ROI (return on investment) is a complicated thing to analyse, especially when it comes to digital marketing.
Digital marketing follows the same principles. As a digital marketer, you have to determine the best way to spend money so that it generates more in profit than it costs. Before getting into the math, let’s identify the key components of the equation. It’s way much simpler than you may think.
1) Average Revenue per Sale (or Average Sale Value)
To calculate your average sale value, divide your revenue by the number of transactions you made. The quickest way for most companies to do this, is to divide the revenue by the number of invoices sent out in any period of time. Unless you changed your pricing or business model drastically, a good benchmark is about 12 months. But this may be different depending on the business. If you did revenue of $1,000,000 and processed 1,000 invoices (or transactions), your average revenue per sale is $1,000.
2) Profit Margin
This one you’re likely familiar with. It’s the simplest business equation.
Revenue – Expenses = Profit
We will use this one to help determine the lifetime value of a customer, which will help us know how much we can afford to pay to acquire a new customer.
3) Lifetime Value of a Customer
The lifetime value of a customer is determined by knowing how much each customer typically spends with your company over the lifetime of their patronage.
For example, if you are a general contractor, and your clients hire you 10 times over 5 years until they eventually stop needing your services, and your average sale value is $1,000, and you operate at a 50% margin, you know each new customer is worth approximately $5,000.
4) Allowable Acquisition Cost
If we know that each new customer is worth $5,000, theoretically, you could spend $4,999.99 and it would still be profitable to do so. That said, there is always risk. As with all business transactions, there are risks involved. What if your business suddenly slows down or dries up and customers stop coming back? What if you get sued and it throws all of your metrics out the window? What if the market turns and suddenly nobody needs what you sell?
Generating a measurable return on investment requires hard work. The best part about digital marketing is that everything is measurable. You can look at Google Analytics to understand how many people are converting to paid customers, and how much we paid to attract them. Google AdWords, Facebook ads and other forms of PPC Advertising can make a straight line between spend and results. Hotjar and Inspectlet allow us to see how people use the website, and identify potential reasons for them leaving your site. The sky is the limit. Always measure everything.