The James Group

Branding Agency/ Full-service Advertising Agency

Marketing Best Practices
How to do ROI Marketing

Every business has a magic number which explains how much one should be willing to spend to acquire a new customer profitably. Do you know yours?

The formula looks scary, but we've made it simpler by offering a free downloadable Excel spreadsheet.

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How to do Return on Investment Marketing

Business people speak a universal language-money. Seasoned management understand business fundamentals such as the cost of goods sold and how to identify areas where costs can be streamlined to increase profit margins. However, great business people understand more than just cutting costs. They understand how to wield money to strengthen a business. Since marketing is essential to grow a business, the best management teams know how to make informed decisions about their marketing budgets, using four main principles of Return on Investment Marketing.

No matter what business we speak of, there are three main engines: 1) Operations, 2) Finance, and 3) Brand Marketing. Entrepreneurs who start businesses are very good at Operations. They have a unique perspective on how to provide a product or service to the marketplace.They work passionately to perfect how they deliver the product. Soon, they realize they need to understand the second engine of business: Finance. Which is why they turn to trusted professionals to help them manage the money.

Most businesses struggle along on two of three engines because they never learn how to cost effectively acquire new customers. They survive, but each year is a struggle.

Good businesses become great businesses, only when they kick in that third engine of business: Brand Marketing.

This is where the math of marketing comes in. To do ROI Marketing, each business must first know its lifetime value of a customer. This magic number explains how much one should be willing to spend to acquire a new customer.

The concept is simple. If the lifetime profit on a customer is $1,000, would it be worth spending $200 to acquire them? Of course! Conversely, if the lifetime profit on a customer was $1,000, would it be worth spending $1,500 to acquire them. Certainly not! You'd be taking money out of your pocket. The thing is, very few businesses actually know their magic number, the lifetime value of their customer-making it impossible to do return on investment marketing.

To calculate the lifetime value of a customer and discount it back into today's dollars, you need to use a simple Net Present Value formula (NPV). For many business owners, this is the moment they were warned about in high school: when algebra would save their life. "Before conducting this analysis," said Tony Lu, President of Roundhouse, an IT company, "we were focused on the wrong customers segments."

To improve your marketing, you need to gain several levels of understanding:
1) Why these types of campaigns are essential. 2) How each campaign type functions. 3) How to isolate the sales moment. 4) When to change your campaign.

The formula looks scary, but we've made it even simpler by a free downloadable spreadsheet available at customervalue, or by clicking on the download link at the top of this article. You can simply enter in designated boxes four variables and instantly understand the lifetime value of a customer. Each of these variables, you or your client already know, and being within 10% is good enough for directional purposes. The variables are: 1) average annual revenue per customer; 2) average gross profit margin before marketing expense (EBITDAM) 3) cost of capital; and 4) average number of years a customer is held.

The Key
The Key: the magic number is the profit a company puts in its pocket for the lifetime of each customer. After all the business costs, this is what a customer is worth. The NPV equation is calculated before marketing expenses to show what you can afford to spend to acquire a customer and still be profitable. The NPV number is discounted back to today's dollar using the cost of capital as the factor to reflect the time/value of money. This allows you to compare apples to apples when the marketing investment will occur. Your cost of capital is a measure of marketing risk and typically runs between 12-20%, depending on how established your business is. Every business has a magic number. Do you know yours?

Why is this so important? Most small and midsized struggle because they don't understand what a customer is worth and how to set their marketing budget accordingly.

Small and midsized businesses are notorious for leaving money on the table because they don't spend enough on marketing. In the last few months, I've advised several business-to-business and business-to-consumer companies who were shocked to realize how poorly they understood the link between their customer value and marketing budget.

Let me share a typical example. Say a company earns $100,000 in average annual revenue from a business-to-business client. They have an average gross margin before marketing expense of 40%. The cost of capital is 12% and their average customer relationship lasts 4 years. The Net Present Value of a customer then is $121,494, expressed in today's dollars-a very healthy lifetime value of a customer indeed.

Now this business had only allocated $200,000 per year to their marketing budget and they were unsure if they should spend $10,000 to have a booth and materials at a key industry tradeshow. Let's evaluate their question using what we know from their customer value. With a $120,000 customer value they could go to 12 tradeshows at $10,000 a piece ($120,000 cost) before they would have to win one customer-and still breakeven. The trade show then would be a very good bet. If they won one customer at that first tradeshow it would be a $110,000 net profit win over the lifetime of the customer.
The Point
The point: by understanding the value of a customer and the probability of winning customers at tradeshows, the client could easily see that for them, this tradeshow was a good investment. Without this understanding, they would have missed the show and limited the growth of the company. Thank goodness for the math of marketing.

Companies often ask, "What should our marketing budget be?" This too is an easy process if you follow the four key steps of ROI marketing: 1. Understanding the lifetime value of your customer. 2. Estimating your target acquisition cost per customer. 3. Determining the marketing budget necessary to achieve your goals. 4. Predicting which tactics will best realize these goals. All of this is math, and simple math at that, which is very helpful.

There are several methods for

determining target acquisition price, one of which is to look at your own historical data. For example a marketing budget of $200,000 divided by 11 customers won equals an $18,000 historical acquisition price. (Budget ÷ customers won = historic acquisition price). You can compare multiple years.

Here's a general example of how to create a marketing budget: if a company loses $3 million of revenue through customer attrition annually and wants to increase revenue $2 million for the year, they need to win $5 Million in total revenue. If the average customer revenue were $100,000, they would need to win 50 new customers to reach their business goal. If the target acquisition price were $18,000 then the marketing budget would be 50 new customers times $18,000 which equals $900,000.

Marketing budget = (target revenue ÷ average customer revenue) x target acquisition price.

While this budget may seem like a lot, consider the company with a customer value of $120,000 times 50 customers: this would generate $5.1 million in profit over the life of a customer.

Business people that understand the math of ROI marketing are superior at strengthening and growing businesses. ROI Marketing is particularly powerful for small and midsized businesses that can't afford to waste money. It is essential to not only manage your costs, but not leave easy money on the table. Shouldn't ROI Marketing be used to help your business make more money?