January 15, 2014

Return On Ignorance

Let's pretend for a minute that we can measure ROI for advertising.

And let's pretend we've measured the ROI for our brand this year and it turned out to be 10%. In other words, for every $1.00 of advertising cost, we got additional sales of $1.10 and, therefore, a return on our investment of 10%.

So the question is, if that is true, why not spend every dollar we have on advertising? I'd be happy to give you every dollar I have if you'll give me $1.10 in return.

The answer is, we don't do it because we intuitively understand that this measurement is bullshit.

Here's why.

Let's say you're the brand manager for Bob-O-Cola. You did a Christmas promotion for Bob-O-Cola during the 4th quarter this year and during the promotional period you spent $10 million on advertising and you did $11 million more in sales. You report to your management that you had a 10% ROI on your advertising expenditure. They applaud and make you C-Something-O and give you a nice fat raise. Seems simple enough, right?

It ain't.

How about the cost of all the advertising you've done over the past 20 years that got you on the shelves in the first place? How about the cost of all the advertising you've done over the years to convince consumers that your brand was made from artisanally curated cola beans? How about the cost of all the advertising you've done to the trade to convince them your displays will earn them more money per square inch of floor space?

In other words, how about all the hundreds of millions in advertising dollars you've spent to get you to the starting line for this promotion that you are not including in your ROI? How do you account for that?

And conversely, how about all the sales you're going to get during the next quarter, when you will not be advertising, that are the residual effect of your Christmas promotion? How do you account for that?

Do you think McDonald's sells a billion burgers every minute because of the Christmas holiday ads you saw? Do you think Coca-Cola is on every shelf in the world because of the advertising it did last quarter? Do you think Nike rules the world because of the website they launched last month?

The total effect of advertising is cumulative, not discrete. These companies have spent billions of dollars on advertising and marketing over the years that have a multiplier effect on the advertising dollars they spend in the short term.

In fact, the billions they've spent over the decades -- that are not being counted in the ROI calculation -- may have far more effect on the outcome of their Christmas promotion than the short-term effect of the recent advertising.

Or it may have no effect at all.

That's what's wonderful and interesting about advertising -- nobody can figure out a fucking thing.

ROI? Just another dubious entry in the encyclopedia of advertising ignorance.


Neil Charles said...

"So the question is, if that is true, why not spend every dollar we have on advertising? I'd be happy to give you every dollar I have if you'll give me $1.10 in return."

Reductio ad absurdum.

Any analyst who tells you that the implication of a positive ROI is moving all of your budget into that type of advertising, needs sacking.

I'd never claim we can measure everything about advertising ROI - we're well short of that for some of the reasons that you mention - but that's not to say that measurement isn't useful.

When finance departments see advertising purely as a cost and threaten to drastically cut the advertising budget, what is there to defend it? An agency's vested-interest assurance that it works brilliantly and you just can't see it yet?

All we have is various measures of ROI to prove that advertising really does make a difference. Imperfect measures, sure but they're what we have.

Tess Alps said...

Unfortunately, as Neil says, we simply have to try and calculate the payback (we prefer this word) of marketing investment. But you are very right about the limitations of some of the approaches, particularly the short-term nature of a lot of it - and I'm thinking trackable media here.

Thinkbox, the company I work for, represents TV advertising in the UK and we have commissioned several longer-term studies: a 10 year one from PwC and several 5 year ones, all covering many hundreds of brands and multiple sectors. As you will imagine, they all show that the longer the time-frame the more brand advertising - TV and radio most of all - can be proved to generate incremental profit, both through extra volume but also by maintaining pricing points.

ROI is generally a dangerous concept when it is expressed as a ratio eg for every £1 spent we delivered 10% incremental net profit 1;1.1. It focuses on efficiency, not effectiveness. It tends to reduce marketing budgets because the most efficient spends will be at the lower end. As you spend more, the efficiency will reduce - but you'll still be making more profit and growing your market share. Is it better to spend £1m and deliver net profit of £100k (1:1.1) or to spend £3m and deliver net profit of £240k (1:1.08)? I believe the latter and that diminishing returns should be accepted, for as long as a net profit is still being made (and that needs to be calculated over the mid-term for FMCG, otherwise they would spend nothing). That's how market leaders are created.

Martin Weigel said...

Tess is right about the dangers of pursuing the ratio.

Blindly chasing ROI can actually destroy economic value for a brand or business.

Compare and contrast these two scenarios, for example:

Scenario 1: A brand spends £2m and generate £6m sales

Scenario 2: A brand spends £5m and generates £10m sales

ROI chasers would of course go for the Scenario 1. It generates £3 for every £1 spent. An ROI of 3:1.

However, Scenario 2 actually delivers more sales and more profit. Even though its ROI was lower, generating £2 for every £1 spent.

So, which company do you want to be a shareholder in? Or an employee of? Or submitting an effectiveness awards paper for?

There is one other significant problem with ROI. It represents the short-term return divided by the short-term advertising expenditure. The problematic word in all of of this is of course, ‘short’.

