What is My Advertising Return on Investment?
“You need to spend a dollar to make a dollar.” We’ve all heard the saying and, most importantly, we don’t mind spending a dollar if we know we definitely will make two dollars. Businesses recognise they need to invest money in marketing and advertising and that, if done wisely, they will be better off.
However, the question is, “What am I willing to risk and what is my potential return on investment?”
‘Risk’ is simple to understand - it’s your investment (the dollars you will spend on advertising) weighed up against the minimum sales you need to recover from that investment.
‘Return on investment’ is a bit more complex. When we think about return on investment, we tend to confine our thinking to immediate known sales, or ‘direct response’. With advertising, there is so much more value than just measurable direct sales.
Here are a few other benefits to advertising:
Branding: It’s the reason Nike can charge $300 for a pair of shoes. Branding is the foundation of your business and protects your price. It sustains you in the tough times as customers seek out trust and value.
Online recognition: When we search online, we are presented with an index of possible businesses to choose from, and people click on business names they recognise. Your print, radio and TV advertising improves your online results because you are a recognisable entity.
Web traffic: Today, many of your print, TV and radio adverts send the prospect to the website. The website is your engagement and conversion tool. If your website is not up to scratch, you’ll be missing this opportunity.
Database: Are you using your advertising or website to grow your email database? Being able to engage with interested parties on an ongoing basis is a very powerful way of generating direct sales and building your brand.
In advertising, we talk about direct response being the tip of the iceberg. It is what we can identify - what we can’t see is what’s under the surface.
So, let’s talk about direct response.
High product value
This is an easy one. Let’s say you’re selling a product for $5,000, $10,000 or $30,000. A customer buys the product once and you make a margin. It’s usually easy to say you need to sell one, two, or five of something per year (for example) to justify your spending. Equally, it is easy to quantify that you need to make two sales in the year to get your money back.
With this, your risk is quantified at two sales. If you make less, your return on investment is less and you have lost money.
Low product value
The value of one good client
Here it gets a little tricky. Consider a beauty or hair salon with a typical sale having a value of $120. One way of quantifying the risk is to say, “I am spending $600 on advertising so I need to make at least six sales to break even.”
I believe this is not the right way to quantify the risk or the return on investment.
Let’s say the cost of treating that client is $20 and hence the gross margin (after removing variable costs) is $100. Let’s also say this client comes back every four weeks or 13 times a year. Therefore, the value of this client over one year is $1300. This is the money you will make, over a year, after removing variable costs such as product, electricity and bonuses. Remember - your fixed costs don’t change whether you have a client or not. This will be things like labour, rent and insurance.
Such a scenario depends on you doing a good job and retaining the client due to your service, not your discounting.
One client generates a 200% ROI
If we look at return on investment through these glasses, you can see you in fact only need to bring in one new loyal client a month to be well ahead. You spent $600 and made a gross margin of $1300, that’s a return of more than 200%. Your risk is less than one new client a month. If we were to introduce the notion of this client referring a friend, then the return becomes even greater and you are on your way to a sustainable, highly profitable business.
So, the moral of the story is to understand the risk versus the return on investment equation for your business. Knowing this may allow you to grow your business even faster.