Here’s the gist of the article: for two of GM’s automotive brands, GMC and Buick, consumers can now go to their website and utilize a vehicle-configuration tool, and then post the custom car from the tool to their Facebook page to solicit feedback from friends.  In addition to seeing responses from friends on Facebook, consumers also can see them in the configuration tool.  GM will be in essence spying on this activity to see what configurations are “liked” by consumers and their friends, and then “will also be able to tie those metrics to purchases.”

I’m curious HOW they plan to tie those metrics to purchases, as they then go on to say they they do NOT “have mechanisms in place to remarket to consumers who build and share a vehicle, other than messaging to those who “like” the brands’ Facebook pages.”  At least GM acknowledges that “likes” on a Facebook page or playing around with a configuration tool are not ROI:

“The ultimate gold standard is to be able to connect how people are engaging on GMC.com and with the tool and ultimately be able to lead that into sales and how this tool helps to facilitate sales at the bottom line.”

Since GM doesn’t tell us how they’re doing it, we can only speculate.  What we do know is that GM obtains permission to access consumers’ basic profile when the user connect their vehicle design with their Facebook account, and GM may use some of this information shared publicly to tailor future marketing communications.  As an exercise I want to think thorough examples of how ROI can be measured in this situation.  I will further break it down into soft ROI and hard ROI, as well as what metrics I’m certain GM can access and what is my speculation (noted by asterisk).

Soft ROI

• # of “likes” on the brand pages
• # of consumers who use the auto configuration tool on the websites
• # of consumers who share their custom car design with their Facebook friends
• # of Facebook friends who “click,” “like” and “comment” on the custom car designs
• # of Facebook friends who “pass-along” the content from one person to another*
• # of variations of car designs
• # of likes per variation (qualitative “comments”can also be coded)
• segmentation of most liked car designs based on other gathered information (e.g. male/female, age ranges, geography)
• # of configuration tool visits and duration of engagement
• source of traffic, other pages visited and in what order
• whether the brands/the promotion are being talked about online (e.g. tweets, blogs, press)
• whether the brands are being talked about more than competitive brands
• # of consumers who visit a dealer month over prior month, year over prior year
• # of consumers who use the configuration tool who own a GM car currently*
• # of consumers who submit or call for more information on their dream car*

Hard ROI aka the “Gold Standard”

• # of consumers who visit a dealer and show a copy of their dream car or mention the tool*
• # of consumers who already pretty much know what they want, due to the tool, saving agent’s time*
• # of consumers who redeem coupons/offer codes*
• # of buyers who respond in a follow-up survey that the tool had a significant bearing on their purchase*

In summary, there are certainly a lot of opportunities to measure the soft ROI of social media marketing integration and, while more challenging to link these activities to hard ROI — money earned or resources saved — it’s not impossible.  If you have any thoughts of your own to fill out these lists, I’d love to hear them!

The Death Of CPM , The Death Of The Retail Store , The Death of Affiliate Marketing , The Death of the Open Web , The Death of Video Rental Stores , The Death of the Landline , The Death of the Book , The Death of the Desktop , The Death of Newspapers , The Death of the Press Release , The Death of Advertising , The Death of the Pageview

What’s going on here?  More importantly what can we learn from it? After studying these articles I have come to the conclusion that no, business isn’t dying…but it is evolving.  We’re evolving; as consumers and as marketers.

As consumers, we want to be marketed to as the individuals we are. “Technology is fueling the consumer’s desire for personalization.1″  As marketers, we are seeing that treating people as ‘the masses’ is no longer appropriate.  It’s no longer about measuring our audience size but about how relevant we are to our audience1. We must become more sophisticated in our targeting efforts.  One-to-one marketing is the key now, whether we are talking to other businesses or to consumers.

In One-to-One Marketing: The true promise of Dynamic Offer-Content Customization it states: “Customizing offers based on customer segments involves a sequence of steps, beginning with identification of meaningful customer segments. Any method of customer-specific message optimization requires knowing ‘who’ your customers are, beyond just their names and email addresses. You must also have some insight into what they ‘want,’ how they think, the words, terms and images that attract and inspire them (as well as those that repel them), and ‘how’ they think.”

