Is ROI Misleadingly Simple?

In a word, perhaps.

The simple formula for calculating ROI is:

ROI = NPV of Incremental Profits (Incremental Revenue – Expenses)
Initial Expenses

Where “NPV” is the net present value of a series of profits realized over a period of time, discounted back to current dollars.

Many marketers and academics have denounced the use of an ROI formula in measuring marketing effectiveness as “too limiting” or possibly “misleading.” I agree. Used in the wrong way or poorly manipulated, ROI calculations can be as imprecise and subject to misinterpretation as any other statistical or financial assessment tool. (Check out Tim Ambler’s opinion on the subject.). And pursuing alternatives that offer the highest ROI can often expose you to significant risks of short-sighted resource allocation.

However, when used properly in the context of driving more profit — not just getting the highest possible ROI score — ROI measurement is a reasonable way to standardize the process of gauging the relative value of one marketing investment against another.

If every marketing investment is held to the standard of ultimately creating some profitable change in customer or market behavior, then we can successfully compare all proposed investments using a standardized assessment process to identify those offering the greatest potential for driving profits. Sure, we might need to make some assumptions, but if we place some significant effort on trying to anticipate the intended behavior changes upfront in the planning stages, we can often identify ways to better structure our investments to help promote reliable measurement of results. This in turn helps us see where our assumptions were accurate, where they were less so, and why. Over time, our assumptions get better and better in planning our investments and achieving maximum return.

A consistent framework for assessing marketing returns allows marketing executives to:

• identify places where spending is most effective;
• correlate the individual and collective impact of marketing initiatives on prospect or customer behaviors, then link those behaviors to the financial value drivers;
• reallocate people or dollar resources towards greater impact — for example, this can include taking an underperforming initiative and retargeting it toward a high-value segment, eliminating unprofitable channel gaps and addressing identified leaks in the funnel progression; and
• extend campaign-level profitability to customer-level profitability across multiple acquisition, retention, and cross-sell campaigns that will optimize customer value.

Just be careful not to get trapped into believing that the ROI calculation gives you this insight. It's the process of asking the right questions and applying the best measures that generates insight. ROI is only one possible measure. Others are discussed in other posts in this blog.