ROI is one of the key performance indicators of your project or promotion channel. In this article, we will analyze what ROI is, what it is, and in which case its indicators do not mean anything.
Basic Concepts
Return On Investment (ROI) is an indicator that reflects the return on all your investments in a product, advertising campaign, or project. Investments are expenses: salary for the team, product manufacturing and inbound/outbound process, investment in a startup company and subsidiaries, rent of an office premises and warehouse, purchase of services and equipment for work, marketing, and much more.
ROI is used:
- For analytics of advertising campaigns, to find out how much money is returned to the organization.
- Investing money in a company or project: a new computer program such as application software, construction of a new building, business development, or recruitment of a new team.
- When investing in a startup, securities, or stocks.
ROI refers to performance indicators, which means it indicates that the resulting coefficient is worth paying attention to.
Why calculate ROI?
The return on investment is calculated to avoid mistakes that lead to a waste of money. That is, to make an important managerial decision: whether to continue buying raw materials for the production of a product, leave or remove the promotion channel, close the project or stop participating in it.
The ROI calculation will give you a clear idea of the level of your investment performance. In simple words, this is an opportunity to estimate the percentage of profit that you will receive after investing money. The indicator is expressed as a percentage for every dollar invested. A high coefficient indicates that your project or promotion channel is successful.
ROI formula
Let's figure out how to calculate ROI. The indicator is calculated as follows: it is necessary to subtract expenses from income (make a profit). The profit is then divided by expenses and multiplied by 100%.
You can find different formulations of indicators in the formula:
- Gross Revenue - also called "Turnover" is the amount of money that an organization receives over a selected period.
- Cost of Goods Sold - also called "Direct Expenditure".
- Gross Profit = Gross Revenue - Cost of Goods Sold. The calculation of gross profit is also possible according to the following formula: Income x Margin.
- Overhead - any other costs, also called "Indirect Expenditure"
- Net Profit - Gross Revenue - Cost of Goods Sold - Overhead.
The payback formula takes into account all income and all costs for one project. Return on Investment, the ROI formula above, is one of the key metrics that a business owner looks at.
What ROI is considered good?
The ROI in marketing is defined as follows:
- ROI > 100 - the project is profitable.
- ROI = 100 - the project paid off, but does not make a profit. Review the project and check which process is holding you back.
- ROI < 100 - the investment did not pay off, you invested more than you received. Consider whether it is worth continuing to invest in the project, but first, compare the rest of the performance indicators.
Example. If we take an advertising campaign on any social network and our ROI turns out to be less than 100%, it is better to refuse such a promotion channel. If we are investors and have invested our money in a startup, the effect of it will not be visible immediately but after some time. In this case, the analysis of the investment efficiency indicator is carried out after a few months.
For equity and foreign exchange markets, ROI is both positive and negative. Investors invest in undervalued assets that change in value over time. In this case, stocks may rise and fall in a couple of hours.
Tips on How to Analyze ROI
Marketers are interested in ROI (return on investment) for many reasons. As Peter Andrews, professor of marketing at Hull University noted, "Boards of directors with experienced marketers have proven to be the best for the company, but research shows that less than five percent of boards have a marketer."
Andrews suggests that the main reason the top marketers are locked out of the boardroom is that marketing hasn't proven to contribute to ROI over the decades. He also gave important tips on how to analyze the indicator.
Analyze Key Metrics Frequently
“Business needs and goals can change from quarter to quarter and from year to year,” said John Webb, director of marketing for IT company Spiceworks. “Often, marketers measure a specific set of metrics regardless of business goals. I think we, as marketers, need to continually reassess how we measure the effectiveness of our campaigns.”
See Wider Impact
Jane Christian, CEO of MediaCom, believes that very often marketers do not get enough information about the effectiveness of their campaigns. She explains: "Effectiveness is often measured in terms of conversions to sales, but if a campaign helps in customer retention, then that should be measured as well."
“The second common mistake is that we focus solely on short-term impact. This is because it is the simplest approach to measuring ROI. At MediaCom, we usually see that half of the impact of advertising lies in the longer term, sometimes up to two years after the campaign. Therefore, if there is no understanding of which advertising channels work best for long-term business growth, the plan focuses only on short-term results.”
The "Measurability" of Online Channels and Absolute Value
According to MediaCom's Christian, ROI can sometimes be bogus of sorts. She explains: "ROI is often defined as the ratio of return on investment to return on investment. In my opinion, the most important indicator is gross profit.
A brand can deliver high ROI but on a tiny budget. It is more important to focus on those campaigns in which large investments can achieve more modest profitability since the gross profit will be higher in general."
Know When to Stop
While a clear and correct understanding of ROI is very important, it is equally important to know when to stop analyzing and get creative. As Simon Ward, CEO and Founder of ITG says, “The typical trap of marketers is sometimes spending too much time evaluating fuzzy metrics, which comes at the expense of time that can be invested in creativity. Marketing plays a key role in attracting leads, but for that, marketers need time to devote to developing creative campaigns."
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So What Is ROI? To Summarize...
In conclusion, it should be said that the investment efficiency ratio does not always have to correspond to high indicators. It all depends on the area where you are going to invest your money.
ROI has two drawbacks to consider:
- It is static and not tied in any way to exchange rates or economic factors.
- The assessment is not very informative. The indicator works only in conjunction with other data. Without them, it is very difficult to evaluate the project, since there are a large number of nuances that are not taken into account in the basic formula.
Based on this knowledge, you will be able to assess the effectiveness of a startup, calculate the approximate payback period and understand its performance. Thanks to this information, you can avoid many mistakes and make the path to financial well-being more efficient.