There are two ways I know of to develop customer segments.  One involves analyzing the people who come to your website, or who you want to come to your website, and developing it around their needs.  In Online Customer Segmentation Made Easy it says “the easiest approach is to ask the five basic questions that all news reporters know:  Who, What, Where, Why and How. By taking time to answer these five questions up front, you will be able to make the most effective use of limited resources, as you build a website that meets the needs and wants of all your customers.”  While creating segments based on online behavior may yield actionable insights for your website, it also doesn’t truly represent your customer base if you sell in other ways, such as direct and retail.

In that case, there is another method that involves surveying your customers.  The company I work with, C.A. Walker, does this type of segmentation analysis.  We design a questionnaire that allows us to group customers as similar or dissimilar based on their attitudes, behaviors and demographics, yielding those segments that are most valuable to target.  Segmentations are a valuable look into customer groups’ beliefs,  lifestyles and habits.

Another point I picked up from these articles is to not be afraid to launch evolutionary products and services, even if a larger company could launch a competitive product/service with greater advantages.  Far too often “industry leaders are usually so focused on maintaining existing profit centers and business practices…they ignore the threat.”4

Lastly, measures of marketing ROI are evolving also.  In The Death of the Pageview it makes a great point: “The most important thing is that you are gathering actionable data. By this I mean that you have to be able to use the information you gather to make a decision and take action.  If you’re not going to use it to make a decision, it’s a waste of time to even look at it.” Consolidating what these articles are saying, the important ROI metrics to gather and take action on are:

• Cost Per Customer (CPC)1
• Customer Lifetime Value (LTV)1 (links to my prior post on how to calculate and increase Lifetime Value)
• Value delivered — e.g. customers or inquiries1,  less stress2, saves time2, original products3
• Average Revenue Per User (ARPU)5

In summary, it is my belief that businesses don’t truly die; they simply evolve and may become a stepping stone into something more relevant to people’s lives.  Marketers must become savvier in order to evolve with these trends and must monitor only those marketing metrics that can assist to improve conversion rates and gain a deeper understanding of  customer behavior.

Sources:

1 The Death Of CPM

2 The Death Of The Retail Store

3 The Death of Affiliate Marketing

4 The Death of Video Rental Stores

5 The Death of the Pageview

Yesterday I was helping a friend work on a marketing plan for her business.  While she is an excellent hair stylist, she has not put any effort so far into monitoring metrics in her business so she can determine how to affect them, nor has she yet conducted any formal advertising, having relied exclusively on word of mouth.  We’re working on changing that.

The first thing I suggested is that she build a simple spreadsheet to log, backwards and forwards, who are her clients, when they are coming in by month/date and how much they are spending.  When completed, she can then make some important calculations.

I have been her client for nearly 14 years, but I don’t know if this is common for her.  In fact, my devotion to her talents may be an outlier that skews her average.  Therefore, we want to first calculate the mean (average) and median (middle figure) in the number of months that her customers have been with her.  Excel makes it really easy using the formulas: =average(starting_cell:ending_cell) and =median(starting_cell:ending_cell).  If the average is much higher than the median, then we know that the results are being skewed.  For a more visual representation, we can create a scatterplot by using Excel’s Chart Wizard tool.  Highlight all the months, click the Chart Wizard, select Scatter, hit Finish and voila!  A helpful chart that lets you see outliers at a glance.

Let’s say that the results of her analysis shows that the majority of her customers are with her for 20 months.  We then have to connect that value with the amount they are spending.  By adding a second column next to the months for dollars spent, we can do similar calculations to derive average and median dollar values.  Taking a look at my own spending with her, on average I’m seeing her every 6 weeks and spending $60 each time.  I’m getting my hair done about 9 times per year, which means over nearly 14 years, I’ve spent $7,560.  So for every new customer that spends $60 a visit, she now knows that’s $540 over a year’s time.

However, that’s not entirely true.  Another thing she has to look at is how much she’s spending to acquire and keep her customers.  If she spends $200 a month on advertising, she has to deduct those costs of $2,400 in the first year towards those clients’ acquisition costs.  Additional monies in subsequent years spent on mailings to encourage those clients to come back will also reduce her profit per customer in those years.  Then there’s the product costs – color, gels, hairsprays, shampoos and conditioners, scissors, scissor sharpening, brushes, blow dryers – which adds up.  Those costs have to also be applied to each client.  Some of those costs can be spread out over all clients using an average and some she may want to do on a more granular level, e.g. color products she may want to apply on a per-person basis since longer/thicker hair requires more product.

