Friday, March 24, 2006

Part 1: The ROI Math of
Contextual Marketing

The Justification is in the Numbers

The following scenario illustrates the case for contextual marketing as a more effective model for managing communications expenditures across the lifetime of the customer relationship. Until this is done, you cannot have cost effective, metrics-driven customer relationships.

Let’s look at a business doing $100 million with a product cost of 45%, leaving a gross profit of $55 million. Next subtract out 25% for overhead and 22% for variable marketing and advertising, leaving a net profit of $8 million or 8%. Better than some and worse than some.

Net Revenue $100,000,000
Product Cost $ 45,000,000
Gross Profit $ 55,000,000
Sales & Marketing $ 22,000,000
Other Overhead $ 25,000,000
Net Profit $ 8,000,000

Marketing customer communications is intended to drive increased purchasing, but most marketing organizations do not measure the relationship of customer purchases to the amount spent to acquire the revenue. How then can managers determine appropriate spending levels … where can you reduce expense without losing customers … and where can you invest to get increased revenue?

Three variable factors that can be altered to improve return on investment:

(1) the reach and frequency yields total number of customer impressions
(2) the rate of response from each communication
(3) the average revenue per response.

Let’s look at promotion with a budget of $1 million to reach 10 million prospects. At a response rate of 7.5% and revenue per response of $50, the ROI is 241%.

Promotion Cost $1,000,000
Target Audience 10,000,000
Response Rate 7.5%
Responses to Promotion 750,000
Revenue Per Response $50
Cost Per Thousand $1,100
Return on Investment 241%

Cost per thousand (CPM) is the cost of communications divided by the total circulation (reach):

$11 million / 10,000,000 = $1.10 or $1,100 per thousand

CPM is the average actual cost for each individual communication. From this promotional effort the expected value per response is $50.00 profit. Thus, the break even (BE) response rate can be calculated as: %BE x $50.00 - $1,100/1,000 or 2.2%.

[ ($50 revenue x 750,000 response) - $11 million cost ] / $11 million cost = 241%

This mathematical framework provides a clear method of comparison for each campaign and a metrics-driven approach for reducing or even increasing customer communications budgets.


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