John Wanamaker remarked, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” With modern analytics that variance has shrunk dramatically, but only if you use them. Large corporations and advertising houses have numerous methodologies for calculating and tracking advertising Return on Investment or ROI. If an advertising medium doesn’t meet with predetermined ROI requirements it is not considered.
Here are a few basic concepts that any business can use to help you make more educated decisions about where to spend your precious marketing dollars. The first step is to determine what percentage of a return on investment you want from your advertising dollars. This percentage will very depending on your Cost of Goods Sold or COGS. If you are a service business your percentage will be different than a retail outlet or restaurant. Remember we are talking about gross sales not gross profit when we’re determining this number. For this example we’ll say that we require a ROI of 3:1, or we need to have sales of $3 for every $1 spent on advertising.
Now that we know what return we want how do we determine if an advertising medium will give us that return? The first thing we’ll need to know is what our conversion rate is. What’s a conversion rate you ask? A conversion rate is the number of prospects you or your sales team need to talk to before closing a sale. We’ll use the automotive industry as an example. The average automotive sales professional has a closing percentage of twenty percent. In other words they need to talk to five prospects before making a sale on average.
With these two pieces of the puzzle we are only missing three more. These are the number of potential leads the advertising medium will generate, your average sale amount and the amount of the advertising investment. Notice we used investment and not cost. Advertising is an investment, no different than stocks, bonds, 401ks, etc. You can mitigate some of the risk of loosing your investment but not all of it. That being said the number we really need is the number of potential leads. Generally the seller of the advertising medium can provide you with statistical averages from third party companies like Jupiter Research or Comscore.
Once these numbers are obtained it’s really nothing more than a simple algebraic equation you can create in your preferred spreadsheet program. Here is one example of a formula you can use with the data you’ve gathered above:
((Ad Investment * Return) / Average Sale) * Conversion Rate = Leads Required
Now one with numbers: (($1000 * 3) / $2000) * 5 = 7.5 Leads
If the advertising medium for the example above cannot show that you will have a reasonable expectation of receiving 7.5 leads to your used car lot example then it probably isn’t a good investment.
Disclaimer: Content is king and if your ad isn’t appealing or speaks to the consumers’ need all the supporting data in the world isn’t going to help you. Just as if a sales professional is poorly trained or inexperienced their conversion rate will be different. This is just a tool to use in your evaluation process.