Return on investment, also known as ROI, is generally used as a method to calculate a company’s return on its advertisement expenditure. To calculate it, you divide the investment profit by investment cost. To simplify, ROI is calculated by subtracting the current value of investment from the cost of investment and dividing it by the cost of investment.
The formula shows that return on investment is a ‘return,’ not ‘profit.’
ROI helps companies make important financial decisions on cutting or expanding expenditures. In digital marketing, ROI works as transparent data accessible to the agency and its customer (only if they know how to calculate ROI).
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How Is ROI Different From Profit Margin?
The major difference between ROI and profit margin is that profit margin cannot exceed 100 percent while ROI can. Let’s understand this step-by-step.
Profit margin is calculated by dividing profit by revenue (sales) and multiplying it by 100, while ROI is calculated by dividing profit by investment and multiplying by 100.
Profit margin: profit/sales x 100 = profit margin
Return on investment: profit/investment x 100 = ROI
For example:
A man named John purchased goods for Rs. 10,000. He carried the goods in a car whose fuel cost him Rs. 1,000, and the driver took Rs. 1000 to drive the car to its destination, your go-down. And selling expenses. John finally got Rs. 30,000 after selling products.
Profit margin:
30,000-10,000-1,000-1,000/30,000 x 100= 73.3%
ROI:
30,000-10,000-1,000-1,000/10,000 x 100= 220%
The percentage difference is because, in profit margin, the denominator is the ‘sales of goods’ while in ROI, the denominator is the ‘purchase of goods.’
What Is ROI In Digital Marketing?
Print and television advertisements cost a lot, and finding their ROI is equally difficult. Imagine spending millions on newspaper advertisements and receiving sales in peanuts. Even worse is when you are spending a lot but have no absolute metrics to calculate your ROI. You cannot find how many people saw your ad in a newspaper and how many packed their sandwiches using it.
In digital marketing, there is complete information on the number of customers who saw your ad, clicked on it, made a purchase, and returned for a re-purchase.
This traditional method of finding ROI looks easy but is full of hassles. This is why most advertisers are shifting from old TV and print advertisements to web ads.
In digital marketing also, most people do not know the calculations, so they mistakenly consider engagements and the number of likes as the parameters of online growth.
However, this does not always apply to an ‘e-commerce’ website. In e-commerce, the focus is on sales rather than the number of likes and engagement. Making sales or conversions becomes the primary objective over brand awareness or engagement. The company is run on facts and improving sales. However, popularity can be used as a tool to establish brand identity.
Everything is on your screen in digital marketing, and you are the boss! Just by opening Google Analytics, you can read the basic information on your investment and its results.
In this blog, we will not devise new methods to find ROI. Instead, learn how one can find ROI on their website through digital marketing ROI.
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How To Calculate Digital Marketing ROI?
These days, companies ask for ROI in digital marketing due to huge ad investments. To calculate ROI in digital marketing, you need to identify the key indicators or metrics that show your efforts’ growth or downfall.
These key indicators include cost per lead, cost per acquisition, average order value, return on ad spend, and conversion rate. There are other key indicators, but these are enough to evaluate your company’s growth.
Cost Per Lead (CPL)
Lead is a probable customer of your website, showing interest in your product. Cost per lead determines the cost divided by each lead. To calculate the cost per lead, you need to divide the total ad campaign cost by the number of generated leads.
For example, if you spend Rs. 3,000 on your campaign and generate 300 leads, then:
3000/300 = Rs. 30 will be the cost per lead.
Now, how does cost per lead help in calculating ROI and determining growth? You have to check if your spending on ads occupied by different customers is costing you moderately or too much.
For example, the profit you get selling one trouser is Rs. 20, but the cost per lead is Rs. 40. This means the additional expenditure is 50 % more than the profit, and you need to make changes in your strategies.
Conversion Rate
Conversion is the ultimate goal of a marketer. The meaning of conversion differs for different marketers because it depends on a goal. Identify the goal, which can be as exhaustible as completing the whole process of buying a product or as simple as filling out a form.
The conversion rate is calculated by dividing the total number of conversions by the total number of leads multiplied by 100. It simply tells that out of X number of leads, Y number have been converted.
For example, if your total number of conversions is 500 people, and the total number of leads is 1000 people, then 500/1000 x 100= 50%
Conversion rate helps in re-marketing and re-running advertisements. This is why you often see ads on the apps you buy products from. A customer who shopped from your website has a higher chance of returning to your website if you persist with them enough with your ads. Hence conversion rate is considered the best indicator of growth.
Cost Per Acquisition (CPA)
Cost per acquisition is one more step ahead of the cost per lead. CPA looks into the cost per individual who completes the whole process of buying your product or services. These individuals or customers become your reliable customers whom you expect to buy your other products or rebuy the same product.
Cost per acquisition is the amount of money you spend to convince one individual to buy your product or services. To calculate CPA, you need to divide the campaign cost by the total number of conversions.
For example, if the campaign cost is Rs. 20,000, and the number of conversions is 500, then:
20,000/500 = Rs 40.
It means it takes Rs. 40 to convince one customer to buy your product. If you feel relieved with this cost when you compare it with your profit, you can continue with your current strategy, or you have to make changes to your marketing plan.
Return on Ad Spend (ROAS)
We use ROAS as an indicator of the amount we invest in ad spending. For example, per Rs. 5 investment on ad campaigns, you earn Rs. 20, which looks like a profitable deal, but if we reverse it (you earn Rs. 5 per Rs. 20 investment on ad campaigns), there is a visible loss.
Average Order Value (AOV)
The average order value refers to the average amount customers spend on a product. As a key indicator, it helps devise new strategies to increase profit. The more the AOV, the better the growth. To calculate it, you need to divide the total revenue by the total number of orders. For example, if the sales from June to October is Rs. 50,000 on 5,000 orders, then AOV will be; 50,000/5,000= Rs. 10.
Now, in this case, a marketer will try to increase the AOV by increasing the price of the product, increasing the number of sales, or both. But both measures require a certain cost. To increase the number of orders, you have to spend on advertisements to reach more people, which is again a cost to bear.
If you go by the second measure, you have to increase the price of products which can make customers hesitant to buy your products and scroll through other websites.
The best way to increase AOV is by increasing organic traffic and making your present customers permanent customers who will buy your product even when its price is high.
Return on investment is needed because it tells the reality behind your ad spending. It is a tool that guides digital marketers, business people, and digital marketing agencies to improve further. It also makes you, as a customer of a digital marketing agency, more informed, so next time you can ask for an ROI from the agency you hired for your e-commerce business.
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To Sum it Up
Marketers prefer comparing ROIs of different years instead of comparing month-wise. Small business owners tend to compare their ROIs every month. It completely depends on the company’s nature, business, objectives, and investment capacity.
ROI is more about marketing strategies than investment because an organic ROI is also considered ROI. Philosophically, investment in organic methods will involve time, brainstorming, and strategies.