Then there’s the cost of inflation to consider.  My $60 paid today is worth less than the $60 given to her nearly 14 years ago.  Using the inflation rate calculator I can see from January 1996 to September 2009 (the most recent month provided), inflation rose 39.88%.  So therefore, my $60 can buy $23.93 less than it did in January 1996 (=60 x 0.3988).  For each of her current customers, she can calculate on an annual basis how much to adjust for inflation.

A really nifty spreadsheet from Harvard Business School makes doing all this pretty easy: Download the Lifetime Customer Value Calculator tool. Clicking on the “Basic Model-Assumptions” tab, I can input:

• Time between purchases.  Every six weeks would be =1.5/12.
• Retention Rate or likelihood that a customer will buy again in the next period.  Let’s use a guesstimate of 80%.
• Average Purchase value.  Let’s use $70.
• Net Profit Margin.  Assuming product costs of $15 per visit and 9.25% taxes, Net Profit After Taxes = $48.53 ($70 – $15 – ($70 x .0925)).  $48.53 divided by Revenue of $70 x 100 = 69.33% Net Profit Margin.
• Profit Per Purchase is calculated for you at $48.53.
• Discount Rate is currently 0.75% as of November 8, 2009 (it rounds to 1%) – think of the discount rate as a forward-looking inflation rate.
• Product (or Service) Inflation Per Year.  Using the inflation rate calculator again, we can see the inflation rate from September 2008 to 2009 has actually decreased -1.29% (it rounds to -1%).
• Cost of Reaching a Potential Customer.  As she plans to spend $2400 a year to reach potential customers, targeting 10,000 customers, her cost per potential customer is $0.24  ($2,400 / 10,000).
• Response Rate.  This is the percentage of respondents to her advertising efforts.  Let’s say 2% until we know for sure.
• Cost of Attracting a Customer is calculated for you at $12.
• Coupon or Other One-Off Costs.  This is the cost to obtain that particular customer, for example, a 10% off coupon for first visit.  The cost to her would be $7 ($70 x 0.10).
• Total Customer Acquisition Cost is calculated for you at $19.

Having inputted these values, I now click over to the “Basic Model-Calculations” tab and see that the Net Present Value of Acquiring a Customer (taking into consideration the stream of a customer’s income, ongoing costs, and cost of acquisition) is $221.

Now I click over to another handy Harvard Business Screen tool, the Customer Lifetime Value Calculator, which does something a bit different than the downloaded one.  First, I clicked in the top right side Reset Inputs to Zero.  I then entered my inputs:

• Average Spend Per Purchase = $70
• Average Number of Purchases Per Year = 9
• Direct Marketing Costs Per Customer Per Year = $0.24 ($2,400 / 10,000 mailing) + $7 coupon = $7.24.
• Average Gross Margin = 69%
• Average Customer Retention Rate = 80%
• Annual Discount Rate = 1% (rounded from 0.75%).

In summary of the below grid:

• The cost of acquiring a new customer is $362 = (cost of mailing / response rate) = $7.24 / 0.02.  What this doesn’t allow me to do is change the mailing costs where in the first year they receive the 10% coupon and in subsequent years they don’t, so I will assume they receive an annual coupon.
• Expected Net Present Value in the 6th year is only $132 because it looks at the value of a dollar today compared to the value of that same dollar in the future, taking inflation (based on the discount rate) and returns into account.  If the NPV is positive, it should be accepted.
• The cumulative Net Present Value (taking into consideration expected inflation, based on the discount rate) of a new customer in the 6th year is $1,171.
• The cumulative Retention Rate shows that in the 6th year, with an 80% retention rate, there is only a 33% chance of making another appointment.  The longer they are a customer the more likely they are to “expire.”

