Review Dr. Thomas Burnham’sPresentation

Ted Mitchell

More on Marketing ROI

MKT 316 ClassMarch 23, 2015

Accounting, Finance, Marketing• How does accounting report profitability of an investment that generates

revenues over time?• Allocate the cost of the investment from time zero and try to match sunk costs

with revenues over time (depreciation)• How does finance treat an investment in capital (a revenue producing asset)?

Profit = (Present Value of cash flows) – Cost of Investment• Hold the cost of the investment at time zero then fold back the future cash

revenues and expenses with time value of money to determine the net present value of the the investment (net profit in today’s dollars

• How does Marketing treat an investment in operating capital?• Marketing profit Z, = ROMI x Investment, I• Invest in a marketing strategy, 4 P’s, and you make a commitment to this strategy

in time zero. All the future marketing expenses which you committed to regardless of when they occur are held to be sunk at time zero. All the future revenues which are generated by these expenses are minus the cost of those expenses are the profits from the investment. All can be pulled back as present values

ROI: Return on Investment

• ROI = (Return – Investment) / (Investment)

Spend $1,000.

Get $1,500 back.ROI?

50%

Spend $1,000,000.Get $1,500,000

back.ROI?

50%

Profit has a quadratic relationship to Investments

Gross Profits $1,00

0’s

Investment $ (or Effort)

1

$500

2

3

4

5

6

7

$1,000

$1,500

$2,000

$2,500

$0 $3,000

ROI: ($1,500 - $100) / $100 = 1,400% ROI: ($5,500 - $700) / $700

= 686% ROI: ($6,800 - $1,300) / $1,300 = 423%

ROI: ($4,000 - $2,700) / $2,700 = 48%

Average ROI is always declining

ROMI is a ratio of

• ROMI = Marketing Profit, Z/Investment, I• Profit is a function of Investment• ROMI = ƒ(I)/I• Where profit, ƒ(I) = aI – bI2

• Profit is a function of Investment size• ROMI = (aI – bI2)/I• ROMI is a function of Investment size• ROMI = a –bI

ROMI = (aI – bI2)/I ROMI= a –bI

Investment $

ROMI

Optimal size, I

ROMI = a–bI

20%

How ROI is Really Used

• Hurdle Rates• Allocation of Budget

• $50K to spend• Justifying Debt for Investment

• Borrow up to $50K at 8% interest

Investment

ROI Profit

#1 $10,000 75% $7,500

#2 $10,000 50% $5,000

#3 $2,000 40% $800

#4 $8,000 30% $2,400

#5 $20,000 25% $5,000

#6 $10,000 20% $2,000

#7 $30,000 10% $3,000

#8 $10,000 5% $500

The mistakes of a hurdle rate

Investment $

ROMI

Optimal size, I

Spend down to the hurdle rate

Low Hurdle rate

The mistakes of a hurdle rate

Investment $

ROMI

Optimal size, I

Lower the level of investment to

achieve the desired ROI

High hurdle rate

How much should we focus on ROI?

• NOT MUCH• We aren’t trying to maximize it, but rather to maximize profits

But…• We do want to measure returns or results of investments• And we want to estimate expected profits

• We want to make sure that ROI will be above zero• That the investment will create positive returns

• We can use ROI to compare investments• As capital is usually limited

• Thinking about ROI prods us to understand numerically how investments generate returns

Buyer Readiness InvestmentsAKLPCP

+ 64 + 32 + 16 + 8 + 4 + 2

Indirect Response: Pre-Purchase Goals

+ 64+ 2

• Spend on Newspaper or Radio?

• Spend $500 or $5,000?

BizCafe: Investments in Advertising

• Do ad effects (on Awareness) decline with increased spending?• Does anything other

than Advertising affect Awareness?

$0

Response

Investment $

0 Radio

5 Radio

10 Radio

Period 2 (baseline) 26.0% 26.0% 26.0%

Period 3 31.1% 36.5% 41.9%

Change 5.1% 10.5% 15.9%

Less baseline 5.4% 10.8%

Customer Responses to Investments (Cost of the Marketing Effort)

The Response Curve Shape Matters

$0

Response

Investment $

Customer Responses to Investments (Cost of the Marketing Effort)

The Response Curve Shape Matters

$0

Response

Investment $

Direct Relationship

Customer Responses to Investments (Cost of the Marketing Effort)

The Response Curve Shape Matters

$0

Response

Investment $

Direct Relationship

Linear Relationship

Customer Responses to Investments (Cost of the Marketing Effort)

The Response Curve Shape Matters

$0

Response

Investment $

Direct Relationship

Linear Relationship

Exponential relationship

Customer Responses to Investments (Cost of the Marketing Effort)

The Response Curve Shape Matters

$0

Response

Investment $

• Questions?