Marketing Return on Investment (ROI)
Marketing ROI is quite easy to define but more difficult to apply. Despite the difficulties, it is vital that the marketing profession improve their ability to use marketing ROI as one metric - otherwise suboptimal marketing budgets will be imposed by CEO's & CFO's, especially when economic conditions are tough and marketing activity tends to be seen as a cost that can be cut rather than an investment that is profitable.
According to the excellent textbook "Marketing Metrics: 50+ Metrics Every Executive Should Master" by Paul W. Farris, Neil T. Bendle, Phillip E. Pfeifer, and David J. Reibstein (Wharton School Publishing) defines ROI as net profits over the investment needed to generate the profits. They describe marketing ROI as a metric that describes how well assets are being used. They also point out that the metric is less meaningful in the short-term because marketing investments usually have a long-term impact - but marketing funds tend to be fully expensed in the current period.
Profits earned in the current period are a function of past marketing activity (especially brand equity building) as well as current marketing activity. So to use marketing ROI meaningfully we should estimate the incremental profits due to the current activity. Some of the incremental profits will inevitably be earned in future years so marketing ROI should include future profits suitably discounted for the time value of money and the risk associated with the activity.
Clearly, ROI on the total marketing budget is a dubious concept and of not much practical value as budget decisions are usually based on increments (or decrements). In this case, we can use return on incremental marketing investment (ROIMI) which is the incremental net contribution due to the incremental marketing spending divided by the amount of incremental spending.
The ROIMI metric is clearly of potential value to CEO's and CFO's because a company can make many types of investment, for example investing in a more efficient plant to reduce costs. If a comparison can be made between the profit which can be earned from different types of investment, including marketing increments, then management can make more optimal investment decisions.
Note that maximising marketing ROI is not the same as maximising profit. This is pointed out by Tim Ambler in another excellent textbook "Marketing and the Bottom Line" (Prentice Hall). Marketing activity should aim to maximise profit but the investment which maximises profit may well be higher than the investment which maximises ROI. He says that ROI is a useful way to choose the preferred options for the marketing mix when the total budget is fixed.