Lastly, those things that she can affect to increase Lifetime Customer Value:

• Work to improve retention rate above 80%.  Be on top of how often her customers come in.  Call customers a week in advance of their normal scheduling to ask if they are ready to make an appointment.
• Send welcome and thank you cards.
• If a customer leaves, be sure to find out why and work to improve those areas she can (if someone moves away, there’s not much that can be done).
• If a customer is not coming in due to financial reasons, make a discount offer for their next session to keep them on schedule. The longer someone is away the more likely they are to look for someone else to do their hair next time.  They will appreciate her understanding their situation and become a more loyal customer.
• Get creative in her approach in obtaining new customers.  For example, she could evaluate the least she could charge someone and still maintain profitability.  She could then offer this discounted rate to the unemployed as a “get back to work” special.  As long as they show her evidence of unemployment, such as a recent pink slip or unemployment income receipt, they can receive their discount.  When they do get back to work, she can then raise her rates to normal and have a new loyal customer.
• Offer a loyalty card, such as buy 9 get the 10th haircut free (color, highlights and other services not included).
• Ask for referrals, which eliminates much of her acquisition costs.
• Offer a discount for purchasing several sessions in advance.
• Survey her customers to better understand who they are, what’s important to them, how satisfied they are, and areas she can improve.  Follow up with calls and letters.
• Segment her customers by lifetime value group.  Conduct different marketing programs designed for each segment.
• Monitor inflation and adjust prices accordingly.
• Reduce product costs where she can, and charge more for people who require more products.
• Offer additional services that bring in higher-paying customers.
• Sell products that will increase her revenue per customer.
• Improve response rate on mailings with messaging that better resonates with potential customers.
• Test mailings’ response rate with and without the 10% coupon.  If she receives a similar response rate without the coupon, eliminate it for cost savings.
• Test different advertising vehicles to determine which provides a better response rate, then focus on those with the highest return and provide unique audiences.
• Determine if other promotions instead of a 10% coupon would yield a better response rate, such as bring a friend with your first booking and receive half off (on the cheaper service of the two).  The LCV of the friend would cover the upfront cost on the other person.
• Don’t just focus on the response rate, but also on the return received (number of new customers times lifetime value) for the advertising investment made. Suddenly she may find she can justify a much greater promotion investment when looking at returns in this way.
• Advertise in higher-income neighborhoods where she can command a better price.  If this is outside where she works, she can make an arrangement with another salon to rent a chair on an as-needed basis when she obtains customers in that area.  She can schedule appointments in that area together to minimize travel and chair-rental costs.
• Use as many free advertising vehicles as she can, such as LinkedIn, Facebook and Myspace.
• Conduct co-operative advertising with related businesses such as spas and nail shops in her area, to reduce advertising costs.

Anyone else have suggestions I can pass on to my friend to improve her LCV?  And if you’re in the Venice Beach, California area and are looking for a great stylist, please call Sondra at 310.780.0290 to make an appointment.

As stated in my previous post, measuring soft ROI is a challenge because it is highly qualitative.  In fact, many of the activities of creating soft ROI are often stepping stones in achieving hard ROI.  To differentiate soft ROI from hard ROI, hard ROI refers to savings related to time, head count, improved quality and subsequently increased dollars. Hard ROI is also tracking how many clients and new assets are brought in based on nurturing and converting prospects into new clients. While hard ROI may be the goal, adding soft ROI benefits to a business case is key in proving true profitability of an strategic business investment.

In The Business Case: The Hard Realities of Soft Benefits, it states, “Labeling a benefit as soft doesn’t necessarily mean that hard ROI payoffs don’t exist. It only means that its tangibility is not apparent and/or acceptable to the decision maker.”  Furthermore, it states, “A successful technique [in business case building] is bundling groups of quantified soft ROI benefits together into categories called ‘high impact benefits,’ ‘medium impact benefits,’ and ‘low impact benefits.’ Strive to make the total calculated value of each group at least equal to the tangible savings that have already been identified.”

To do this, you have to be able to identify those additional benefits that don’t necessarily factor into the “hard ROI” equation but nevertheless achieve desired results, and then sort them into high, medium, and low impact buckets.  Does the option being considered…

• Improve customer service?
• Reduce implementation pain (vs. other options)?
• Reduce training pain (vs. other options)?
• Provide more functionality?
• Improve employee morale?
• Increase employee commitment to a process?
• Optimize use of resources (labor, space, etc.)?
• Lead to improved billing?
• Reduce carbon footprint?
• Increase employee collaboration/customer engagement?
• Improve competitive position?
• Reduce confusion against competitive products/services?
• Increase customer satisfaction/loyalty?
• Expose your company to new, potential clients?

As mentioned in my previous post, many of the activities that go into creating soft ROI are, in fact, branding exercises.  Increasing brand value/equity creates on-the-books value for a company and is measured as an intangible.

