While measuring the true value and effect of brand building activities can be challenging, doing so is vital for organizations who want to understand the true ROI on their marketing efforts and for marketers needing to justify brand building investments. In this post, a simple model for calculating the ROI on marketing efforts is presented.
One of the key fundamentals of business economics is that all organisational investments and expenditures should be planned, budgeted—and most importantly—followed up (Baye and Prince, 2017).
When calculating the ROI on marketing investments, it is first important to recognize the two principal categories forming the basis for all marketing strategic work:
- Transactional activities
- Marketing activities and assets with the primary aim of generating direct actions such as sales, and which often has a short-term objective.
- Brand building activities
- Activities with the purpose to form a particular conception or view of organizations, products or services and which often have a long-term revenue objective.
Figure 1, below illustrates the difference between a brand-building versus a transactional advert from the soap brand Dove:
While measuring the ROI on transactional- and brand-building marketing activities is fundamental for efficient marketing planning (Baye and Prince, 2017), there are some distinct differences in how this metric is calculated for transactional- compared to brand-building activities:
ROI on transactional marketing efforts
In the 2013 bestseller ‘Delivering Happiness’ (2014) Tony Hsieh shares some of his core marketing strategies, which he used to build Zappos into a multi-billion e-commerce retailer in just a few years’ time.
According to Hsieh, what enabled him and his partners to build Zappos to become one the most successful e-commerce merchants of all time before selling-off to Amazon for $1.2 billion, was a marketing strategy which he partly copied from Zynga—the NASDAQ-traded video game developer most known by its multi-billion dollar Facebook-game FarmVille.
The strategy of marketing which has built these two exceptional companies is as brilliant as it is simple:
- 1. Implement mechanisms to measure the total net-profit attributed to the entire future relationship with each of your customers (Customer Lifetime Value).
- 2. Measure the exact cost to acquire a new customer in each marketing effort, campaign or channel you engage in (Customer Acquisition Cost).
- 3. Invest your marketing budget in activities which have the greatest ROI.
In other words; if an organization knows the total net-profit which can be expected from each new customer relationship (the CLV) and also the cost of gaining new customers in all channels of marketing the organization engages in (the CAC); it then becomes possible to assess—not only which marketing activities that generates the best returns—but also which activities having a negative ROI and should be avoided in the future.
Understanding what each new customer is worth to an organization and also the ROI on every marketing activity performed is the key to convert marketing expenditures from constitute as costs to becoming investments.
How to measure the CLV and the CAC
Several established formulas and methods for measuring the CLV:CAC-ratio exist, of which many also are adapted to specific market segments or business objectives, including Lodish (2015), Tunguz (2017) and Gotham (2017). Regardless of formula, the key for implementing these methods, is to implement a system to track and measure profit margins, customer retention rate and lifespan, purchases per year and average spend per purchase, and mapping these measures to related marketing costs and outcomes.
While it is possible for an organization to manually calculate the CLV:CAC-ratio by aggregating and triangulating data from CRMs such as Salesforce (2017); web analytics tools such as Google Analytics (2017); and financial data from book-keeping systems—numerous tools and marketing platforms exist which can help a marketing team to automatize this process, including Adobe Marketing Cloud (2017), Oracle Marketing Cloud (2017) and Optimove (2017). By implementing platforms such as these, much of the complexity of calculating the CLV:CAC-ratio to a large extent can be automatized.
ROI on brand-building marketing efforts
Brand value or brand equity can be defined as the price variance between two identical or almost equal products or companies, and the metric is clearly illustrated in the fact that many customers are prepared to pay 300% or more for toothpaste from Pepsodent or dishwashing liquid from Palmolive—compared to generic alternatives as effective in making your teeth and dishes clean and shiny (www.dailymail.co.uk, 2017).
As the example with Pepsodent and Palmolive above shows, widely recognized brands and companies enjoy many benefits including higher price margins, greater perceived quality, and more loyal customers to name a few (Keller, 2013), which explains why the world’s largest advertisers including Procter and Gamble invest large shares of their marketing efforts in brand building efforts (Harvard Business Review, 2017).
