Managing Communications ROI
By Don Sexton, Columbia University, The Arrow Group.
For several years now marketing
and communication managers have
been feeling the pressure to justify
their expenditures in terms of returns.
In today’s competitive environment,
such pressure is certainly expected and
reasonable, but often marketing and
communications managers have not
been able to provide the answers
required. Setting communications
budgets effectively requires an answer
to the question: “What is the return on
the communications investment?”
Determining Communications
Investments
Many practitioners, and most marketing textbooks, suggest three different ways to determine the communications budget — and none involve communications ROI. The methods are:
(1) percentage of sales revenue, (2)
competitive parity, and (3) objective
and task. All three approaches have
serious and well-known limitations.
The percentage of sales approach is
much like cost-plus pricing — it’s
simple, and it’s likely wrong. The
main problem with a percentage of
sales approach is that it reverses the
advertising/sales relationship. Instead
of the assumption that advertising
leads to sales, use of a percentage of
sales rule rests on the assumption that
expected sales should determine what
advertising is “affordable.” With no
underlying strategic rationale to support advertising spending, the advertising budget then becomes a justifiable
target for cost cutters. The percentage
of sales approach also takes what often
should be thought of as a fixed cost
and makes it look like a variable cost.
Such a change can confound decisions, just as it does in full cost-plus
pricing.
With the competitive parity
approach, budgets are set in relation to
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competitors’ spending. Such thinking
can lead to advertising spending wars,
which can be as destructive as price
wars. Some years ago, I wrote an article for the Journal of Advertising
Research in which I surveyed a number of studies on the sales effects of
advertising. I concluded that in many
mature markets, advertising was found
to change only relative market share,
not the absolute level of sales. In such
conditions, increased advertising
expenditures could actually result in
negative returns — not only to the
firms involved, but to society as a
whole.
The objective and task approach
has a rich history, going back to
Russell Colley’s DAGMAR model
(Defining Advertising Goals for
Measured Advertising Results,
Association of National Advertisers,
1961). Advertising objectives such as
unit sales are defined, and then tasks,
such as building awareness or prefer-
as it led to high spending, so most of
their clients employed a percentage of
sales approach instead.
The objective-and-task approach
can easily lead to high spending, in
that often it includes no explicit calculation of the value of the objectives
and the costs of the tasks. Another
possible problem is that the tasks that
lead to sales (or similar objectives)
and their relationship may not be
known. In a tour-de-force article in the
January 1999 Journal of Marketing,
Demetrios Vakratsas and Tim Ambler
surveyed more than 250 articles on the
effects of advertising and did not find
any systematic evidence for the hierarchy of effects model (Figure 1) typically used to support the objectiveand-task approach. What they found
was support for more than one model
of how advertising affects sales, suggesting that perhaps the objective-andtask approach might be more useful if
coupled with a more sophisticated
ence, are determined that supposedly
will achieve those goals. To many, the
approach has strong face validity but
may result in large communication
outlays. One high-placed executive in
a leading advertising agency explained
to members of one of my Columbia
classes that their clients did not want
to use the objective-and-task approach
view of how advertising works.
Value/Cost™ Approach
The Value/Cost™ approach to
managing communications ROI
utilizes some of the ideas from the
objective-and-task approach but takes
them further both statistically and
financially.
ANA / The Advertiser, October 2003
return. For example, those customers
who tend to be loyal to specific credit
cards or telephone services. My more
general model examines the communications return both for retaining customers and for persuading them to
return.
The cost of customer acquisition is
the cost of moving a potential cusIn the Value/Cost™ approach
(Figure 2), the communications return
consists of the value of the customers
acquired and retained by the communications investment. The communications investment is the cost of acquiring and retaining those customers.
Customer value is the estimated
profit (or cash flow) stream from a
customer over time (Figure 3). It
requires estimates of share, usage,
variable margin rates, and retention
rates and how they change over the
years. Given space constraints, the
model described here focuses only on
the acquisition of customers and
would be most applicable to situations
where customers tend to stay with specific sellers and, if they leave, do not
tomer to purchase and depends, in
part, on what is assumed about the
hierarchy of effects model. FCB
suggested that purchase situations be
classified into four behavior models
according to the importance of the
purchase and whether cognitive (functional) or affective (emotional) aspects
are more crucial (Figure 4). In my
opinion, the FCB grid sorts out very
well many of the empirical findings of
Vakratsas and Ambler and leads to a
revised hierarchy of effects model —
actually four models that vary according to purchase situation (Figure 5).
Depending on which of the four models applies, the communications costs
of converting customers from one
stage to the next are estimated to obtain
the overall customer acquisition cost.
32
ANA / The Advertiser, October 2003
An illustration of the type of calculations in the Value/Cost™ percentage
approach is given in the sidebar. For
more detailed examples or additional
information, please send the request
to: donsexton@mindspring.com.
The Value/Cost™ approach is now
being used by some Arrow Group
clients to determine their level of marketing communications investments –
including advertising and personal
selling — and to allocate them over
customers or segments. They feel they
now can answer the question: What
return are we getting for our communications investment? ■
Don Sexton
Professor of Marketing
Columbia University
President
The Arrow Group, Ltd.
Estimating the Communications Return on Investment: Sample Calculations
Note: Numbers are assumed to remain constant to make the arithmetic simple — in practice, most of the numbers
would change over time. Also for simplicity, customers in the target segment are assumed to be homogeneous and
remain throughout an entire year. Once they leave, customers are assumed not to return.
Annual purchases of member of target segment: $4,000
Share of annual purchases of typical customer: 25%
Variable margin rate: 20%
Fixed cost of service per customer: $50
Year-to-year retention rate: 70%
Interest rate: 20%
Communication investment: $150,000
Number of customers acquired: 2,000
Acquisition cost of customer: $75
Value of customer per year: ($4,000)(.25)(.20) – $50 = $150
Max life of customer: 4 years
Year
Value
Cumulative
Retention Factor
1
2
3
4
Total
$150
$150
$150
$150
1.00
.70
.49
.34
Communications ROI:
(as % of investment)
34
(2,000) * ($264.06)
(2,000) * ($75)
Discount
Factor
.83
.69
.58
.48
= ($264.06)
($75)
Present Value of
Expected Contribution
$124.50
72.45
42.63
24.48
$264.06
= 352%
ANA / The Advertiser, October 2003