Wednesday, March 29, 2006

Part 2: The ROI of Contextual Math

I hope the columns in my math tables render correctly for you to read them properly.

This part of ROI Math explores the variable cost impact of customer retention vs. customer acquisition.

The two examples below illustrate the return on marketing to current customers is more efficient than new customer acquisition. While acquisition of new customers should not be abandoned, the increased response rates that come from marketing to current customers does support the importance of programs for building customer relationships that help retain customers. In each case, the campaign cost is $11 million and the revenue per response is $50. The reach and response rates are variables that produce ROI’s that are quite different:

Current Customer Campaign New Customer Campaign
Campaign Cost $11,000,000 $11,000,000
Campaign Reach 10,000,000 100,000,000
Response Rate 7.5% 0.4%
Responses to Campaign 750,000 350,000
Revenue Per Response $50 $50
Cost Per Thousand $1,100 $110
Return on Investment 241% 59%

Increased Response Rate from Contextual Marketing Creates Cost Savings

The total cost ($11 million) is the product of the cost per thousand for the communication itself and the circulation or distribution to reach the prospects. It is difficult to alter the average cost per communication without changing the mix between channels, but what about the circulation? What would be the impact of reducing circulation by not sending promotions to people who are unlikely to respond? Again, this is a basic premise of contextual marketing – send expensive direct marketing campaigns at people who are in an active buying cycle and use less expensive communications to build relationships with others who are not yet in the cycle.

Base Example Reduce Circulation 20% Reduce Circulation 30%

Campaign Cost $11,000,000 $8,800,000 $7,700,000
Campaign Reach 10,000,000 8,000,000 7,000,000
Response Rate 7.5% 9.4% 10.7%
Responses to Campaign 750,000 750,000 750,000
Revenue Per Response $50 $50 $50
Cost Per Thousand $1,100 $1,100 $1,100
Return on Investment 241% 326% 387%
Net Profit $26,500,000 $28,700,000 $29,800,000

In the above example, assuming the predictions are accurate, the return has grown from 241% to 387%, based on first a 20% reduction in circulation and then a 30% reduction. In the $3.3 million cost savings could be invested in a similarly responsive promotion, incremental profits of $12.75 million could be generated:

($3.3 million / $1.10 per customer) x 10.7% response x $50.00 value - $3.3 million cost = 12.75 million

Cost Savings and increased Revenue

Looking further at this model, if response could be increased, revenue would possibly increase. More targeted communications, aligned contextually with customer interests, generates an improved response rate well above the increases cited below.

Base Example +10% Response +20% Response

Campaign Cost $7,700,000 $7,700,000 $7,700,000
Campaign Reach 7,000,000 7,000,000 7,000,000
Response Rate 10.7% 11.8% 12.9%
Responses to Campaign 750,000 825,000 900,000
Revenue Per Response $50 $50 $50
Cost Per Thousand $1,100 $1,100 $1,100
Return on Investment 387% 436% 484%
Net Profit $29,800,000 $33,550,000 $37,300,000

In this example, response has been increased first by 10% and then by 20%, with the final example contributing an incremental $7.5million profit.

This leads to a strategy to improve response results while reducing cost. A customer-focused strategy simultaneously establishes both of these goals, increasing response (revenue) while reducing the cost of communications.


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