New company branding: $12,300, new website to match brand: $8,650, new commercial campaign for brand: $16,900, not knowing if these efforts will pay off for your business, priceless…… for your competition!

Knowing if your marketing will pay off is all about understanding the relationship between expected returns and cost, or in other words knowing your expected ROI (return on investment). Knowing this relationship saves you tons on money on wasted marketing gimicks and has the added benefit of breeding optimism within a company.  This is why the savvy company takes time to evaluate return on investment scenarios. The benefits include:

1. Knowing likely returns
2. Finding solid information to plan on
3. Breeding optimism based on sound planning and information (we call this reality)

Getting these benefits does not take a whole department, huge budgets, or much time; all it takes is a dedication to making purposeful decisions. Once you have made that commitment, then the rest is easy as 1,2,3.

Note, some of the equations we used to get ROI figures may seem complex, but with a little study, and using our excel cheat sheet, you can help your company measure expected ROI of proposed marketing.  Use the attached excel file for a quick reference to calculate your ROI 3 Step Guide to ROI Marketing Calculations

Step 1: Know Your Variable Margin Rate

The variable margin rate is your incremental profit rate. It is a measure that allows you to estimate how certain decisions will affect your bottom line profitability.

To begin we will setup a contribution format income statement. This type of income statement organizes cost by behavior. It shows the relationship of variable cost and fixed cost, regardless of function a given cost item is associated with. Or in plain English, it shows the fraction of sales that offset fixed cost, hence each unit’s sale profitability.

Above is a example table with a contribution format income statement. Our example statement list $1.35 Million in net sales, with a variable cost breakdown of $607.5K. To get the contribution or variable margin we divide total variable cost by net sales. In our case variable margin equals 45%.

With our variable margin rate we can estimate that 45% of each sales dollar represents profit. From this point we have an informed foundation to measure the outcome of proposed marketing decisions.

Step 2: Scenario Building

This step includes creating a scenario matrix using your variable margin rate. These scenarios will give you baseline information about how to proceed and measure activities. Baseline scenarios should include:

1. Break Even Sales Level: the amount of sales to break even (no profit)
2. Shutdown Sales Level: the amount of sales that just cover direct fixed cost (those cost you have to pay)
3. Target Profit Sales Level: the level of sales needed to meet profit goals

Here are the formulas and examples using our previous table:

Break Even Sales Level (BSL):

• BSL = fixed cost / variable margin rate
• $744,444 = $335,000 / .45
• So our company has to make at least $744,444 to break even

Shutdown Sales Level (SSL):

Note,direct fixed costs are those things you have to pay regardless, as they are required to run the business. Items like a professional fees, rents, insurance, etc. Things like advertisement, marketing, and other add-on fixed cost are not included in this figure.

• SSL = direct fixed cost / variable margin rate
• $466,667 = $210,000 / .45
• So our company will lose money if it does not at least make $466,667

Target Profit Sales Level (TPSL)

We will use $300,000 profit level for our example

• TPSL = (fixed cost + target profit) / variable margin rate
• $1,411,111 = $335,000 + $300,000 / .45
• So our company would need to make $1,411,111 to make $300,000 in profit

Step 3: Evaluate Marketing Options

Now that we have some baseline figures at hand we can begin to evaluate marketing options. Let’s say we have 3 options before us to market our company.

1. Radio advertisement
2. Brochure Development & Mass Mailing
3. Video Commercial Spots

Let’s evaluate each scenario:

Radio Advertisement:

• expected cost = $33,000
• expected return = $135,000
• contribution return = $135,000 x .45 = $60,750
• contribution - cost = $60,750 - $33,000 = $27,750
  • running the radio ad would profit us $27,750

Brochure Development & Mass Mailing

• expected cost = $45,000
• expected return = $170,000
• contribution return = $170,000 x .45 = $76,500
• contribution - cost = $76,500 - $45,000 = $31,500
  • the brochure development and mass mailing would profit us $31,500

Video Commercial Spots

• expected cost = $125,000
• expected return = $200,000
• contribution return = $200,000 x .45 = $90,000
• contribution - cost = $90,000 - $125,000 = -$35,000
  • video commercial spot would lose us -$35,000

Using our formulas we can see that the radio ad and the brochure marketing are profitable, while the TV spots lose $35,000. Special note: though radio and brochure marketing are profitable, brochure marketing has the edge because of cost to benefit ratio.

Radio has a cost to benefit ratio of 1.19 or roughly 19% return on investment (33,000 / 27,750), while the brochure has a cost to benefit ratio of 1.42 or roughly 42% return on investment (45,000 / 31,500). This means brochure marketing has almost 21% more relative return than radio in our example.

Another great figure to know is your minimum sales requirement. This gives you baseline revenue that your marketing must reach to break even. If you do not feel absolutely confident your marketing can reach this figure, then it probably is not a good idea to proceed.

Minimum Sales Requirement (MSR) = Change in Cost / Variable Margin Rate

• Radio Ad: $33,000 / .45 = $73,333
• Brochure Development & Mass Mailing $45,000 / .45 = $100,000
• Video Commercial Spots $125,000 / .45 = $277,778

The minimum each marketing campaign should bring in to break even is listed above.

When you use these simple formulas to make educated decisions about your marketing dollars you are empowered and in the driver seat. You would not set out on a trip without a destination or road map, same thing with marketing. Understand your cost and options to make the absolute best decision possible.

Below is a link to a excel sheet which allows you to easily create a contribution statement and evaluate potential marketing choices.

3 Step Guide to ROI Marketing Calculations