There has been a lot of discussion lately about whether Facebook and Twitter are being valued too high.  Naysayers believe that since both are not making the hard ROI revenue that they should be, they are being overvalued (see Facebook’s valuation: The cheat sheet and Is Twitter’s Valuation too High?).  What some people don’t get is the soft ROI benefits that are being added to their brand value/equity.  A brand with high soft ROI (brand awareness, usage, differentiating strengths and brand loyalty, to name a few), which has potential high-growth hard ROI, may be a better investment, in the right leadership hands, than a company that has higher hard ROI results but fewer growth opportunities, for whatever reasons.

Getting back to the point of this posting, there are ways to measure soft ROI results.  The company I work with, C.A. Walker, does B2B and B2C survey research that can be used in the process of calculating soft ROI benefits,  therefore, I feel qualified in pointing out some of the ways this can be done.

• To measure improved customer service, a survey can be emailed out following an exchange with the customer service team.  For example, a company may be interested in evaluating the soft ROI benefits of new call center software.  It would be wise for them to query customers prior to and after the upgrade to determine if there is an improvement in customer service satisfaction ratings, current brand perceptions, and willingness to recommend the product/service to others.  It can also be determined if resolution times are shortened (hard), if there are increased up-selling opportunities (soft/hard), and whether fewer customer service employees are needed due to improvements (hard).
• To measure implementation pain, a company could evaluate expected pain across departments – those performing the implementation and those expected to utilize the new program – vs. other options.   In The ROI on IT investments, it is stated, “For many IT projects, the resulting value does not occur immediately but rather over a period of time.  Some of the other factors include how many people will be affected (either positively or negatively) by the investment, and how often the new application/system will be used.”
• To measure training pain, a company could evaluate employees’ training experiences currently vs. that in a new program.  They can be interviewed post-training for feedback on how they feel about the new program, effectiveness of the trainer, persisting product/service confusion, difficulty using the program after training, and other qualitative measures.
• To measure improved functionality, a company could evaluate, in advance, those functions that will be made available in the new product/service, however, those benefits won’t be fully realized until it is in the hands of its users.  They could survey (heavy/medium/light) users of the product/service to provide feedback on how the new functions have affected them (positive/negative) and suggestions for further improvements.
• To measure improved employee morale, companies can conduct regular employee satisfaction surveys, which has the added benefit of sending a message to employees that they are open to receiving input and their opinions about likes/dislikes/challenges are valued.  Every employee should be included, or else a self-selected group of disgruntled employees may have the loudest voices and skew results.
• To measure increased employee commitment to a process, employees can be interviewed to uncover reasons why a desired process is not being followed.  It can then be determined whether implementing a new program is likely to increase adherence.  Policy-breakers can be engaged in evaluating the new program, sending the message that this issue is important to management and hopefully increasing adherence once the new program is in place.  Post-measurements of adherence can determine success.
• To measure optimization of resources (labor, space, etc.),  measurements should be gathered before and after changes are made.  Taking labor as example, certain departments may be over-worked and putting in long hours,  resulting in hard ROI losses if on an hourly wage, and certainly in soft ROI losses with decreased employee satisfaction.  Reconfiguring department and/or job assignments could improve this, thus potentially improving both employee and customer satisfaction.  Taking space as example, in There’s more to ROI than meets the “I” it states, “Installation of a new transportation management system might lead to improved freight billing, better route management and denser loads – all very real improvements, albeit tough to quantify.”  In this example, if shipping containers were packed differently to improve efficiencies, it could lower shipping costs (hard), and customer satisfaction improvements could be made due to receiving shipments faster or at a reduced rate (soft).
• To measure improved billing, employees and customers could be interviewed to determine billing problem areas.  A new billing system could improve accuracy resulting in faster payment, and reduce stress (soft) and man-hours spent (hard) by sales teams who have to correct statements with the billing department.
• To measure effects of decreased carbon footprint, it can be determined, for example, that a grocery store that replaces its lighting equipment with a less carbon-emitting option can result not only in cost savings (hard), but also in happier customers who prefer less harsh lighting and patronizing eco-friendly retailers (soft).
• To measure increased collaboration, a company has to know what type of collaboration they are looking to improve.  It can be increasing customer engagement via their own online community, or employee collaboration using a CRM (Customer Relationship Management) solution or even a Wiki.  As example, in Quantifying Your CRM Investment, it states, “Measuring a CRM solution’s ROI can be a daunting process…a piecemeal approach involving smaller projects, however, can allow companies to easily measure factors such as increased call-center efficiencies and improved sales response times.”
• To measure improved competitive position, it has to be evaluated whether a new program can create efficiencies that allow a company to better compete. In The Business Case: The Hard Realities of Soft Benefits, it states, “Wal-Mart’s decision to employ [a cleverly automated logistics system] was not justified with hard benefits…[but] led to an eventual takeover of retail leadership from K-Mart, [which] is a prime example of a ‘competitive-edge-based’ soft benefits business case reaping hard benefit rewards.”
• To evaluate improvements in confusion against competitive products/services, a research survey may be conducted before an ad campaign to determine the competitive landscape, the brands in that category that stand out and why, competitive brand perceptions (strengths/weaknesses), and differentiating strengths of the company’s brand.  Post-campaign, a survey can again be conducted within the same target market(s) to see if these measurements have improved.
• To evaluate increased customer satisfaction/loyalty, a research survey may be conducted to determine customer satisfaction measures, how well the brand’s products and competitive products fit into their lives, whether they would recommend the brand/product to others, and likelihood to switch to a competitor’s brand/product.  These  measures can then be monitored over time, in conjunction with the measures in the above bullet, as part of a brand tracking study to determine key drivers of loyalty, likelihood to use/purchase/recommend, monitor awareness/image/value-add trends over time, and provide a perceptual map of the company’s brand vs. competitors.
• To measure exposure of your company to new, potential clients, it really depends on the marketing activity, but some soft ROI measures are:  number of business cards obtained, number of calls/meeting made (tied to a particular activity), number of people who view a presentation, source given for a sale, number of people who register for an e-newsletter, unique visitors to a website, number of responses to a blog posting, number of pingbacks (links) to your blog posting and the traffic they create, number of requests for more information and proposals, amount of daily traffic past a billboard where your ad is located, number of listeners to a radio program where your ad is run, number of incoming calls to a unique phone number, number of people who submit a promotional tracking code with their order, number of people who download a whitepaper, and so on.

