By Guy R. Powell

Marketers often forget that spending plans must be developed to generate results for their organization. Effective marketing plans can no longer just list how the marketing budget will be spent. Instead, marketing plans must also clearly state how each line item will achieve specific quantifiable results and where these results, when rolled up across the entire company, will help achieve corporate objectives in the short term and long term.

ROMI, ROMI, read all about it!

Your marketing plan can achieve these results if you follow a return on marketing investment (ROMI) model. By using a ROMI model, marketers will:

• Know whether their plan can achieve stated objectives (is "good" good enough?).
• Be able to make informed decisions regarding the prioritization and mix of activities within the marketing plan.
• Be able to measure results and then learn from them.
• Communicate measurable objectives to executives.

ROMI is a simple yet valuable tool that helps marketers determine the incremental value of their marketing activities. Its purpose is to help marketers optimize their marketing plans for both the short term and the long term by building a model of their market based on valid metrics, measurements, and techniques.

Finding the value of your marketing activities

At the simplest level, ROMI is an index of the quality of a specific marketing activity. The value of marketing activities can be calculated as follows:

• ROMI (revenue-based) = incremental revenue ÷ marketing cost
• uROMI (unit volume-based) = incremental unit volume ÷ marketing cost
• mROMI (margin-based) = incremental contribution margin ÷ marketing cost
• dcfROMI (discounted cash flow ROMI) = incremental discounted cash flow ÷ marketing cost
• Marketing ROI = (incremental contribution margin – marketing cost) ÷ marketing cost expressed as a percentage

Depending on your company's goals, and keeping in mind the do's and don'ts listed here, you can choose which index calculation is right for you.

Some do's and don'ts of ROMI

• Focus on incremental revenue/margin/net present value (NPV)   ROMI calculations must include incremental revenue generated by incremental marketing investments.
• Keep it simple   Keep complexity in line with the scope of decision. For example, can revenue be used as a reasonable proxy for margin? Or is the calculation of discounted cash flows required?
• Capture all relevant costs   When calculating the contribution margin for alternative programs, be sure to include all relevant variable costs specific to the decision. Use them consistently throughout the decision-making process.
• Include residual values   If residual values can be reliably estimated, they should be factored into the ROMI calculation. For example, residual values can include leads that don't turn into immediate revenue but may deliver revenue at a later date through other marketing programs.

ROMI and nonrevenue objectives

Marketing is all about helping deliver revenue to the company today or setting up the company to deliver revenue in the future. Marketing campaigns that are intended to position the company to deliver revenue in the future can be planned based on interim results using similar ROMI methodologies. Instead of an index based on revenue or margin, these indexes might now be based on the cost per incremental percentage of brand awareness or brand consideration. With the ROMI methodology, marketing activities can be more accurately planned across the entire purchase funnel.

ROMI — a practical example

In this example, you'll look at the value of proposed marketing activities that are based on revenue (ROMI) and based on margin (mROMI) by using a simple direct mail campaign.

Fabrikam, Inc., a high-tech company providing hardware to small and medium-sized businesses, is developing a direct mail campaign. The company has estimated its costs for 100,000 direct mail pieces to be about $1.00 per piece (simple, four-color, unfolded). These costs include everything associated with the campaign: creative development, printing, mailing list rental, postage, and mail drop.

Calculating for revenue

Based on prior experience, Fabrikam expects a response rate of about 1.5% from this mailer, of which about 33% of respondents will actually make a purchase. Assuming the net revenue (after shipping and handling and any discounts) is $1,495 per purchase, the company expects its incremental revenue from this direct mail campaign to be $740,500, yielding a ROMI of 7.5. The calculations that were used to arrive at this ROMI are as follows:

1. Marketing program costs = 100,000 × $1.00 = $100,000
2. Number of expected responses = 1.5% × 100,000 = 1,500
3. Number of expected closed sales = 1,500 × 33% = 500
4. Expected revenue = 500 × $1,495 = $747,500
5. ROMI = $747,500 ÷ $100,000 = 7.5

This means that for every dollar invested in this direct mail campaign, Fabrikam expects to generate an incremental $7.50 in revenue.

