Why ROI Is Often Wrong For Measuring Marketing Impact

We might (and indeed do) talk about marketing “investments” all the time. But marketing expenditures are technically an expense, as opposed to an investment, and that’s an issue here. In finance-speak, marketing costs are a P&L item, not a balance sheet item.

As a result, notes Hanssens, who is also co-founder of MarketShare, marketers rarely mean ROI when they say ROI. “Plain” ROI is certainly an important metric for managers. But it falls well short of helping us understand marketing’s contribution to business goals, or how those contributions can be improved. ROI is too limited. To gauge and improve marketing effectiveness, for example, we must factor in the strategic intent of all marketing investments a company makes.

The Rub over ROI

We’d all love to quantify marketing performance with a single number. But ROI is a ratio, and ratios are not what matter here. Net cash flows are what really matter, says Hanssens. Performance measures such as net profit, for example, are derived by subtracting various costs from revenue. ROI is different. You get it by dividing net revenue by cost.

Question is, how can a CMO compare the ROI for different marketing investments, such as a television ad campaign versus a paid search campaign? As it turns out, you can only make an ROI comparison if the spending amounts are the same.

And it’s also critical to know that maximum ROI does not necessarily produce maximum profit. Oops!  Blame the Law of Diminishing Returns. Many marketers might think that the highest ROI corresponds to the best spending level. Unfortunately, that’s not so. For example, should you stop spending when ROI drops, even if you continue to produce bigger profits? Most likely not. The point at which you’d stop or make a change depends on the return of the last incremental amount spent, not the overall ROI.

This is also what’s known as “return on marginal investment” – or ROMI.  And “marginal” return vs. an average is what makes all the difference for accurately interpreting results and making decisions on future spending. So if you must use a return measure to gauge marketing effectiveness, use ROMI.

ROI, you see, changes at different spending levels. It is not only a function of the medium, but also of the investment in that medium. The only thing you really need to know is whether ROMI is positive or negative. Or, put another way, are you underspending in a given category…overspending…or getting it “just right” (where ROMI is zero)?  And the determining lever is how much you spend.

Tracking Complex Interactions

What’s more, a good ROI around a specific activity means nothing if broader marketing goals aren’t being met. Focusing solely on dollars-in (“I”) compared to dollars-out (“R”) ignores a complex web of interactions that happen in between. Only by analyzing as many of those intermediate processes as possible can we gain insights into what’s working and what’s not, and alter allocations to achieve better results. (This video on the “Essentials of Advertising 2.0” explains further.)

The core takeaway bears repeating:  If you settle for a seductively simple measure such as ROI, you may severely distort the true value that marketing is delivering for your organization.

This article was published before on forbes.com

By Daniel Kehrer, Director at MarketShare. Daniel Kehrer, a long-time business & financial journalist, columnist and editor, is the author of seven books and earned his MBA from the UCLA Anderson School of Management.