Marketers misunderstand ROI

Warc, 11 July 2013

NEW YORK: Return on investment is not an accurate way to measure marketing effectiveness and marketers frequently misuse the term, a leading academic has claimed.

Writing in Forbes, Daniel Kehrer reported on the work of his colleague Dominique Hanssens, professor of marketing at UCLA Anderson School of Management.

Hanssens argues that marketing is an expense rather than an investment and that marketing costs appear on a company's profit and loss account rather than the balance sheet.

The consequence of this, according to Hanssens, is that marketers rarely mean ROI when they say ROI. In addition, ROI is a ratio when what is important is net cash flow.

Nor, as many marketers wrongly assume, is a higher ROI necessarily better, because the law of diminishing returns comes into play. "Should you stop spending when ROI drops, even if you continue to produce bigger profits?" asked Kehrer.

The answer for most is clearly no, and Kehrer pointed out that "the point at which you'd stop or make a change depends on the return of the last incremental amount spent, not the overall ROI".

This new figure is the return on marginal investment (ROMI), which Kehrer declared to be a much more useful return measure for gauging marketing effectiveness.

While ROI changed at different spending levels, the only thing one needed to know about ROMI, he said, was whether it was positive or negative.

Another problem with ROI as a measure of a specific activity was that it counted for little if wider marketing goals were not being met.

Kehrer argued that an ROI focus ignored a complex web of interactions that took place between the simple dollars-in/dollars-out calculation.

"Only by analysing as many of those intermediate processes as possible can we gain insights into what's working and what's not, and alter allocations to achieve better results," he concluded.

Data sourced from Forbes; additional content by Warc staff