Why MarketShare needs better alignment with CFOs

A little knowledge is a dangerous thing. That's especially true in finance. It often serves to confuse. This Forbes article entitled: Why ROI Is Often Wrong For Measuring Marketing Impact is a case in point. It has multiple flaws that are easily missed by a casual reader. Starting from the top:

• The story is posted under 'Forbes Insights - thought leadership in action.' This gives the impression that it carries weight.
• The post is attributed to a director at MarketShare, which in turn is a business focused upon content marketing. 
• The post draws almost exclusively upon Dominique Hanssens, professor of marketing at UCLA Anderson School of Management, who also turns out to be co-founder at MarketShare. Instant conflict of interest that is exacerbated by the fact that the two facts (professorship and vendor position) are split in the text. 

The argument is predicated upon the idea that:

But is “return on investment” an accurate way to measure marketing effectiveness? Sadly – and perhaps even shockingly to some – the answer is no.

The author then explains:

It’s not that the notion of ROI is evil or anything. After all, linking marketing to financial performance is absolutely critical. It’s just that most people who use ROI in a marketing context probably aren’t applying it correctly, or really mean something else, says Dominique Hanssens, professor of marketing at UCLA Anderson School of Management. ROI’s roots are in evaluating one-time capital projects. “But is marketing a one-time capital project?” asks Hanssens. Clearly not.

[My emphasis added.] No evidence is produced to support this assertion and there is nothing asserted as wrong with ROI as a measure. Just the way 'most people probably' apply it.

I've spent most of the last 20 years butting up against marketing people. In the last year, I've been close to marketing budget decisions of one kind or another. In all that time, I have never met a marketer who thinks about capital projects that are written off over multiple years. I certainly hear from marketers who are making longer term - i.e.  multi-quarter investments but that's not the same as attributing asset status to marketing spend. I would be very worried if that was deemed a correct treatment as it likely falls foul of GAAP rules.

The argument goes that since most marketing is an expense, then ROI is incorrect as a construct and that what really matters is cashflow. Here is how it is phrased:

We’d all love to quantify marketing performance with a single number. But ROI is a ratio, and ratios are not what matter here. Net cash flows are what really matter, says Hanssens. Performance measures such as net profit, for example, are derived by subtracting various costs from revenue. ROI is different. You get it by dividing net revenue by cost.

Question is, how can a CMO compare the ROI for different marketing investments, such as a television ad campaign versus a paid search campaign? As it turns out, you can only make an ROI comparison if the spending amounts are the same.

The author has scrambled three concepts (profit, cashflow and ratios) without good explanation other than to reinforce the idea that using ROI is looking in the wrong direction. Nobody I know thinks the way the author suggests. In fact people I meet will most often ask something like: OK - so we're spending $1,000 on XYZ but does anyone know if it would be better spent doing ABC?

Aligning finance and marketing

My position is that marketers and finance people need to be aligned in order that marketing objectives are adequately financed. At the same time, it is crucial that marketing understands the role finance has to play. So while I agree that cash is king - and perhaps a better way to express this concept is ROS - Return On Spend - even that concept is flawed. Here is an example.

Let's say a services vendor decides to spend $1 million on Google AdWords with a view to returning $10 million in net cash. Is that the same as $10 million in profit? Not necessarily. Revenue recognition rules might dictate that the cash received is recognized rateably over a period of years. Both ROI and ROS measures are important but for different reasons. The choice of investment is, therefore a matter of combined objectives, not just one measure. Muddling the two without adequate explanation is dangerous.

The marginal returns argument

The author also introduces the concept of return on marginal investment (ROMI) analysis. He argues that it should be used as a measure of spend effectiveness. So far so good. But he goes wrong in arguing that:

The only thing you really need to know is whether ROMI is positive or negative. Or, put another way, are you underspending in a given category…overspending…or getting it “just right” (where ROMI is zero)?  And the determining lever is how much you spend.

A little math will help.

Investment: $10,000, profit $5,000. ROI = 50%

Calculate ROMI for additional $500 profit. (5,000+500)/10,000 = 55%. ROMI = 55-50=5%.

This is a very simple example but you get the picture. Anything above zero is good news. Getting it 'right' at zero has no meaning here. Of course nothing is quite as simple as it looks.

Marginal returns analysis is a very good way to assess investments of any kind - but only when it is properly understood and where there are clear choices that present comparable alternatives.

The implied complexity should not deter marketers from embracing the marginal concept. But...trivialising what needs to be understood is unhelpful in my experience.

Here is another view on marginal rate of return

Image credit - © Petr Ciz - Fotolia.com