Charles Channon had long ago warned of the lure of efficiency: “It works in the short term ( the bottom line or the decision maker do not have to wait for the benefit), it is measurement-friendly (and some would say measurement-led) and it is highly actionable (in that it appears to offer a greater degree of certainty in both planning what to do and evaluating it afterwards).”

But as Peter Field has put it: “The single greatest threat facing marketing at the moment is short-termism.”

ROI does not take into account the longer and broader effects of advertising. It takes not take into account longer-term cash flows, and the effects on the dynamism of the business and brand equity.

The evidence is that most advertising activity does have some kind of short-term volume effect. So far, so good. However, the average uplift is small – usually about 5% in grocery markets. That is too small to be profitable for all but the biggest of brands.

Short-term effects, whether from advertising or price promotion, are usually unprofitable. The economic value that advertising creates emerges from long-term effects: gaining new customers who go on to buy again and again at premium prices.

Tim Boadbent cites a study of single-source data that measured advertising’s effects over 12 months as 2.5 times larger than the initial sales uplift. Over a full year, repeat buying means that the average 5% uplift in short-term sales accounts for about 12% of the brand’s total annual sales.

Broadbent reminds us that because a typical grocery brand accounts for about only 40% of a household’s category buying, attracting new users has a significant impact on long-term sales. IRI for example, have measured the carry-over effects in years two and three as almost equal to the effects in year one, namely 2.4 times the uplift. Thus, the short-term 5% sales uplift is multiplied to about 29% of the brands volume by year three.

Clearly, we should be calculating the long-term effects of advertising, not merely the short-term effects.

So if you want to assess the short term efficiency of your efforts, by all means measure ROI. Calculate R divided by I. Conscious and clear sighted as to its limitations.

And if you want to calculate the financial value your efforts create over the long term, measure the effectiveness of your efforts. And calculate R minus I.

But please, don’t speak of them as if they’re interchangeable.

Jason Hartley said...

I understand the point, but the argument "why not spend every dollar we have on advertising?" doesn't stand up. What does "every dollar we have" mean? Obviously there are costs to doing business that are outside of advertising, so you can't spend *every* dollar. You can argue for a larger budget, which it sounds like in this case might be the right thing to do as it appears that your current efforts, on top of the previous advertising you've done (which was held to its own ROI metrics I'm sure, so you are in a sense double counting the cost but not the return in your formula for long-term ROI), are successful. It's not that difficult to test which tactics are driving the success, either, so you could maybe even improve next year. to say we can't figure out *anything* is a bit much. Is the measurement perfect? Of course not. Nothing is. The issue is not really that we try to come up with an ROI, it's that we pretend that it is more precise than it really is, which results in less risk taking and underfunding of advertising.

Cecil B. DeMille said...

The effect of stupidity is also cumulative, sadly. Numbers lie. Math doesn't. As Martin said, people chase the wrong unicorns in this business. It's all about having good business perspective.

Jason E Leigh said...

The best methods of ROI calculation, a version discussed below by Tess, take long term impacts of past advertising into account.

And, as Neil points out, ROI should never be used as the sole factor in making a marketing/advertising budget decision. It should be one of the factors used in making that decision.


Jim Powell said...

ROI used this way treats advertising as a commodity.

If we advertise we get x back.

It swerves the conversation about what makes good advertising. Or what if our advertising was better. How would we make it so?

And it also swerves the conversation about product quality too.

Great advertising makes a poor product fail faster as some once said.

In Martin's question re 1 and 2 wouldn't it depend on other factors too?

For example what were their total sales figures already and how did they do in similar time frames ,and how do they relate to their profit margins, how were there competitors doing, the 'state' of their market place etc.

a) Google, P & G, Unilever et al may spend £5m on a particular product and see nothing back and then drop it.

b) A trendy craft beer may spend £2m and see sales rocket enough to cover their VC fees. Or they may even become profitable.

Yet I may have reason to stick with a0 over b).

Never bloody easy is it?

Neil Charles said...

It's not really fair to say that ROI swerves the conversation about what makes good ads. That's like saying cars swerve the issue of how to travel on water - it's not what they're for.

ROI (calculated correctly) is a really simple metric. I spent $X and I got $Y back. It's useful when that number is what you need to know. If you want to know what kind of message might appeal to 16-34 year old men, or why everybody hates the ad you're running at the moment, why ask for an ROI number?

Provided it's not flat-out wrong, then seeing ROI as the cause of problems is attacking the wrong issue. It's just a number. Abuse of the number and claiming it's the only important metric in advertising are the problems.

Jim Powell said...

I totally and utterly 100% agree Neil. ROI is not an explanation is just a simple calculation. It myopically describes not big picture explains.

Martin Weigel said...

I agree with you on one point.
Any evaluation of the contribution of advertising should take into account other factors.
These might be distribution, pricing, competitive failure, share of voice, superior product performance, market monopoly, seasonality, price promotion, macro-economic pressure, cultural bias, legislation, average temperature, rainfall, force majeure, popular culture, fashion, politics... and so on (and on)
The list of potential factors in the fortunes of companies and the performance of brands and the buying behaviour of consumers is almost infinite.

Ignoring other factors is to simply establish correlation.
Establishing causation is much trickier.

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