In summary, I quote again from The Business Case: The Hard Realities of Soft Benefits, which says, “You need to believe in the power and relevance of soft ROI benefits. Many of the world’s greatest business success stories are built on the back of courageous business-case creators who convinced…executives that ‘hard to measure’…investments don’t automatically mean ‘bad’ investments.”

Happy ROI hunting!

In reviewing what others have to say about soft vs. hard ROI, soft ROI is described as those activities that lend a human face to a company, earn trust for a brand, increase positive image, increase collaboration, help to recruit and retain high quality personnel, shorten costly cycles, and so on.  Generally, it is those benefits that are difficult to measure but help to achieve worthwhile objectives.

Some activities of soft ROI, being more qualitative, may be:

• Engaging people as part of something larger then themselves.
• Making people proud of who they are and their values.
• Providing an experience, rather than just a product/service, that can be passed down to their children.
• Giving people a voice in how resources are used or treated.
• Soliciting the best of the character in a person.
• Allowing people to participate in a process that improves a situation.

So how can we put increasing soft ROI into business practices?  I’d like to using as example a product that could benefit from a focus on the softer side of ROI: eggs.

• I would rather buy eggs, even if it costs me more, that are Certified Humane Raised and Handled®.
• I would like to participate in a community that believes in and promotes the purchase of Certified Humane Raised and Handled® products.
• I would like to visit farms that participate in this program and share that experience with young people.
• I would like farms that participate in this program to install video cameras in their facility to view their treatment of animals online.
• I would also like those farms to enlist their community of purchasers in discussions about how to improve their treatment of farm animals  (e.g. hens beyond their prime egg-laying years could be adopted).

In the effort of creating hard ROI we have to be mindful to create soft ROI results as well, which is also good for business and creates long-lasting results.

I read an interview today with Merry Elrick, author of the book “What’s the Truth about B2B Marketing ROI?” who says the following:

“Marketing ROI is NOT an increase in market share, click-throughs to your web site or even revenue generated from your marketing communications. Marketers must understand the literal definition as the rest of the world does, including everyone in the C-suite. ROI is the profits generated over and above the initial investment and expressed as a percent of the investment. There’s a formula, but you really need to understand the nuances of how ROI is calculated in your company because there are multiple ways to interpret concepts like gross margin, net present value or discount rate, just for starters. You need to know your own company’s standards.”

