Marketing for IT Companies > Marketing Strategy > How to Calculate ROMI (Return on Marketing Investment)

How to Calculate ROMI (Return on Marketing Investment)

The formula to calculate ROMI (ROI for marketing activities): take your LTV and divide it by your CAC. That’s why ROMI is also called “LTV CAC ratio”.

ROMI is one of the key metrics for investors

According to George Deeb, a Managing Partner at a financial advisory firm, a healthy ROMI should be 5-10x on a revenue basis, or 2.5-5x on a gross profit basis. He prefers to use gross profit as the numerator and shoot for a 5x return, understanding most companies will be around 2.5x with a 50% gross margin.

Companies that can’t exceed 3x on a revenue basis typically lose money, after subtracting their cost of sales and operating expenses.

He also notes that marketing for brand new companies is going to be expensive and less efficient than established companies (e.g., one-third as effective, on average).

“Investors prefer to pour gasoline on an established fire; they don’t like to start the fire”.

George Deeb

Deeb proposes the formula to calculate ROI for marketing activities: take your LTV and divide it by your CAC. Other experts call it the “LTV CAC ratio”.

Cost of Customer Acquisition (CAC)

CAC (cost of customer acquisition) is the total marketing investment required to bring in one NEW customer in the year, excluding the quantity of “free” customers generated from repeat sales or word of mouth. 

  • Revenues last year = $1,000,000;
  • 10% of revenues spent on advertising = $100,000;
  • The number of generated customers = 5,000;
  • CAC = $20 per new customer acquired.

Lifetime Value of Revenues (LTV)

  • Average transaction size = $100;
  • Average repeat customer rate = 50%;
  • 5 year LTV = around $194:
    – $100 in year one,
    – $50 in year two (50% of $100);
    – $25 in year three (50% of $50);
    – $12.50 in year four (50% of $25);
    – $6.25 in year five (50% of $12.50).

Average transaction size

Take your total revenues in the period, and divide it by the number of transactions in the period.

  • Revenues last year = $1,000,000;
  • Number of orders in total in the period = 10,000;
  • Average transaction size = $100;

Average repeat customer rate

What percent of your current year’s transactions came from prior year customers? You can calculate this based on unique customer identifiers, like client numbers or email addresses in your system. According to George Deeb, anything north of 33% is acceptable, and if anything less, you may have a customer retention problem on your hands (which may spook investors).

  • Total number of orders in the period = 10,000;
  • Number of orders from customers acquired in prior years = 5,000
  • Average repeat customer rate = 50%.

Return on Marketing Investment

  • 5 year LTV = around $194;
  • CAC = $20 per new customer acquired.
  • ROMI = almost 10x.

Return on marketing investment (ROMI) is calculated using two primary metrics: the cost of doing something, and the resulting outcomes.

There are a few challenges with calculating ROI for marketing activities.

  • Calculating ROMI for marketing can be tricky, depending on how you measure impact and costs. Large corporates have complex formulas and algorithms which factor in dozens of different variables.
  • Calculating ROMI manually for each marketing campaign takes time and access to company financials.
  • Calculating ROMI requires patience. It could be months before you know if a campaign was profitable.

The revenue-to-marketing cost ratio provides a simple way to calculate ROMI: it measures how much money is generated for every pound spent on marketing. For example, $5 in sales for every $1 spent on marketing yields a 5:1 ratio of revenue to cost. Ratios such as these are easy to understand and easy to apply.

A marketing cost is any incremental (variable) cost incurred to execute a campaign. Such costs include:

  • pay-per-click spend;
  • display ad clicks;
  • media spend;
  • content production costs;
  • outside marketing and advertising agency fees.

The ratio gives planned campaigns a simple ‘pass/fail’ test. At an absolute minimum, the campaign must cover the cost of making the product plus other allocated overheads, as well as the cost of marketing it.

A further challenge in measuring ROMI arises if you only measure revenue generated from the initial campaign: this may not provide a true representation of the return generated, so you have to factor repeat sales into the ratio too. You can obtain an even truer picture if you can calculate customer lifetime value – that is, the value a customer brings to a business over their entire life as a customer, not just through their first transaction.

However, even if these customers return several times, they may do so from different channels, so it is not easy to calculate the revenue generated from them against any specific marketing activity.

Advances in web analytics software and attribution methodology are now providing better insights for measuring activity over time and across different devices.

Further reading

  •  
  •  
  •  
  •  
  •  
  •  
  •  

Leave a Reply

Your email address will not be published. Required fields are marked *