The Math of Marketing: Calculating ROI for Direct Marketing (Part 1 of 2)

Every small business needs to market itself. For some, this means nothing more than maintaining a strong presence in a particular business community (Linux software developers, wedding planners, etc.). For others, it involves a complicated mix of advertising, public relations, online presence, and personal attendance at industry functions. For this latter group, it's important to track the return on investment for marketing dollars, particularly in hard times.

Since the numbers may come from several different sources, it's a good idea to create a little spreadsheet to collect and analyze them. The process is a bit like creating a bid. You make some assumptions at the front end of your marketing campaign and then collect data when the campaign is over to evaluate its success.

For now I'll concentrate on one type of advertising that can actually be tracked: direct marketing. This includes fliers sent out in the mail or e-mail messages to potential customers who have “opted in” to various lists (i.e., they have actively agreed to receive marketing announcements via e-mail that would otherwise fall into the category of spam). I'll also narrow the discussion to products and services where the sell price is high enough so there will be human interaction as part of the sales process. But the principles here will work in any direct marketing situation.

These are the numbers (beyond total campaign cost) that are involved in evaluating a marketing campaign:

• Number of recipients: This is self-explanatory.
• Response rate: This is the percentage of recipients who respond. This may mean replying to an e-mail, visiting a designated link on your Web site, calling a toll-free number, or even showing up at your place of business with a coupon. It is very important to set up your campaign so that you can count the number of respondents. This means, for example, if you want them to visit your Web site, you need to create a “landing page” so that the respondents don't get mixed in with everyone else who visits your site.
• Percentage of qualified leads: Not everyone who responds to a solicitation is in a position to actually buy something from you. For example, companies that advertise software intended for large corporations can count on a certain number of responses from computer science students keeping up with the latest developments.
• Close ratio: This is the percentage of qualified leads that turn into a sale.
• Average sale: Again, this is self-explanatory.
• Gross revenue: This is the total sales you can trace back to your campaign. At the front end, it will be Gross Revenue = Qualified Leads x Close Ratio x Average Sale. In the evaluation phase, it will be a simple sum.
• Gross profit: Marketing companies that run large-scale campaigns encourage their clients to compare the gross revenue from a campaign to its cost. If the gross revenue number is higher than the cost of the campaign, they argue, the campaign was a success. This is not accurate. The number you should use is gross profit. If you spend $5,000 on advertising to get a $5,000 order, you're worse off than if you hadn't advertised at all.

In my next post I'll talk about what-if scenarios that will get you into the ballpark of realistic expectations and what to look for when you're analyzing the results.