It is a common question in advertising, how much spend is the right amount of spend? As any marketer can attest, answering this question is not easy — especially when it’s asked by your CFO. A straightforward (but overly simplified) response to the question is, “you should spend as much money as it takes to maximize your profits.” But, how can you project profits accurately?
The first thing to remember is that, when calculated as a percentage, maximizing return on investment (ROI) is NOT the same thing as maximizing profits.
Revenue Generated [minus] Investment [divided by] Investment [multiplied by] 100
So, if you spend $1,000.00 on a campaign, and you attribute $2,000.00 in revenue to the business generated from that campaign, your ROI is 100%. Or, the campaign returned a profit equal to the amount of the initial investment.
Now, back to the original question, how can you predict the profits you’re likely to achieve from a given marketing investment? It becomes a little easier if you can focus on a single marketing activity, and if you have the ability to attribute revenue to that activity in isolation. So, for the sake of simplicity, let’s consider an e-commerce company that generates customers only through its online banner (display) advertising.
Assuming the company had enough historical data (from testing), it could begin to predict customer conversion rates at different banner impression levels. Simply put serving X number of banner impressions will likely result in a customer conversion rate of Y. But remember, similar to the Law of Diminishing Returns found in economics, there will be a point at which each additional advertising impression will become less effective than the one that preceded it. Consider the three different points along the curve on the graph below.
Maximizing ROI (the first point) is based on finding the highest point in the distribution curve. Maximizing profits (the second point) is based on finding the point JUST BEFORE you begin overspending (the third point). [note: assumes the cost of each impression is the same, and the value of each new customer is the same at each point, at an $8.00 CPM and a customer value of $465.00]
In this (admittedly simple) example, if you were managing against an ROI metric (%), you’d choose to serve 70 million impressions. But, if you were managing against a profit metric, you’d choose to serve 140 million impressions.
Managing against profits represents a higher risk, because it increases your likelihood of overspending. But as you can see, if you’re focusing too much on ROI, you could be limiting the profits your campaigns generate for the company.
