What is ROI, How to Calculate Return on Investment?
We’ve already talked about the definition of one important metric for business: the lifetime value of a customer, or CLV. In this article, we’ll tell you about another important indicator and its meaning: ROI. With it, you can identify effective channels to attract customers and, as a result, more wisely manage your budget for advertising campaigns.
Table of contents
- What is Return on Investment (ROI)?
- How to Calculate ROI: ROI Formula
- Benefits of calculating ROI
- Limitations of ROI
- Annualized ROI Formula
- How can you efficiently allocate your budget and increase revenue from ad campaigns based on ROI data using OWOX BI?
What is Return on Investment (ROI)?
Return on investment (ROI) measures the efficiency of an investment. The definition of ROI is a ratio of income from an investment to the expenses to finance that investment. The higher the ratio is, the more benefit you earn. It’s important to have the ratio >100% to avoid losses.
ROI calculations are quite simple. They can help you understand whether an investment opportunity is worth taking or not. You can also use it as an indicator of investment performance: the meaning of ROI (>100% or <100%) defines the value of your investment.
How to Calculate ROI: ROI Formula
Let’s look at an example for a better understanding of how to calculate return on investment.
Imagine you sell a product through your site. You have a budget that you’re willing to spend on Google Ads. Suppose it’s $1,000 per month. You launch a campaign, everything is going fine, and by the end of the month, your income from advertising campaigns is $6,000.
To calculate return on investment, you need to include salaries and all associated marketing costs. For example, say you paid $200 for a PPC specialist to set up this ad plus $50 to the copywriter who wrote the ad.
General formula for calculating ROI:
ROI = (income — costs) / costs × 100%
ROI calculation: ($6000 — ($1000 + $200 + $50) / ($1000 + $200 + $50)) x 100% = 380%
What does this mean for you? Well, it means that for every dollar you spent, you earned $3.8 in profit.
Benefits of calculating ROI
For different businesses, the figures are different: some businesses can make money with a very low ROI; others may need a relatively high ROI to avoid losing money on digital advertising. But one rule stands for all: return on investment must be positive (above 100%).
By observing the dynamics of changes in reports, you can redistribute your budget to more effective advertising channels. If your company spends more on Google Ads than it gets in return, spending on Google Ads should be invested, for example, in the Google organic channel in order to increase revenue if this channel is more effective.
Limitations of ROI
At first glance, ROI is a simple and understandable indicator that can be calculated without problems, but there are a few nuances to keep in mind.
1) Choose the right attribution model to make accurate calculations
In a simple case, a user clicks on an ad and makes a purchase. This revenue clearly belongs to the ROI calculation we’ve mentioned above. But what if the user clicks but doesn’t buy right then? What if someone clicks on your ad, goes to your website but closes it, then three weeks later sees a post for your product on Facebook, clicks on it, goes to your website, memorizes the URL and closes the site, and then a month later goes directly to your website by typing in the URL and makes a purchase? You could argue that this customer should be counted in the calculation for the initial ad because they first found your store via that ad campaign. Or you could argue that the Facebook post should get the credit since that was the last click before the purchase. A third option would be to split the revenue between the initial ad and the Facebook post.
The attribution model you choose determines how much credit your initial ad gets for this customer. What’s important is that you pick a single attribution model and use it consistently when comparing ROAS across channels and campaigns.
To objectively distribute the value of an order, it’s necessary to evaluate not just the last session but each buyer session. This is why we suggest using a ML attribution model.
2) Take into account all factors affecting revenue
Let’s take a look at a couple of things that might affect revenue.
Your best sales manager has switched to another company.
You’ve changed a supplier, affecting the timing of delivery for certain goods. At the same time, you’ve launched an advertising campaign and have many potential buyers — but there are no goods available. As a result, you have decreased ROMI, but this has nothing to do with advertising and marketing.
For a real-world example of the importance of a ML funnel-based attribution model, read our case study about how the insurance company INTOUCH built an effective advertising campaign evaluation system and optimized advertising costs by automating the collection and processing of all necessary data.
3) Account for differences in costs (hard to calculate the average check)
Imagine this. Last month you paid $100 to ship an order to Europe. But this month, your shipping service has raised their prices and now you need to pay $100 for shipping to US customers and $200 for shipping the same product to European customers. Or perhaps your customers preordered some expensive products due to an ad on Facebook. As a result, your ROMI may decline, although your marketing strategy is correct.
Annualized ROI Formula
One of the disadvantages of the regular return on investment calculation is that it doesn’t consider time periods. For example, a 20% return for 3 years is the same as a 20% return for 3 days, even though a 20% return in 3 days is better than 3 years. To deal with this issue, use an annualized ROI formula.
For example, if you invest $10 in advertising on January 1, 2020 for $10 and receive $12 revenue from it on June 25, 2020, the regular and annualized formulas will be the following:
($12 – $10) / $10×100%= 20%
[ ($12 / $10) ^ (1 / ((Jun 25 – Jan 1)/365)) ] −1 = 0.46 or 46%
Therefore, even though a regular return on investment ratio is 20%, the same figures in longer perspective give you more profit. The annualized rate of return and annual return differ because the former one also includes the sum of investment earnings over time.
How can you efficiently allocate your budget and increase revenue from ad campaigns based on ROI data using OWOX BI?
With OWOX BI, you can measure the effectiveness of your campaigns more deeply and automatically compare ROAS and ROMI, display results on a dashboard in OWOX BI Smart Data, Google Sheets, or Data Studio. As a result, you’ll be able to make conclusions about the payback of a channel based on complete data and will be able to properly allocate your budget.
In order to have a complete picture while comparing ad channels, you need to:
- Set up data transfer from advertising services (Facebook, Criteo, etc.) to Google Analytics via OWOX BI Pipeline, combining this data with behavioral data from your website.
- Configure OWOX BI Attribution.
- Build the necessary reports in OWOX BI Smart Data.
In the Results tab of OWOX BI Smart Data, there are several predefined reports:
You can find more reports in the Smart Data service itself and in the support section.
Measuring the return on marketing and business investments is a must. These metrics will help you find out where you really should invest in order to earn more. You should start setting up data collection and calculating ROI from the moment you start thinking about business and marketing costs.
When calculating return on investment, you need to:
- Choose the right attribution model
- Define your income and costs
- Consider the full sales cycle
Let us know in the comments if you still have questions about ROI. We’ll answer them in a short time.
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What is ROI and how is it calculated?Return on investment measures the revenue attributed to a particular investment.
What is a good ROI?For different businesses, the figures are different: some businesses can make money with a very low ROI; others may need a relatively high ROI to avoid losing money on digital advertising. But one rule stands for all: return on investment must be positive (above 100%).
What is a 50% ROI?A 50% return on investment means that you get $0.5 for each $1 you’ve invested.
What is a 100% ROI?A 100% return on investment means that you’ve doubled your primary investment.