What is advertising’s ROI?
Q: We have a new CEO who’s a finance person. Our board hired him from outside and he started mid this year when our former CEO retired. We’re now preparing for our 2012 business plan.
For us in marketing, our new CEO issued a planning guideline that told us among other things that for our marketing budget especially for advertising, he will not accept a proposed advertising budget that does not show advertising’s ROI. And he wants hard evidence to support the claimed ROI.
This is the very first time that we’ve been asked for such a thing. We’ve talked to our friends in the industry but they too said they’ve not been required to justify their advertising budget on the basis of its ROI that’s also evidence-based.
You once had a column about accountable marketing. We recall that it said that marketing’s final objective is not only revenue but much more profitability. So we thought you may be able to help us about how we can show that advertising can be accountable for profit or ROI. Please help.
A: Frankly speaking, we were surprised to hear that you and your friends are unfamiliar with accountable marketing and accountable advertising. Making marketing and advertising accountable for profit is not new, although, depending on the product category where you belong, it’s still not common practice. We’d like to answer your question because it’s a concern we’ve been asked more than once.
The accountability movement started back in the 80s. It was directed at marketing as a whole or at the total marketing mix. Asking the total marketing budget to show its accountability for profit wasn’t that difficult to establish. That’s basically a supposition on our part because if it were not true, the issue would have lingered. So it’s not all of marketing that’s been suspect for its profit contribution.
The finance circle seemed to have been happy with marketing’s claimed primary responsibility for the topline revenue. Marketers were known to present the compelling logic of their existence by this simple, Jack-Welch-sounding business logic: “No marketing this year, no topline revenue this year. No topline revenue this year, no bottom-line profit this year. No bottom-line profit this year, no topline revenue next year.”
So what marketing, what functional component of it came into suspect? Advertising. And it was actually advertising’s fault. In the ’60s when Advertising started to replace Sales as the “darling” of businessmen, admen came to be critical about how finance treated advertising in the P&L (profit and loss) statement. “We are not just an expense item. We are an investment because the returns to advertising take place years after the allocated budget for us have been disbursed,” said Advertising from one conference to another. So it was understandable that Finance came back to retort: “If you’re an investment, then show us your ROI!”
As you can see, the resolution of the issue is in correctly diagnosing advertising as an “investment.” So what’s an investment? If advertising is an investment, then this year’s ad budget should earn money in later years. In contrast, as an expense, an ad budget this year should generate money this same year.
But can we not expect advertising to “earn money” also this year? Of course, that will happen if this year’s advertising boosts sales. Unfortunately, orthodox marketing says: “Sales is a function of the entire marketing mix, not one, not two, not three but all of the four Ps together. And advertising is just one-half P of Promotion, that’s just one of the 4 Ps.”
However, it was the credible research of Wharton’s Professor Leonard Lodish that proved otherwise, at least for FMCG [fast moving consumer goods] ads. For ads that obtained positive sales results, Professor Lodish provided data showing noticeable revenue gains within the first six months from the start of the ad campaign launch. In most cases, the sales impact was clear within the first three months. The positive gain averaged 15 percent sales volume increase. So Professor Lodish concluded that the ad industry’s rule of thumb that claims that advertising is slow-burn and that therefore it takes a long time for advertising to work is not at all true.
So if we can expect advertising to yield returns this year, we can understand the common sense language that the Treasurer of a Chinese pharma client of ours used to tell the company’s ad executive this: “Ako bigay pera para advertising budget mo sa darating na taon. Tapos ng taon, ikaw balik pera sakin pero me tubo gaya nung tubo galing dun sa pinangako sakin na babalik nung trade promo budget nung kumpare mo.” (I gave money for your advertising budget this coming year. At the end of the year, you give back my money but with an earning just like what was promised for the trade promo budget money I gave to your colleague here.)
If we dig deep into this “deal,” we will understand and appreciate that we’re talking about profit return AFTER DEDUCTING the ad campaign expenses. It’s not profit return DIVIDED BY the advertising “investment,” which is ROI’s definition. This means that ROI is not the relevant practical ratio to talk about regarding advertising’s accountability for profit. The prevailing “best practice” is to SUBTRACT the advertising money from the generated profit return. It is not to DIVIDE the generated profit return by the advertising money.
What about the reality that advertising gives returns that span several years after? London Business School’s Professor Tim Ambler in his 2005 bestseller book, Marketing and the Bottom Line, gives a practical prescription. He says that the “payback” metric captures that concept of future returns even though it considers only the timing and not the magnitude of the returns. The payback formula simply computes how many years it would take to recover the advertising “investment.”
So there’s our long answer to your short question. It’s an answer that satisfies the twin character of advertising as an expense as well as an investment.
Keep your questions coming. Send them to us at [email protected] or [email protected]. God bless!
