a basic calculation, but there are better, more accurate ways to do the math.
In the more accurate version of LTV, you factor in several key data points:
- The profitability of each sale
- Your retention rate (i.e., the likelihood your customer will remain a customer from one year to the next)
- The discount rate (i.e., the time value of money; in other words, the fact that $10 earned today is worth more than $10 earned 5 years later because of inflation and other things)
Using the Comcast example, our datapoints might look like this:
Total number of customers at the beginning of Year 1 = 1,000
Average purchase price = $100 per month
Net profit per purchase = 20%
Number of repeat purchases = 12
Average retention rate = 80% (and then everyone quits after year 3)
Discount rate = 10%
Let’s dig into the terms above so we’re clear on what they all mean.
When we say that the net profit per purchase is 20%, we’ve already accounted for all other costs. For example, if we charge $100 for our product, and we make $20 in net profit, that means we’ve already included the overhead (e.g., labor, office space, etc.), the cost of goods sold (e.g., cable, trucks, etc.), taxes, interest, and even the acquisition cost (e.g., the cost of running ads to acquire that customer).
In other words, you would sell your product for $100, then pay for everything required to make that product, and then have a 20-dollar bill to stuff in your pocket at the end of the day.
The discount rate represents the opportunity cost of using the money for marketing instead of using it in other ways.
For example, if you had $500,000 to spend on your Comcast marketing campaign for Kansas City, you would have to account for the fact that, alternatively, you could invest that money in other investments in the company and make, say, a 10% return on it.
In order to understand why we have a discount rate, pretend for a minute that you’re the CFO of Comcast. Your job, your salary, and even your bonus are tied to one thing – how you invest Comcast’s money.
If you have $500,000 to invest, and you could get a 10% return by putting it into the stock market or a 5% return by putting it into marketing, then the smart thing to do would be to put it into the stock market, right?
While the scenario above over-simplifies things, the discount rate gives smart numbers people (like the CFO) a way to account for other investments they could make with that money. In other words, the discount rate kind of levels the playing field when you’re thinking about where to invest capital.
The next section is a breeze … if you’re a math major. For the rest of us, we’ll need to put on our thinking caps.
In the chart below, you’ll see a term called net present value (NPV), which is the number you arrive at when you use the discount rate to calculate the value of your money over time. The NPV gives you the accurate dollar value of your investment.
Take a spin through the numbers below. They might be a bit confusing at first – that’s normal – but we’ll talk about them afterwards so we can be sure we’re all on the same page.
Also, it might help if you just review the “Year 1” numbers at first. Be sure you have a handle on that column before diving into the other columns. If you do that, it’ll be much easier to follow along.
|COMCAST Kansas City Example Calculation|
|Year 1||Year 2||Year 3|
|Total Customers||1000||1000 x 80% = 800||800 x 80% = 640|
|Average Yearly Revenue per Customer||$100 x 12 = $1,200||$100 x 12 = $1,200||$100 x 12 = $1,200|
|Average Net Profit Per Customer||$1,200 x 20% = $240||$1,200 x 20% = $240||$1,200 x 20% = $240|
|Discount Rate||1||1 + 10% = 1.1||1.1 + 10% = 1.2|
|Yearly Net Profit||1000 customers x $240 per customer = $240,000||800 customers x $240 per customer = $192,000||640 customers x $240 per customer = $153,600|
|Yearly Net Profit at Net Present Value (NPV)||$240,000||$192,000 ÷ 1.1 = $174,545||$153,600 ÷ 1.2 = $128,000|
|Cumulative Net Profit from 1000 customers at NPV||$240,000||$414,545||$542,545|
|Total LTV per customer at NPV||$240||$480 ÷ 1.1 = $436||$720 ÷ 1.22 = $600|
Okay, now that you’ve looked at the numbers in the chart above, let’s do a quick recap and then plow ahead:
- Over the past few paragraphs, we discussed the fact that the starting point for all ROI calculations is customer lifetime value (LTV).
- LTV is the total amount of profit you’ll generate from your customers over the course of their engagement with your brand.
- So, if you had 1,000 customers and your annual profit is $240 per customer, your total profit would be $240,000.
That’s pretty straightforward, right? Hang on a second. It gets a little more complicated:
- To accurately calculate the LTV over time, you have to use the discount rate to represent the opportunity cost if you used that money elsewhere.
- The term net present value is a way to use the discount rate to account for the fact that $1 in year 1 is worth less than $1 in year 2. In other words, if you have $1 today, that dollar is only worth about 97 cents next year because of the 3% inflation rate.
- In the example above, if you generate $240 in net profit per customer, and you keep that customer for 3 years, the cumulative net profit is not $720 (i.e., $240 x 3 = $720). Instead, it’s $600 because of the net present value calculation.
Now that we’ve calculated our net profit per customer and used the discount rate to arrive at the net present value, we need to talk about a few other things:
- For starters, every year, we lose 20% of our customers. (That’s okay, we didn’t like those customers anyway. Kidding!)
- Since we lose 20% of our customers, our annual net profit drops by 20%. That has to be factored in each year.
- So, if we start with 1,000 customers, then drop to 800 in year 2 and drop to 640 in year 3, that impacts our cumulative net profit. Instead of our cumulative net profit for 1,000 customers being $240,000 x 3 = $720,000, it’s $542,545 because we lose 20% of our customer base every year.
Now that we’ve done the recap, go ahead and re-visit the chart and study the numbers again. If you’re like most people, you just skimmed the chart the first time, so go back through the chart and run down each column making sure you understand each concept before moving on to the next item in the chart.
