Catalog and Direct Selling: Measure Your Success

How to run and read an ROI analysis

September 2006 By Steve Trollinger

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Return on investment (ROI). It's one of the most commonly used phrases in the direct marketing lexicon and one of the paramount benchmarks on which success or failure of a campaign is measured.

But as common a concept as ROI is, many direct marketers still don't perform the analysis or, perhaps worse, perform it incorrectly. As a financial analysis, ROI is a measure of a company's net income related to its total asset investment. For direct marketers, that "asset investment" generally is the advertising cost associated with generating the sales that contribute the net income. Depending on the business, it also could include the investment in inventory to sell.

For the purpose of this column, the focus is on advertising dollars as the investment to illustrate the technique.

ROI then is the net profits (the return) related to the advertising dollars spent (the investment). For example, if, after all costs are accounted for, net profits for a campaign are $10,000 and the advertising costs for producing and mailing the piece are $50,000, ROI would be equal to $10,000 divided by $50,000 or 20 percent.

What ROI is not is sales divided by ad spend. This is a common mistake. By focusing on sales as the numerator, none of the pertinent costs are addressed, and the calculation is virtually meaningless from a decision-making standpoint. If, using the numbers above, a company generated $95,000 in sales with its $50,000 investment, this miscalculation would render a 190 percent "ROI." But if costs rise in any key areas such as cost of goods, advertising expenses, fulfillment or overhead, the profits will shrink and a big sales generator may become an investment loser.

Using ROI Analysis
For most mailers, ROI analysis is applicable as a strategy-level analysis as well as a post-mortem analysis.

As a strategic analysis, a pro forma ROI should be evaluated prior to any effort or campaign. Each campaign, when built, typically is forecasted for sales and net profits at the segment level, as well as overall. That campaign P&L becomes the foundation for the ROI analysis, and the results of the analysis should provide insights during the decision-making process for whether a campaign should be executed and to what extent.

If the company's ROI requirement is 25 percent and the pro forma analysis suggests an expected ROI of 50 percent, this may indicate the mailing can go deeper into the housefile or can be mailed to more prospects. It's also important to perform the ROI analysis to establish campaign expectations against which the final results of a campaign can be measured.