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%.
Pretty elementary, right? Well, in my opinion, there are two glaring problems with the ROI metric. First, it measures financial performance without taking into account the level of risk, particularly when assessing marketing strategies. Second, except for simple strategies, ROI is likely to lead to poor decisions—for example, when the firm uses a multimedia plan, sells products to a common customer base, or sells products that share joint costs.
For many people, the idea of adjusting ROI for risk is quite novel and the idea of comparing risk-adjusted ROI across different strategies is equally so. But at a time when most businesses could use a boost, and some are in serious trouble, it's time for such "new school" strategies to become commonplace.
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.