More Fun with Math
Once you’ve done that, we’re going to throw another concept at you, which is this – cost per acquisition (sometimes called cost per sale).
Cost per acquisition (CPA) is exactly what it sounds like. It’s how much it costs you to acquire one customer.
Let’s say you spent $300,000 in advertising to acquire 1,000 new customers. If you looked at just the first column in the chart above, you would see that you generate $240,000 in net profit from those 1,000 new customers in year 1.
But wait … that would mean you spent $300,000 to generate $240,000 in net profit. That doesn’t make any sense, does it?
No, it doesn’t.
But if you take into consideration that those 1,000 customers will generate profit for your company in year 2 and year 3, suddenly the calculation makes sense.
In fact, by the end of year 3, the customers who are still with the company have generated $542,545 in net profit for Comcast. So, a $300,000 marketing investment in year 1 generates $542,545 in net profit by year 3 (and that’s including the discount rate which factors in the time value of money).
In the end, if you spend $300,000 to acquire 1,000 new customers, then your cost per acquisition is $300. When you look at the last row and the last column of the chart, you’ll see that your LTV on a per customer basis is $600. So, you’re spending $300 to make $600 in net profit. That’s an ROI of 2:1 – in other words, you make $2 in profit for every $1 you spend.
Not bad for a day’s work.
A Quick Recap
The concept of Lifetime Value is best used for products or services that have predictable recurring revenue. For example, monthly lawn service, monthly cell phone service, or a monthly consulting fee works great. It’s a little harder to calculate the LTV for a consumer packaged goods product unless you make some generalizations about your customer’s engagement with your product or service. (For example, some people might drink Coke from ages 18 to 34, then switch to Pepsi for a decade, then switch back to Coke. Since there are a lot of variables in that scenario, you have to make some generalizations and stick with them.)
If You’re Like Most People, You’ll Need to Re-Visit This a Few Times for it to Sink In
There are three kinds of people – those who are good with numbers, and those who aren’t.
If you’re in the second category, don’t be freaked out by all of the math we just threw at you. We’ve found that if you re-visit the concept a few times, it all starts to sink in and make sense. So, don’t give up!
Okay, let’s talk about one last concept that’s important. It’s called attribution modeling and it’s essentially a way to assign value to each interaction that happened along the way. In the example mentioned above, the prospective Comcast customer took this course of action:
- They clicked on a Comcast paid search ad
- They clicked on a Comcast banner ad
- They clicked on a Comcast Facebook ad
- Finally, they typed the Comcast URL into their browser and ordered the service
The question is how do you decide which of the four interactions was responsible for the actual sale? Was it the paid search ad? The banner ad? The Facebook ad? The final visit to the Comcast website?
In most cases, there’s no way to decide which single action resulted in the sale, so you have to designate an attribution model in order to assign value to each step in the process.
There are a lot of different attribution models but the five most common can be seen in the chart below. Take a spin through the chart and see which one is a fit for your business. Spoiler alert – you’ll probably want to avoid first touch and last touch attribution since those two models tend to overvalue the first and last interactions the prospects had prior to purchasing the product or service.
|Attribution Model||How it Works||Pros||Cons|
|First Touch||Assigns 100% of the credit to the first touch point||Simple and easy to calculate||Gives too much credit to first touch and zero credit to other touch points|
|U-Shaped||Assigns 40% of the credit to the first and last touch point. Remaining 20% distributed evenly.||Some argue that first and last touch are most important||Can undervalue key touch points, especially during long sales cycles|
|Linear||Every touch point is given equal credit||Easy to calculate||Undervalues the important touch points. Overvalues less important touch points.|
|Time Decay||Bulk of credit given to last touch points||Easier to calculate||Might overvalue last touch points|
|Last Touch||Assigns 100% of the credit to the first touch||Easier to calculate||Gives too much credit to last touch and zero credit to other touch points|
Let’s do a Final Recap
Okay, we’ve covered a lot of really important concepts in this chapter. We discussed lifetime value, studied a chart with a lot of calculations around LTV, took a look at cost per acquisition, discussed calculating the ROI, and then discussed attribution modeling.
If you’d like to take a deeper dive into the math behind marketing, you might read Guy Powell’s book, Marketing Machine: The Secret History of the Future of Marketing (ROI). And if you’d like to understand broader financial concepts, be sure to visit Investopedia.com, which is a well-structured and well-written website that takes a deep dive into a range of financial concepts.
Here are some things to keep in mind as you reflect on the concepts in this chapter.
- Simplified vs. Complex ROI: The simplified version of ROI is fine if you’re at lunch with a friend and want to do a quick, easy calculation on the back of a napkin. If you’re heading into a meeting with your CFO, you’ll want to do the more advanced calculation.
- Lifetime Value: An important concept to understand is Lifetime Value (LTV). If you have a product that’s a recurring revenue product (e.g., life insurance, cable service, lawn care service, etc.) LTV is relatively easy to calculate. If you have a consumer package goods product, it’s a little harder to calculate since people might buy your product for a year, then stop buying it, then start buying it again 5 years later. So, it’s best used for recurring revenue products and services.
- Attribution Models: We also discussed attribution models, which help you assign value to each engagement the prospect has with your brand over the course of your campaign.
This article has been adapted from An Audience of One by Jamie Turner and Chuck Moxley. Doug Dichting, a former VP of R&D and Innovation at Del Monte Foods says, “An Audience of One provides a road map on how marketing is changing today and where it is headed tomorrow.”