Calculating for margin

Now calculate this on a margin basis (mROMI). Fabrikam has a product margin after discounts and other charges of 25%, yielding an mROMI of 1.9. The calculations that were used to arrive at this mROMI are as follows:

1. Incremental contribution margin = 25% × $747,500 = $186,875
2. mROMI = $186,875 ÷ $100,000 = 1.9

This means that for every dollar invested in this direct mail campaign, Fabrikam expects to generate an incremental $1.90 in contribution margin.

The road not taken

During the course of planning for this campaign, Fabrikam contemplated creating a more expensive direct mail piece — a six-color, die-cut, four-sided, and folded card — which would have increased the costs to $2.00 per piece. With this enhanced piece, Fabrikam estimated that the response rate would have increased to 1.7%, with no change in the purchase rate. This would change the results as follows:

1. Marketing program costs = 100,000 × $2.00 = $200,000
2. Number of expected responses = 1.7% × 100,000 = 1,700
3. Number of expected closed sales = 1,700 × 33% = 561
4. Expected revenue = 561 × $1,495 = $838,695
5. ROMI = $838,695 ÷ $200,000 = 4.2
6. Incremental contribution margin = 25% × $838,695 = $209,674
7. mROMI = $209,674 ÷ $200,000 = 1.05

Given these expectations, Fabrikam chose the first, less expensive design.

What's the definition of "good enough?"

You can see that the first scenario yields better results than the second scenario, but how do you know whether this result is good enough? Will this plan support the Fabrikam's stated marketing objectives?

The definition of "good enough" is critical in determining whether or not any particular marketing activity should be undertaken. A ROMI hurdle rate is a simple mechanism that can be used as a benchmark to help discover whether the marketing activity is good enough. The ROMI hurdle rate can be defined as the minimum, expected incremental revenue from marketing divided by the marketing program's budget.

Assume that Fabrikam's marketing department is responsible for generating $10 million in incremental revenue and that the marketing program's budget (that is, money that will be spent in the marketplace to generate demand and awareness) is $1.75 million. The ROMI hurdle rate for Fabrikam would be calculated as follows:

ROMI hurdle rate = $10,000,000 ÷ $1,750,000 = 5.7

That is, all marketing programs, on average, need to generate at least $5.70 for every dollar invested.

The mROMI hurdle rate would be as follows:

1. Expected contribution margin = $10,000,000 X 25% = $2,500,000
2. Margin ROMI hurdle rate = $2,500,000 ÷ $1,750,000 = 1.4

Based on this information, Fabrikam's marketing programs on average need to generate at least $1.40 in contribution margin for every dollar invested.

For this simple example, the direct mail campaign previously described exceeds the ROMI hurdle rate and the mROMI hurdle rate and is therefore good enough.

In practice, the ROMI hurdle rate can include a number of other important considerations:

• Program risk   For programs with a higher risk or uncertainty, a higher hurdle rate should be expected.
• Revenue source   Different hurdle rates may be appropriate for new customer acquisition versus up-selling or cross-selling. For many companies, it is easier (less expensive) to generate revenue from existing customers. In situations where revenue from new customers must be balanced with revenue from existing customers, a lower hurdle rate would be set for new customer acquisition and a higher rate would be set for up-selling or cross-selling. The average of the two must still deliver the required results to meet corporate financial objectives.

Going for the gold

ROMI is an effective methodology for planning, calculating, and communicating marketing performance and its impact on corporate results. It can be used to help optimize the development of marketing budgets, programs, and activities. Based on effective metrics and valid data, ROMI can be used to help marketers support and achieve the short-term and long-term goals of the corporation. Internally, it can also help foster improved communications with the rest of the company and, most important, with company executives. ROMI is a simple tool that everyone in the organization can quickly grasp and that can lead to improved decision making and improved results.

About the author  Guy R. Powell is president of DemandROMI, a company that helps marketing organizations measure the return on their marketing investments. DemandROMI helps companies prove and improve marketing performance so that they can deliver quantifiable revenue and profit as a result of marketing investments. Guy is author of Return on Marketing Investment: Demand More from your Marketing and Sales Investments.