What is ROI and How to Calculate It
What’s the one term that globally resonates with all people, platforms, and businesses, both professionally and personally?
An expression that gives you insights to separate the wheat from the chaff, the good from the bad, and right from wrong.
A phrase that dominates your subconscious to such an extent that it leads you to make the simplest of decisions every day without even realizing it.
Should I take that road to work during rush hour?
Should I spend that much to watch the new movie that just came out?
Should I invest $20,000 in a pre-owned car when I could buy a new one for $25,000?
You probably even used that ideology before you started reading this blog. Would I get the desired ‘return’ out of this blog if I ‘invested’ the next 11 minutes reading it?
The answer to that question is ‘yes’ by the way, but you can see where we’re going with this.
What is ROI
Return on investment (ROI) is a metric that businesses around the globe use to calculate the return generated from an investment. It helps them analyze the efficiency of an investment and understand whether the decision behind investing the money was the right one strategically.
While there can be many variations when it comes to calculating ROI, most simply, the return on investment can be calculated by taking the difference between the current value of the investment and the cost of the investment, and dividing that value by the cost of the investment.
It isn’t necessary, however, that ROI will (and can) always be represented by a numerical value. Take the rush hour example mentioned above. The ‘investment’ and ‘return’ in that scenario cannot be represented with ‘money’; they have to be represented and measured with ‘time.’
On the other hand, while the investment is money and time when it comes to watching a new movie, the return is neither of those facets. It’s the value that you would get after watching the movie, which cannot be represented in the form of a number.
In general, though, agencies tend to associate ROI with a numerical value since it’s the most straightforward way of deciphering the efficiency and productivity of making a decision.
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What is a Good ROI
The definition of a good ROI for a marketing and advertising agency is to invest in something that results in them making a profit either instantly or at some point in the foreseeable future.
While the rule of thumb states ‘higher the number, the better the ROI,’ there is no correct answer for what number is good and what is bad. Some agencies might be very happy with a 10% ROI, while others might not even be satisfied with a higher number like 30%. It is true, however, that agencies tend to chase high ROI percentages when delivering results.
The idea that defines a good ROI for an agency depends on a few factors. Companies are prone to making errors while deciphering how to calculate ROI because they might miss looking at these external factors that include taxes, inflation, time, and opportunity costs.
Keeping track of these factors becomes important while forecasting ROI, and it is the combination of that, along with valuable white-label solutions, that led a marketing agency to pull off an ROI of 4,381% for one of their clients - Cafe Mexicana.
The Importance of Knowing ROI
Wouldn’t it be great if there was a way you could distinguish between the strategies that lead your agency to glory and those that drain it out of money?
Well, there’s good news and there’s bad news.
The good news is that knowing the ROI for a given project gives agencies an accurate idea about the strategies that are successful and those that are not.
The bad news is that there is no way for you to know that at the onset of starting a business.
There has to be a phase of trial and error where you try different strategies and measure them for their pros and cons to know which ones truly work the best. Doing so would not only help your agency thrive in the long run by investing in the right projects, but would also help it save money by eliminating the wrong ones.
Let’s look at an example.
Imagine that you’ve been given $1,000 as marketing budget and your goal is to increase the number of incoming leads for your business through various marketing channels. You know that the logic is simple — more marketing, more leads, the more chances of bringing partners on board.
But, what you’re not certain about are the channels of promotion that would be most efficient when it comes to spending less and generating more leads. Are Facebook ads the way to go? Or is email marketing the more preferred method? What do you do?
This is where it gets a little tricky. The importance of knowing the ROI is only beneficial if there is an initial gamble involved. In this scenario, the gamble would be to invest some part of the $1,000 in both Facebook and email marketing to see which channel delivers more leads.
Taking inspiration from the Dennis Yu book of tactics, let’s say you decide to use a play called ‘Dollar a Day.’ You invest the same basic minimal amount allowed in both channels and initiate your marketing efforts. You wait for some time and measure the returns from both investments.
Depending on which strategy gave you a better ROI by generating more leads, you now know where you must invest the remaining share of your marketing budget to get the most returns.
However, marketing strategies are dependent on a lot of different factors. The results that you get once are just the best representation of the most probable outcome. There might be other instances where different channels might deliver different results. Hence, it is always advisable that the results are averaged out over time to determine which strategy works best.