As with building friendships, brand building, however, is a process which takes time and genuine effort. Contrary to transactional marketing activities, such as a sale advert for a great deal on soap from Dove (Figure 1) on which the ROI can be calculated by measuring the number of sold products generated by the advert, the return on brand building efforts not only can take years to determine as brand equity are the sum—not from one individual activity of marketing—but is an accumulation of all historically performed activities of marketing and customer relationships (Keller, 2013). This fact makes brand-building activities not only more difficult to measure than transactional activities, but also demands different methodologies to measure:
Measuring the ROI on brand building activities
From an accounting view, the first point of recognition when discussing the difference between transactional and brand-building activities is that while the ROI on transactional activities are reported on the income statement, the outcome of brand-building marketing activities is measured as an intangible asset on the balance sheet where it in many organizations historically has been defined as “Goodwill.” Stating a model for measuring this metric, thereby, needs to consider many factors including type of organization and business objectives; such as if the organization is planning to capitalize on their marketing investments by a sell-off, merger or an IPO.
The accounting model for valuing brands since 2010 is standardized by ISO (the International Organisation for Standardization) which specifies three alternative approaches for brand valuation:
- Cost Based
- In this model, a brand is valued as an accumulation of all the costs which have incurred to build the brand since its inception.
- A market-based brand valuation is based on an analysis of comparable market transactions and/or stock-market valuations.
- When assessing brand equity using an income approach, an estimation of future net-earnings that directly attribute to the brand is applied, which involves an estimation of attributable future cash flows which then is calculated to a present value at an appropriate discount rate.
It should be noted that a fourth model by Srinivasan, Park and Chang (2005) over the last few years has won attention in the business- and marketing literature. This model—in addition to accounting for financial outcomes—also attributes for brand awareness asserted by customer surveys. While still not approved by ISO as an accounting model for appreciating brand equity value and thereby is not a legal accounting model in many countries; the model can be seen used internally by many large corporations for measuring and forecasting the true values of their brands, and to calculate the ROI on brand building marketing efforts.
Regardless of the method used to calculate brand values; when an organization has defined an appropriate model accounting for organizational goals the ROI on brand-building activities can be measured fairly accurate by analysing how this construct evolves over time in comparison with the organisations brand-building activities.
A model for calculating the ROI on marketing efforts
The following points summarize the discussion made in the previous sections and present three steps organisations can make to enable a calculation of return-of-investments on marketing efforts:
- Assessment of market value
- Regardless accounting model; to understand how much an organisation can and need to invest in brand-building efforts—the economic vision and value for its owners which might be a future sell-off, IPO or a yearly profit must be clearly stated. After this is done, an estimated future market value of the brand can be established based on an analysis of factual market data, such as mergers and acquisitions and stock-market valuations of similar brands. Understanding the return that can be expected on marketing investments always should be the guiding principle for marketing related ventures, projects and expenditures.
- Establishing accounting model for brand-valuation
- As noted in this post, an understanding of ROI on every marketing activity performed by an organisation is the key to convert marketing expenditures from making up as costs to becoming investments. The first step in doing so is to enable a forecast of the ROI on brand-building marketing efforts and to establish a suitable accounting model for evaluating brand equity. When such a model is in place, the value of an organisation’s brands will be clearly visible as a quantified asset in the balance sheet. By tracking and mapping this metric to performed brand-building activities and costs, a calculation of the effects as well as returns on brand building activities is possible.
- Implementation of means to measure the CLV:CAC-ratio
- While calculating customer-life-time values and customer-acquisition-costs can be performed manually as discussed in Section 1.1, a number of marketing platforms exist which to a large extent can help to automate this process. Whether an organisation decides to manually calculate their ROI on marketing investments or to use a platform to automate this process; to enable efficient marketing strategic work the ROI on every activity of marketing always should be clearly visualized and understood by its marketing team.
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- Hsieh, T. (2013). Delivering happiness. Grand Central Publishing.
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- Tunguz, T. (2017). The Math Behind SaaS Startup Customer Lifetime Value. [online] TechCrunch. Available at: https://techcrunch.com/2015/08/28/the-math-behind-saas-startup-valuation [Accessed 14 Oct. 2017].
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