Ben Hirons, a member of the Entrepreneurs’ Organization (EO) in Brisbane, is the founder and CEO of Due North, a digital marketing agency that develops strategic, growth-oriented systems and products. After his recent blog post outlining why it is in your best interest to ignore SEO, we asked Ben how important ROI is for marketing. He announced the following:
I recently had a chat with a good friend who runs a successful plumbing business. He was just about to work with a digital marketing agency.
I asked, “Why did you choose this agency?”
He replied, “They promised me a 400% return on investment (ROI).”
I said, “And do you think that’s a good result?”
His answer: “Yes, of course. Not true? “
To answer my friend’s question, we need to look at the math of an actual, not fictional, return.
Let’s say you spend $ 1,000 to make $ 4,000, right? This gives you a profit of $ 3,000 as you should get back the original amount plus the return on every investment, yes? This immediately brings us to a 300% ROI.
My friend’s business is on a 50% gross profit, or in other words, it costs him 50% of his sales to keep his promise. So 50% of $ 4,000 = $ 2,000, which brings us to a 100% ROI. ($ 3,000 minus $ 2,000 gives us $ 1,000).
Then we have employee wages that are 20% of sales, so we’re another $ 800 less.
It also has other fixed costs. Opening its doors costs 25% of its sales. So for $ 4,000 in sales, it costs $ 1,000. I know what you are going to say – these are a fixed cost so there is no additional cost to deliver their products or services.
But tell this to anyone who has built a business before. As fixed costs grow, so do so, so you need to take them into account at all times. Otherwise, profit will decrease when sales increase!
So now we have a negative ROI of $ 800. Not only did I not make any money, but I lost money for what I thought was good business. That’s not a good ROI. What started out as 400% ROI is actually 80% ROI.
This is just one example of how misleading it is to use the term “ROI” in a marketing sense.
Next, let’s take a step back and look at the definition of ROI in Investopedia:
“ROI is a measure of performance that is used to evaluate the efficiency or profitability of an investment, or to compare the efficiency of a number of different investments. The ROI seeks to directly measure the amount of return on a given investment in relation to the cost of the investment. “
Notice that the key phrase is “investment” throughout, and as we look at this definition:
“Investment is the act or process of investing money for profit.”
Profit is the operative word. Revenue is not a profit. When marketers use the term ROI, they are measuring sales, not profit, which is very misleading. The saying goes: “Turnover is vanity, profit is reason”. Income is irrelevant; Profit is what really matters.
This all started with a smart (and maybe a little seedy) marketer who wanted to look good. As a result, they have started using accounting terms in a marketing sense, making marketing a “sales driven” proposition without affecting the real cost impact on the business. What used to look impressive no longer makes business sense.
If you spend $ 1,000 on Google Ads to make $ 5,000 in sales, it is not an investment but an expense. (This is why it appears in the expense column of a profit and loss, not on the balance sheet).
Income is also not a return on investment. It’s actually a terrible measurement because it hides the underlying outcome for the company. It is not accurate and does not say anything of real value. What looks like a good ROI can in reality mean the company is losing money.
The better and more honest metrics are:
What are acceptable “cost-per” numbers?
It depends on the business and every business is different. To find out, take the time to go over your finances and degrees. Once you’ve established your target profit (and percentage), work backwards to calculate the acceptable cost per acquisition.
There are two notable exceptions in marketing that can be considered an investment. However, as you will soon see, it is next to impossible to give exact ROI numbers:
Even so, it’s time to remove ROI from our marketing vocabulary and get smart about reporting on things that really matter.
So the next time you hear a marketer spend about 700% ROI, or a marketing firm tell you they are bringing back five times your investment, you run into the mountains!
For more insights and inspiration from today’s leading entrepreneurs, visit EO on Inc. and other articles on the EO blog.