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What Does ROI Mean to You?

August 21, 2010

When you use the term ROI or “return on investment” what do you mean? Charlene Li of the Altimeter Group speaking on her new book, “Open Leadership” recently said (and tweeted) “…there’s too much emphasis on “ROI” as metric of social media.” But Charlene went on to add that she has a whole chapter on measuring the VALUE of social media in her new book. So what is the difference between ROI and value? Its all in the semantics of how we use the term ROI.

from the Solution Matrix article on ROI


FORMAL DEFINITION OF ROI

“Return on Investment” has a very straight-forward financial meaning when evaluating the results of an investment into a process or an asset that yields direct returns. Entrepreneur Magazine offers the following definition: “A profitability measure that evaluates the performance of a business by dividing net profit by net worth,” and goes on to explain:

Return on investment, or ROI, is the most common profitability ratio. There are several ways to determine ROI, but the most frequently used method is to divide net profit by total assets. So if your net profit is $100,000 and your total assets are $300,000, your ROI would be .33 or 33 percent.

A terrific article from Boston based management consulting firm Solution Matrix takes up ROI calculation in detail, looking at how organizations can measure investment decisions against direct financial results. But this narrow definition is not what most business people mean when use the phrase ROI.

HOW IS ROI DIFFERENT FROM VALUE?

When business people ask the question “what is the ROI of social media” they are usually using the term ROI as a shorthand for asking “how can I value social media” and not about how to make a direct calculation of the expense of a tactic against the direct revenue that might result. As James Lenskold observed in his 2003 book Marketing ROI, “There is no magic formula to convert soft marketing metrics such as awareness and satisfaction into an ROI equation…” But understanding any marketing activity, social media or otherwise, as an investment instead of as an expense is crucial to making the right decisions on how to allocate scarce resources in an organization. As Lenskold goes on to say

Every strategy and tactical decision should be intended to increase profits. It is completely reasonable, and highly beneficial, to expect a return on investment for each incremental marketing dollar spent… Ultimately, broad goals for quality, customer satisfaction, new product development, and employee satisfaction should all lead back to sustaining and growing long-term profits.

This last passage illustrates the key distinction in the classical financial use of the term and the more nuanced and difficult use when applying ROI to marketing activities — looking at effects over time.

DIRECT VS. INDIRECT ROI CALCULATION

In a simple financial ROI calculation, an investment is bound in a specific time interval to some direct return so that a ratio can be calculated. But the problem with marketing activities, social media or otherwise, is that the result of these activities often impacts a business through many other processes, Lenskold having listed a few in the quote above. Charlene Li agrees and calls this “the benefits of dialog” in her book. Some of the items she lists in calculating the value of social media include: increased awareness, improve reputation of the organization, avoid potential PR blow up, hire better people… A terrific set of resources accompanying Charlene’s book are provided on her website, including a “benefits and lifetime value calculator.” Using these tools in a methodical way will allow an organization to associate the value of social media activities against their expense, even when the association is indirect. So isn’t this ROI??

GOAL DECOMPOSITION

Avinash Kaushik in his terrific Occam’s Razor blog (and in his books) argues that we must use the creation of economic value as the ultimate objective when evaluating any of our activities, but recognizes the complexity of doing so when some of those activities have an indirect impact. In a recent post, “Ensure a Clear Line of Site to Net Income,” Avinash provides an explanation of what he calls “macro conversion” and “micro conversions.” To paraphrase his excellent article, it is crucial for us to understand how the small things we do ultimately relate to our larger goals. At Open-First we call this analysis “goal decomposition” and apply this discipline to understand the ROI of marketing activities that have long term results. For example, what is the ROI of attending a conference? Knowing how often attending conferences leads to winning new customers allows you to associate the expense of attending with the value of the customer. You can even set an objective of a minimum number of prospect introductions at the conference and evaluate how well a particular conference performs against others.

OBJECTIVES AND KEY RESULT PLANNING (OKR)

Ultimately this thinking should lead companies to the concept of OKR (objectives and key results), an essential discipline in businesses committed to a developing a data driven culture. Implementing OKR across an organization will clarify the objectives that the entire organization should be focused upon and connect everyone’s activities to those objectives. Loosely defined, objectives are the ultimate outcomes that an organization is hoping to achieve. Key results are the means to achieving those objectives. Goal decomposition is the method by which objectives are defined through goals that can in turn be broken down into realistic, measurable, time-related key results. A result of this discipline is the ability to evaluate the contributions made by each part of an organization, in each of their activities. An open set of cascading management dashboards can allow every member of an organization to both contribute and comprehend the organization’s focus and progress. With these tools in place, companies can determine the value of social media or any other indirect contribution toward economic value — ROI.

Ultimately Charlene Li’s attention to the importance of evaluating the value of social media is not in conflict with the frequently asked question about ROI. But rather than trying to dissuade business people from asking this question it is perhaps more important to emphasize the long term contributions that social media makes to achieving a company’s objectives. In fact any calculation of marketing ROI must take into account those long term contributions and cannot simply examine a direct transactional connection between actions and income.

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