Difficulty in Calculating ROI
When it comes to increasing the ROI there can be multiple ways,—the 5R philosophy being one of them— however many agencies find it increasingly difficult to measure and calculate ROI.
In addition to tracking complicated financial terms like customer lifetime value (LTV), customer acquisition cost (CAC), monthly recurring revenue (MRR), and average revenue per account (ARPA), agencies also have to struggle with tracking equations and complex calculations.
Furthermore, the ROI calculation process can be quite taxing since it involves multiple variables and the consolidation of data, which can take a toll.
Finally, there’s the pain of knowing the different ways that ROI can be calculated. From the basic formula that incorporates just the total investment cost and the current investment value, to the more complex method that involves knowing the customer LTV, CAC, and total revenue.
If only there were a specially-designed customizable ROI calculator tool that could reduce hours of stressful calculations to just minutes of spreadsheet fun.
How to Calculate ROI
As mentioned before, the difficulty when it comes to calculating ROI lies in the consolidation of data and the tracking of complicated financial terms. Using Vendasta’s ROI calculator, agencies can mitigate those pain points and calculate the ROI efficiently and productively.
Here are some of the different approaches that are used to calculate the return on investment.
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Basic ROI Calculation
As the name suggests, the basic approach involves determining the ROI by taking into consideration the basic cost of investment and the value that the investment generates.
For example, let’s say that you spent $250 to purchase shares in a company. A year later, you sold those shares for $300. In this case, your basic return on investment calculation would be:
Cost of investment = $250
Current value of Investment = $300
ROI = ($300 - $250) / $250 x 100% = 20%
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Capital Gains ROI Calculation
Capital gains ROI calculation works on similar lines as the basic approach one. The only difference is that in the capital gains approach, investors must incorporate all the extra benefits that they might have received during the investment window.
For example, let’s say that during the one-year period when you had possession of the purchased shares, the company paid dividends of $12, $34, $15, and $17 in the four quarters respectively.
Therefore, in this case, the calculation for ROI would be:
Cost of investment = $250
Current value of Investment = $300
Extra benefits (total dividends) = $12 + $34 + $15 + $17 = $78
ROI = ($300 + $78 - $250) / $250 x 100% = 51.2%
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Marketing ROI Calculation
The tricky part when it comes to calculating marketing ROI is delineating and calculating the various costs associated with all of your marketing efforts.
If you’re one of those wizards who can remember all the different categories and the related costs of the gazillion marketing projects that your agency undertakes, then you’re one of the very few superhumans present on earth who need no help.
However, if you do not belong in that segment and feel that a template that takes care of hours of consolidation and calculation would provide you with value, then this is the tool you need.
Marketing ROI correlates directly with the number of customers that a campaign brings in. For example, let’s assume that your agency executed five different strategies — social media marketing, email marketing, outbound marketing, SEO marketing, and inbound marketing — and collectively those strategies led to the acquisition of 200 customers.
Furthermore, let’s assume the breakdown of your marketing spends is as follows:
Social Media = $5,000
Email = $6,000
Outbound = $10,000
SEO = $2,000
Inbound = $8,000
Therefore, the total marketing cost is = 5,000 + 6,000 + 10,000 + 2,000 + 8,000 = $31,000
Now, after calculating your customer LTV you find that value to be $800 and, based on the number of customers you acquired with your marketing campaigns, the total revenue becomes:
Total revenue = 200 x $800 = $160,000
Therefore, your marketing ROI in this case would be:
ROI = ($160,000 - $31,000) / $31,000 x 100% = 416%
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Customer LTV ROI Calculation
When it comes to calculating ROI based on the value an individual customer brings to the company, a lot of related factors need to be calculated and taken into consideration as well.
For example, in addition to taking the marketing figures mentioned in the previous example, let’s assume that the total sales cost (including salaries and commissions) for your agency is $66,000
Therefore, with the total number of customers acquired being 200, the total customer acquisition cost becomes:
CAC = Total marketing cost + total sales cost / total customers acquired
CAC = $31,000 + $66,000 / 200 = $485
While the rule of thumb suggests that the optimum customer LTV: CAC ratio must be 3:1, when it comes to calculating ROI, there is no right or wrong answer. The desired value for ROI varies from agency to agency and the goals and targets that they set out to achieve in the beginning.
