Remember the Basic Economics of Marketing (ROI)

I got a call recently from a friend whose company has developed a new consumer software application. He had been presented with an opportunity to buy banner ad exposures on a newspaper web site.  “The price,” he said, “seems pretty amazing.” (In a good way.)

The newspaper had offered him banner ads on their site at a price of $0.02 per exposure. So, he would pay 2 cents every time the banner was presented to a site user.  This seemed so cheap, he was suspicious. My reaction was the opposite.

This seems to be a common challenge faced by marketers – forecasting return on investment (ROI) BEFORE deploying marketing dollars. Yet I would argue that there are few if any cases in which ROI should not be the primary driver of marketing decisions.

Here is the very simple exercise that we undertook to determine that this apparent bargain from the newspaper was actually a BAD investment for his company.

His software product retails for $50.00.  With a software product (unlike tangible widgets), the cost is largely incurred by the company up front in development.  But nevertheless, when people order this particular software, they receive a package including a CD ROM that costs approximately $7.00 including shipping.

So, their gross profit on a sale is approximately $43.00 before any overhead expenses or recuperation of development costs are taken into account.

Now, lets suppose he takes the newspaper’s offer at $0.02 per exposure.  If things go AMAZINGLY well, 2% of people who see the banner will click through to his site. (In reality, this click through rate will likely be less than 1%.)

So, for every 100 exposures ($2.00 spent), he gets two click-throughs – for a cost of $1.00 per click.

Now let’s suppose that his site converts visitors into buyers at a rate of 2% (average to slightly above average for an e-commerce site). For every 100 visitors ($100.00 in banner ad exposures), he makes two sales – for a cost per sale of $50.00.

You see the problem.  Even with generous assumptions about click-through rates, his customer acquisition cost ($50.00 in this scenario) is higher than his gross margin ($43.00). Translation – $0.02 per banner exposure is a BAD deal for him in this case.

Were there a recurring revenue stream from the sale of this product (a subscription of some kind), maybe an argument could be made using a higher lifetime value for a customer, but in his case, the sale is a one-time event with no real potential for additional revenue.

The moral of this story – be sure you can realistically expect a positive ROI before you invest your marketing dollars.  The math is usually pretty simple.  The hard part for marketers is often simply gaining access to sufficient cost data to establish thresholds for acquisition costs (a topic for a future post….).