Marketing Revenue Attribution and the Common ROI Fallacy
How do you properly measure the ROI of marketing?
For marketers, the advent of digital marketing and analytics was like finally finding the Holy Grail of Marketing: revenue attribution. Immediately, savvy marketers were able to turn marketing from a cost center into a profit center.
How does this work? Briefly, a general overview of this is:
- Utilize a piece of digital content to drive traffic to your web site (examples include a Facebook ad or an email).
- Track the traffic from your marketing content and, using an analytics package, view how this traffic interacts with your web site.
- Measure how much of this traffic turns into a lead and then into business.
Through this general framework, it is possible for marketers to directly attribute revenue to their marketing efforts. And, to their credit, marketers very quickly embraced this use of data to measure the effectiveness of their marketing. Marketers began to generate reports on marketing effectiveness that directly tied marketing spend to revenue, and have been able to show ROI from money spent on marketing. This is fantastic!
But the way many marketers measure ROI is wrong.
Wrong in a way that often vastly overstates the effectiveness of marketing and marketing ROI. Let’s take a look at how:
It amazes me at how often I’ve been in financial analysis meetings and have seen some form of data based on this calculation presented by marketing teams to show the effectiveness of their digital campaigns. On it’s face, this equation makes some kind of sense. We spent $1000 on marketing, and made $3,000 in marginal revenue that we can directly attribute to that spend. Ok, great - so we made an additional $2,000, and our marketing had an ROI of 200%!
Those numbers sound fantastic! 200% ROI!!
This is lazy, and it is wrong. Even if you are marketing a software product, with essentially minimal to no marginal cost for each new purchase, there are still costs for each new customer. Assuming a gross margin of 100% neglects other ongoing costs for each customer. Even cloud-based SaaS companies do have marginal costs - including server costs, storage costs, and increased utilization of Customer Success / Customer Support teams, for example. Our previous equation does not at all take into account the costs for our product.
And what if your product is physical, with an (often much lower) gross margin common to physical products? Let’s take a look at two cases.
Case 1: assume you have end-to-end control of your processes from manufacturing to distribution, and have been able to minimize your production and logistics costs for a premium product in a market with low pricing pressure. Congratulations - your Gross Margin is 80%!
To calculate our marketing ROI, we first need to multiply our revenue by our gross margin.
Our ROI equation should be:
Using our revenue and spend numbers from before with our gross margin, we have $3,000 * 80% = $2,400, which, after subtracting our marketing spend ($1,000) yields a marketing-generated marginal revenue of $1,400, and ROI 140%. Still good! But realistic.
Case 2: You are operating in a price-sensitive market with many competitors. Let’s say you run an auto dealership. Due to the high costs for product (buying cars is expensive!) that dealerships pay, gross margin is frequently as low as 15%. Let’s see how well our marketing did in this case.
$3000 (revenue) * 15% = $450. $450 - $1,000 (marketing spend) = -$550!
Uh-oh. Looks like that $1,000 spent to get an extra $3,000 of revenue lost the company money overall. What looked great from a surface level is actually very ungood.
(One big caveat: We have not at all discussed life-time-value (LTV) of a customer here. In businesses where it can be expected that a customer will have a life-time-value of revenue greater than the initial revenue generated, LTV may be incorporated as a factor when calculating the ROI from marketing. However, things can then become much more complicated, and I’ve purposefully left LTV considerations out from this post.)
Why is marketing ROI being overstated?
My guess is that in most cases this stems not from a deliberate effort to deceive about the effectiveness of marketing, but from ignorance and maybe some overexuberance in wanting marketing to look great.
Many marketers may not have access to actual product costs. They may be marketing a mix of products that make performing a realistic ROI calculation complex. Or they may not even have the business-focused background that would cause them to even think about product costs. I’ve seen examples of all of this (including marketers deliberately overstating their effectiveness, unfortunately.)
So how should this be addressed? First, anyone looking at a report on marketing needs to question how the numbers were calculated. I’ve seen people who should know better accept completely unrealistic marketing ROI calculations.
But really, marketers, if reporting on financials, should have a better grasp of fundamental business accounting. If you’re going to play in this area, and claim to be a profit center, it is incumbent on you as a marketer to know the very basics of business financial calculations (and what we’ve discussed is the very basics.)
Digital marketing and analytics are fantastic, and provide a window into marketing effectiveness that, when used correctly, allow companies to increase revenue and operate more efficiently. There’s a lot of power to that.
But with great power comes great responsibility. I hope we all use that power wisely.