In this case, the ROI calculation would be:
CAC = $485
Customer LTV = $800
ROI = ($800 - $485) / $485 x 100% = 64.94%
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Lead Conversion ROI Calculation
One of the most crucial metrics for measuring ROI is the number of leads an agency’s marketing campaign brings in. As logic states, more leads means a better ROI.
However, in such scenarios, it becomes imperative that agencies also calculate the ROI from an investment perspective. Bringing in more leads by spending more is good, but for agencies to sustain themselves, they must learn to master the tactics of spending less and generating more.
One way for them to do so is by looking at the total marketing investment and comparing it with the total revenue generated, which can be calculated by knowing the customer LTV.
Looking at our earlier example where we had to choose between email marketing and Facebook ads, let’s assume that both strategies collectively led a total of 6,000 visitors to our business platforms in a specified period.
Based on analyzing the historical data, we’ve also figured out that, on average, approximately 30% of the total visitors on our platform get converted into qualifiable leads. Further, we’ve also deciphered that approximately 11% of those converted leads are closed and brought on board.
As before, using the customer LTV calculator, we were able to find out that the value each customer brings to our business in their lifetime is $800. And finally, keeping track of our campaign spends on email and Facebook, we calculated that the total marketing spends for our business in the specified period is $104,000.
Taking these figures, the calculation for ROI would be:
Total visitors = 6,000
Total clients brought on board = 198
Customer LTV = $800
Total revenue = $158,400
Total marketing investment = $104,000
ROI = ($158,400 - $104,000) / $104,000 x 100% = 52.31%
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Gross Profit ROI Calculation
While most software as a service (SaaS) companies calculate their ROI using one of the methods mentioned above, there might be a few who resort to using the gross profit method.
This method involves the analysis of the cost of goods sold (COGS) metric, along with other variable costs that agencies incur. Based on the number of products/units that they sell, agencies can calculate the ROI generated from a project and manage their costs accordingly.
For example, let’s assume that the COGS per unit for a company is approximately $100, the selling price per unit is $200, the number of units sold in a specified period is 500, and the total variable costs amount to $8,000.
Using these values, the calculation for the ROI using the gross profit method would be:
Total COGS = $100 x 500 = $50,000
Total revenue = $200 x 500 = $100,000
Gross profit = ($100,000) - ($50,000 + $8,000) = $42,000
ROI = ($42,000) / ($50,000 + $8,000) x 100% = 72.41%
How to Increase ROI
Once you’ve calculated the ROI and have analyzed the strategies that work well, the next step that agencies must incorporate is to ‘invest’ time and money in ways to increase their ROI.
Along with utilizing valuable white-label solutions that reduce costs, agencies must also incorporate other ways to increase ROI. When looking for quick wins, they must analyze and introspect the returns generated from existing investment strategies and plan the way forward.
Maybe Facebook ads are better since they are relatively more accurate when it comes to targeting the right kind of demographic.
Or, maybe email marketing is the way to move forward because it delivers a better ROI when compared to the amount of money invested.
To do so, agencies must implement the 5R philosophy that focuses on targeting the right people by executing the right tactics and strategies by having the right tools and the right teams in place.
Looking at the 5Rs individually and collectively, agencies must come up with the best mix that leads them to increase their revenues, reduce their costs, and ultimately increase their ROI.
How Can Vendasta Help You
Vendasta’s white-label solutions, along with its marketplace products, can help your agency increase its ROI by either reducing costs or by reducing customer churn that increases revenue.
Products like reputation management, listing builder, advertising intelligence, and social marketing can not only help your business sustain itself, but also edge out the competition.
The ROI calculator can help agencies save time when it comes to tackling those complex ROI calculations and also provide valuable insight into strategies that can reduce business spends.
For example, looking at the marketing ROI calculator, you realized that you could be spending more on social media marketing as it would lead to the acquisition of more customers, thereby leading to a better ROI.
Or maybe you realize that you’ve already maxed out your advertising costs and must now look for an alternative source that provides you with value-for-money solutions.
When it comes to reducing customer churn, there’s always the challenge of managing the reputation of your business, not just on time, but also in an efficient manner. Maybe your business needs a solution that effectively tackles reviews and improves your reputation.
In conclusion, looking at the different ways through which ROI can be calculated and measured, every Vendasta product has the potential to boost your business and increase its brand equity.