How to calculate ROI

Yesterday I was chatting with a young friend who was incredibly excited about a new marketing program she’d launched for her company.  She’d spent about $65,000 and brought in almost $130,000 in new revenue.

She proclaimed, “My campaign generated 100% ROI!”

Whoops.  I hated to rain on her parade, but she was making a major mistake – she was comparing her investment ($65,000) to her gross revenue ($130,000).  In her mind she had earned the company another $65,000, or 100% of her initial investment.  She thought she’d doubled their money.

In poker, her calculation would be accurate.  But in business, you have to consider what it costs to produce whatever it is that you’re selling and subtract that cost from your gross revenue.

In other words, you have to calculate your return based on your PROFIT, not on your GROSS REVENUE.

ROI calculations for marketing campaigns can be complex — you can have many variables on both the profit side and the investment (cost) side.  But understanding the formula is essential if you need to produce the best possible results with your marketing investments.

In simple terms, the formula for ROI is

(Profit – Investment)
Investment

Here’s how this common mistake can get you into trouble.  Let’s say that her company’s average profit margin for this type of product/service is 50%.   That means that only 50% of that $130,000 in revenue was profit; the other 50% was spent to build the products she was selling.

In this scenario, her true ROI is actually 0:

($65,000 - $65,000)
65,000

Unfortunately, she would have been better off putting her $65,000 in an interest-bearing checking account than spending it on this campaign.

Marketing campaigns are investments. And like any smart investment, they need to be measured, monitored and compared to other investments to ensure you’re spending your money wisely.

With solid ROI calculations, you can focus on campaigns that deliver the greatest return to your company regardless of which product or service you’re selling.  After all, you probably earn more profit in some areas than in others.

Using ROI also 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 accurate ROI measurements, you can help your company move away from the idea that marketing is a fluffy expense that can be cut when times get tough.

If you’re not sure how to calculate your profit, here are two more formulas:

• Profit = Gross Revenue - Cost of Goods Sold [here's an article that shows you how to calculate COGS]
• Profit = Gross Revenue * Profit Margin (the % of your revenue that is actually profit)

Check out our Growth Panel marketing platform if you’d like to access a set of ROI calculators and tools to use on the job.

Tagged as: cogs, marketing, metrics, return on investment, roi