The Pursuit of ROI: Will It Lead You to Rags or to Riches?
It's no secret that the business world is slow to change.
Sure, it has made the evolution from typewriters to computers for word processing, and from snail mail to email for written communication. But in regard to the core of doing business—from the methods and measurements that are used to the way departments are siloed—many 21st-century companies might as well be stuck in the Stone Age. And now that the recession has set in, this unwillingness to replace old business models, strategies, and metrics with new ones is causing some companies hardship and leading many others to their deaths.
Given the gloomy circumstances many businesses find themselves in today, I ask CEOs and marketing executives to reconsider one popular metric: Return on Investment (ROI) as a resource-allocation tool and measure of performance (including marketing productivity).
It is time for CEOs, managers, and decision makers at different levels to take a closer look at this old-school way of doing business and to reassess whether the ROI approach is leading them to rags or to riches.
The idea behind ROI is commonplace in business regardless of whether you're a CEO or a finance, marketing, or sales executive. As you doubtless already know, the traditional formula goes like this:
ROI = Profit/Investment
So, if your profit equals $1 million and your investment equals $20 million, then your ROI is 5%.
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Sharan Jagpal is the author of Fusion for Profit: How Marketing and Finance Can Work Together to Create Value (Oxford University Press, 2008). He is the president of Strategic Management & Marketing Consultants and a professor of marketing at Rutgers Business School.
Comments
Sharan,
You bring up a good observation in terms of the risk and how it relates to ROI in marketing decisions. First, your article raises the question as to whether ROI is a good metric for marketing and seems to raise doubts as to its value, when in fact I interpret your conclusions as ROI being a good metric that you want to enhance with more precision around risk adjustment (correct me if I did not interpret this correctly).
Risk-adjusted ROI makes perfect sense mathematically. But practically, marketers are working toward getting reasonable estimates of the expected incremental sales and profits and are a long way off from the ability to provide a quantifiable risk assessment. There are ways to manage risk, either by looking across the entire portfolio of marketing investments (as I wrote about in my book Marketing ROI back in 2003) or through testing and measurements on a smaller scale prior to making large investments.
Companies that are measuring and managing marketingt ROI are generally not just choosing the highest ROI but are create processes for decision making that leads to constant improvement. This is always about profitability improvements and never about the highest ROI (in fact you need to use techniques such as Incremental ROI to optimize profits and not total ROI).
I do agree that where good data is available to provide risk coefficients, marketers should run risk-adjusted ROI. This may be practical on large scale initiative such as entering new markets or launching new products but most marketers are dealing with everyday campaign decisions where ROI is very effective at improving performance and profitability.
Hope that perspective helps.
Jim Lenskold
Lenskold Group (www.lenskold.com)