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Marketing: Expense or Investment? - Stanford Management Consulting

Tips and Tools“Julia, I am overwhelmed with the number of advertisers and marketing sales people who all offer great deals to help me attract more customers.  How do I know who to “believe” or know what will work?”

If you have met me at least once you have heard me say “I don’t do law and I don’t do taxes!” I don’t do marketing either!  In fact, I have been known to say that marketing is a necessary evil, which doesn’t make my marketing friends happy!  The point is, without marketing, how do customers know who you are and what products and services you offer? You can be really good, even great, at what you do but if no one knows about you it is pointless to call yourself a business because you are simply supporting your hobby!

Many of our clients are overwhelmed with phone calls and emails on how to gain new customers by signing up for countless marketing opportunities.  So, how do you decide what to do and how much to spend on marketing activities or campaigns?  The best approach is to budget appropriately and understand what the return on your investment (ROI) will be.  We cannot predict the future but there is a way to measure a return on investment for marketing activities used to obtain future customers! 

What is Marketing?

Marketing is the wide range of activities involved in making sure that you’re continuing to meet the needs of your customers and getting value in return. Marketing is usually focused on one product or service. A marketing plan for one product might be very different than that for another product. Marketing activities include “inbound marketing,” such as market research to find out what your target groups of potential customers are, what their needs are, which of those needs you can meet, how or where you should meet them, etc. Inbound marketing also includes analyzing the competition, finding your market niche, and pricing your products and services. “Outbound marketing” includes promoting a product through continued advertising, promotions, public relations and sales.

Before discussing the return on marketing investments, let’s review other popular words that confuse most non-marketing folks!  The most frequent words I hear clients interchange are:

  • Advertising – bringing a product (or service) to the attention of potential and current customers. Typically done with signs, brochures, commercials, direct mailings or e-mail messages, personal contact, etc. Find out who your target is and advertise where they hang out!
  • Promotion – keeps the product in the minds of the customer and helps stimulate demand for the product. Involves ongoing advertising and publicity.
  • Public Relations – include ongoing activities to ensure the overall company has a strong public image.
  • Publicity – mention in the media. Organizations usually have little control over the message in the media, at least, not as they do in advertising. Good publicity is free advertising!
  • Sales – cultivating prospective buyers (or leads) in a market segment; conveying the features, advantages and benefits of a product or service to the lead; and closing the sale (coming to agreement on pricing and services).

A few years ago I found a quote in “Promoting Issues and Ideas” by M. Booth and Associates, Inc. that says it perfectly:

“… if the circus is coming to town and you paint a sign saying ‘Circus Coming to the Fairground Saturday’, that’s advertising. If you put the sign on the back of an elephant and walk it into town, that’s promotion. If the elephant walks through the mayor’s flower bed, that’s publicity. And if you get the mayor to laugh about it, that’s public relations.” If the town’s citizens go the circus, you show them the many entertainment booths, explain how much fun they’ll have spending money at the booths, answer their questions and ultimately, they spend a lot at the circus, that’s sales.

Understanding the difference in the above activities is just part of the equation.  The ultimate challenge is to choose how to spend your marketing dollars! Learn to know what is working and what is not! 

What is a Return on Investment?

Return on investment (ROI) is a measure of the profit earned from each investment. Like the “return” you earn on your portfolio or bank account, it’s calculated as a percentage. The calculation is:

(Return – Investment)

It’s typically expressed as a percentage, so multiple your results by 100.

In simple terms, marketing ROI is implementing a system of measurement to help determine or confirm that you are getting at least $1.01 back in sales for every $1.00 you spend on marketing the product or service. Marketing ROI can be applied to either an individual marketing tool like email marketing or to a campaign itself.

Applying the ROI formula to marketing:

ROI calculations for marketing campaigns can be tricky but once you master it you will begin to approach this expense category differently and more confidently. You may have many variables on both the profit side and the investment (cost) side. But understanding the formula is essential to produce the best possible results with your marketing investments.

The components for calculating marketing ROI can be different for each organization, but with solid ROI calculations, you can focus on campaigns that deliver the greatest return. For example, if one campaign generates a 15% ROI and the other 50%, where will you invest your marketing budget next time? If your marketing budget only returns 6% and the stock market returns 12%, your company can earn more profit by investing in the stock market.

Basic Marketing ROI Formulas: Which one will you use?

One basic formula uses the gross profit for units sold in the campaign and the marketing investment for the campaign:

Gross Profit – Marketing Investment
Marketing Investment

However, some companies deduct other expenses and use a formula like this:

Profit  – Marketing Investment – *Overhead Allocation – *Incremental Expenses
Marketing Investment

*These expenses are typically tracked in “Sales and General Expenses” in overhead, but some companies deduct them in ROI calculations to provide a closer estimate of the true profit their marketing campaigns are generating.

Why you want to use ROI on marketing campaigns

ROI helps you justify marketing investments. In tough times, companies often slash their marketing budgets – a dangerous move since marketing is an investment to produce revenue. By focusing on ROI, you can help your company move away from the idea that marketing is a fluffy expense that can be cut when times get tough.

Best Approach Minimum Effort

Common Approach

You measure and track the ROI of all of your marketing investments. Your campaigns deliver the highest possible return and you’re able to improve them over time. You understand the choices you make because there’s solid data to support your investments. You calculate ROI on some investments, but because it can get complex, you don’t attempt to measure it at all times. You have a general idea of how your investments perform relative to each other, but you can’t pinpoint the exact return you’re generating. And in tough times, your budget is cut. You don’t measure the performance of any of your investments. In fact, marketing is viewed as a cost, not an investment at all. Your company isn’t sure what works and what does not and it’s a struggle to meet goals.

Where to start

It’s a good idea to measure ROI on all of your marketing investments – after all, you’re in business to earn a profit. If your sales process is long and complex, you may choose to modify or simplify your ROI calculations, but a simple calculation is more useful than none at all.

1. Confirm your financial formulas

There are several figures you’ll need for your ROI calculations:

  • Cost of goods sold (COGS): The cost to physically produce a product or service.
  • Marketing investment: Typically you’d include just the cost of the media, not production costs or time invested by certain employees; however, in certain cases it may be better to include all of those figures.
  • Revenue: It can be tricky to tie revenue to a particular campaign, especially when you run a variety of campaigns and have a long sales process. This is why it is important to outline before you start a campaign and know how you will track results.

2. Establish an ROI threshold

Set an ROI goal for your entire budget and individual campaigns; set a base as well. By doing so, you gain more power over your budget. If you project that a campaign won’t hit the threshold, don’t run it; if you can’t get an ongoing campaign over the threshold, cut it and put your money elsewhere.

3. Set your marketing budget

When you have an ROI goal and annual revenue/profit goals, you can calculate the amount of money you should spend on marketing – just solve the ROI formula for the “investment” figure. You’ll be more confident that you’re spending the right amount of money to meet your goals.

4. Calculate ROI on campaigns; track and improve your results

Tracking ROI can get difficult with complex marketing campaigns, but with a commitment and good reporting processes, you can build solid measurements, even if you have to use some estimates in the process.

Use your ROI calculations to continually improve your campaigns; test new ways to raise your ROI and spend your money on the campaigns that produce the greatest return for your company.

You must have a way to measure a return on investment for marketing activities. Remember, you can’t manage what you can’t measure!  Track, track, track results! 

Tip- Determine what your marketing budget should be each year. The general rule of thumb for calculating your company’s ideal marketing budget is below:

*Total Revenue x 5% = budget required to maintain current awareness/visibility    

*Total Revenue x 10% = budget required to grow and gain market share

*Average and varies per industry