In SEM (Search Engine Marketing) ROI is a safer metric, at the end of the day, than profit.
The pros of going with ROI outweigh profit in the immediacy.
Profit is almost always the primary goal in the long term, but marketers have a lot more control over ROI so programs are designed around this KPI first.
This is a guest post from my good friend David Chung, who used to work with me in Search Marketing and now works for Google in Korea:
Everyone’s getting smarter. Everything’s getting smarter, too.
I recently swapped out my Android mobile device for a traditional flip phone and it took no longer than ten minutes to feel the smart-ness sinking away into a dumb oblivion.
It took ten minutes to feel the urge to enlighten myself with the latest tidbits of wisdom from my social network.
Just ten minutes, and I was already fumbling around with T9 Word trying to reply to a SMS dinner invitation. Instead of “if I’m home by 7” my phone kept trying to write “he im good by p”. So dumb.
Marketers are getting smarter, too. With best practices scratched on every virtual wall, it’s hard to tell which marketing professional has the true edge. I don’t blame you.
We all look and sound the same lately, flaunting tons of white paper lingo like quality score optimization and ROI focus.
Every article, blog, RSS feed, and tweet I’ve read lately talks about making sure your SEM campaigns are maximizing their return on investment.
Here’s my response: Save the white for summer.
Here in Q2, as we start planning our marketing budgets for 2012, we have a responsibility to jump off our “high level” thrones, and start defining viable strategies that will maximize the one thing better than looking good in person—looking good on paper.
Bottom line profits.
But What’s Wrong With Maximizing ROI?
It’s a fair question.
I’ve been asked about this numerous times, and I found the following analogy to help.
Imagine you’re a soda salesperson. Now, you pride yourself on being an amazing salesperson. You can sell ice to an penguin and run of network display media to a direct response marketer.
Your price for a bottle of soda – $1. Now, you can sell that bottle for $100 (because you’re that good), but the problem is, it’s going to take you a long time to move product.
People are getting too smart, and their phones are even smarter. Just one snapshot with Google Goggles, and they’ll know every soda price within a 20 mile radius and the cheapest gas stations to fill up en route to boot.
So, for the sake of example, let’s just say it takes, on average, 3 months of good ol’ fashioned hustling to sell that bottle for $100.
But hey! You just got a ONE HUNDRED to one ROI! Amazing.
In the meantime, your counterpart down the street is selling bottles at $1.25. He isn’t even close to a 2 to 1 ROI. However, it doesn’t take much to move product at this price, and it turns out that your competitor can easily sell 5 bottles a day.
After 90 days of consistent 1.25 to 1 ROI execution, you meet and compare numbers.
The 100 to 1 ROI sounds good, but at the end of the day, the second salesman ends up netting more profits. The first guy made a profit of just $99.
The second guy finishes the same 3 months with more than 10% higher profit—a handsome $112.50.
The moral of this totally, oversimplified story is even simpler.
A campaign’s success is ultimately dressed in black. Black ink bottom line numbers. Profit.
The Difference Between ROI vs. Profits
ROI is a great KPI for monitoring overall campaign health, but it’s just a rate.
So how do we evolve from an ROI-focused approach to one that’s profit-maximizing?
The first step is to understand the relationship between operational profit and your advertising budget.
Your media spend is essentially one of many line items that add up to COGS (Cost of Goods Sold), or the cost of goods sold. Once you’re able to determine average margin of profit on your goods, then factor in ad spend, you can come up with a rough estimate of what your COGS percentage is.
The next step involves some calculation, using the square root rule to predict when you’ll hit diminishing returns on an advertising buy.
Here is an example:
Assume you spent $1,000,000 on marketing last year, generating $3,000,000 sales.
Your profit factor is 35%, yielding profit of $3,000,000 * 0.35 – $1,000,000 = $50,000 .
What would happen if you cut 20% from your marketing budget.
Step 1: Sales = (($800,000 / $1,000,000) ^ 0.5) * $3,000,000 = (0.894 * $3,000,000) = $2,683,282.
The “0.5” number is the square root … you are taking the square root of the ratio in change of marketing spend.
In this case, a 20% reduction in spend yields a 10.5% reduction in sales.
Step 2: Profit = $2,683,282 * 0.35 – $800,000 = $139,149.
In other words, you’d lose a little over $300,000 in sales, but profit would increase by nearly $90,000.
Using the square root rule enables marketers to model hypothetical scenarios, which then enable senior management or your clients to make informed decisions.
Are you losing out on potential profits by depending too heavily on brand keywords, albeit at a 20 to 1 ROI?
Perhaps it’s time to explore non-brand search terms.
Maybe this is an opportunity to expand your program into other channels, such as contextual targeting or a another search engine.
Even if your expansion efforts, on their own, were to yield an ROI of 2 to 1, this still pads your overall profit margin.
Yes, your 20 to 1 ROI will suffer because of the new “inefficient” campaigns entering your mix.
However, at the end of the day, both top line and bottom line revenue increase incrementally.