GROSS PROFIT MARGIN

From About: The Gross Profit Margin is a measurement of a company’s manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient.

From InvestorWords: Gross Profit Margins reveal how much a company earns taking into consideration the costs that it incurs for producing its products and/or services.

It can be expressed in absolute terms:

Gross Profit = Revenue − Cost of Sales

$89,250.00 = $109,250.00 – $20,000

Gross margin is expressed in the form of a percentage:

Gross Margin % = Gross Profit / Revenue

81.69% = $89,250.00 / $109,250.00

Note: Gross Margins of 82% rarely exist.  The example does not take into consideration costs that are continually increasing to pay for overhead and marketing, thus lowering Gross Profit Margin.

As example, a company makes 100 widgets in their first year and sells them for $1,000 each.  With tax of 9.25% the Revenue or Net Sales is $109,250.00, which is the amount generated after the deduction of returns, allowances for damaged or missing goods, any discounts allowed, freight, and any other expenses (in this case, $0).

The Cost of Sales or Cost of Goods Sold (COGS) is $200 each or $20,000.  COGS is the beginning inventory, in this case $0, plus the Cost of Goods Purchased during some period, $20,000, minus the ending inventory, $0, in this case. Gross Profit or Gross Income then is $89,250.00.

RETURN ON INVESTMENT

Now that we have the Gross Margin, we can generate the ROI in the first year (it typically is done on an annual basis).

ROI = ((Revenue – Expenses*) / Investment)

*namely, business, depreciation, interest, and taxes

To get the figure in percentage format, multiply ROI by 100%.

To further the example, when the company went into the widget-making business, they spent $5,000 as their initial investment in setup costs, plus $200 for every widget produced ($20,000), plus $9,250 in taxes.  On a sale of 1,000 widgets their ROI is 300%

300% = ($109,250.00 – $34,250) / $25,000

It would be wise to calculate how many widgets they had to sell at pre-tax $1,000 to break even.  According to my calculations, when they sold widget #22 they broke even on their current plus future investments.

Furthermore, the investment of $25,000 is likely a loan.  If the company borrowed this amount on a 3 year plan at a rate of 20%, by my calculations it would cost them $33,447.24 if compounded annually.  Monthly payments, therefore, would be $929.09. As we are just talking about the first year of operations, the first year amount due would be $11,149.08 with the remaining $32,050.92 due in years 2 and 3.  Total first year expenses also increase by $2,815.75, which is one third the total interest: $33,447.24 – $25,000 = $8,447.24

Realized Gross Profit (first year): $78,100.92 = $89,250.00 – $11,149.08

Realized Gross Margin (first year): 71.48% = $78,100.92 / $109,250.00

Realized ROI (first year):  289% = ($109,250.00 – $37,065.75) / $25,000

From these results, we can conclude that it would not be a bad investment.  However, as more and more details of the reality of costs are added into the equation, profit, margin and ROI will all decrease.

NET PRESENT VALUE

The good business person will then decide if making widgets has the best ROI for the outlay of $25,000 or if some other opportunity – including an investment in financial markets – may yield a higher return.  To evaluate this, calculate the Net Present Value, which takes a look at the current value and timing of cash flows, comparing it to the discount rate – the rate of return that could be earned in the financial markets – currently 0.75% as of September 20, 2009.  Another name for discount rate is the IRR rate (Internal Rate of Return).

SUMMARY

When we talk about marketing ROI we’re often looking at things like the results of a campaign (purchases, new subscribers, click-throughs), but we have to keep in mind that those results roll up into the real ROI, which calculates return on an overall investment.  To do this, we have to calculate three things: Gross Profit, Gross Profit Margin, and ROI.

Gross Profit = Total Revenue minus Cost of Sales or Cost of Goods Sold, which is inventory plus the Cost of Goods Purchased during some period minus the ending inventory.

Gross Profit Margin % = Gross Profit divided by Revenue or Net Sales, which is the amount generated after the deduction of returns, allowances for damaged or missing goods, any discounts allowed, freight, and any other expenses.

ROI = Total Revenue minus Total Expenses, divided by the Total Investment.  The result can be calculated across different scenarios and it can then be decided where the investment can be best spent, taking into consideration the Net Present Value of the differing cash flows that are created.