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Insight/Strategic Planning
Cost of Conversion: The Right Way to Calculate Marketing ROI

By Jeff Josephson, CEO, LeadGen.com
Originally published: 1/17/2014

Article Highlights:

  • It would be silly to credit a marketing program that cost $100 to implement and produced $1,000 in sales with a 1,000 percent ROI.
  • Not all outputs from different marketing programs are equal.
  • The only way to measure your marketing ROI is to include the expense associated with converting the leads by type of lead.

Calculating the return on your marketing investment (ROMI) may seem challenging given so many factors, both known and unknown, to consider. But if you ignore some of those factors or oversimplify them, you can end up misleading your audience.

Here’s how to get it right.

To start, we need to agree on what a return on investment is. While several complex financial formulas are available, the most intuitive and practical is going to be a formula that relates some measurable return, such as sales, revenue, or profit, to some investment, such as marketing expense, by dividing the former by the latter.

But it’s clearly not just a simple ratio.

For example, it would be silly to credit a marketing program that cost $100 to implement and produced $1,000 in sales with a 1,000 percent ROMI. At best, we only made $900. Instead, we should probably take $100 out of the revenue figure in order to calculate a more realistic ROI of 900 percent.

But this, too, has a flaw. Unless our revenue doesn’t have any cost of goods sold (COGS) associated with fulfillment, we probably shouldn’t imply that we made $900 in profit on an investment of $100 in marketing, which is what is suggested when we start subtracting out costs. Instead, we should probably also subtract the COGS (in this case, let’s say it’s $500) from revenue and only give the program credit with something that’s closer to gross profit. So now we’re down to a COGS of $400 divided by our initial marketing expense, for an ROI of 400 percent.

Subtracting your COGS from the revenue line is especially important if the marketing program emphasizes one particular product over another because different products (with different costs of goods sold) can easily generate different gross profits or margins. It is assumed that the marketing expense isn’t included in COGS. But if it is, just back it out to avoid any double counting.

This is all well and good, but now we have a new problem: Can marketing legitimately take credit for all of those sales or profits, even after it has been adjusted for marketing expense and COGS? In most companies, the answer is no.

One reason is that in most companies, the sales department is usually charged with closing sales. The marketing department “only” stimulates demand, gets the word out, or generates leads. And so if you’re going to allocate resources optimally, then you’re going to have to allocate credit according to the degree to which each function contributed to the sale.

An even more important reason for splitting credit is simply that not all outputs from different marketing programs are equal. From the perspective of the sales process, a click is not the same as a scheduled appointment with a decision maker. A whitepaper download is not the same as a business reply card. An exposure isn’t the same as a referral. In order to properly calculate your ROMI, you have to put a discrete and comparable value on the outputs of (or leads from) your marketing program, whether it’s a click, impression, email address, Web site visitor, referral, contact, or face-to-face appointment.

Lead Valuation

There are two ways to put a value on the output of your marketing program. One is simply to calculate the cost of producing a lead. For example, if you built a Web site and counted the number of visitors, then you could calculate the cost per visitor by dividing whatever it cost you to build the Web site by the number of visitors. If you sent out a mailing that included a business reply card (BRC), then you could divide the cost of the mailing by the number of BRCs you received to get a cost per lead.

But the problem with this approach is that the two outputs--visitors and BRCs--are not comparable. Sure, it might have cost you $1 per visitor, or $10 per BRC. But are they truly comparable? If they were, then you’d be arguing to invest in your Web site since those leads generated cost a small fraction of what they cost with a mailing. But we also know that a visitor isn’t worth the same as a BRC. First, we may not know any more about the visitor than his IP address, so our ability to convert it to a sale is quite limited. Second, even if we knew who this person was, the close rate is going to be different.

And that’s where the problem lies. Specifically, while the output of virtually any marketing program can be called a lead, not all leads are the same. In fact, not only are they different, but their different values make using their cost of production meaningless in the calculation of ROI.

Instead, you need to calculate the value of each lead in the sales process--not just its cost.

Calculating the Value Of A Lead

Every company has a unique sell cycle that represents the series of investments and events, from the earliest announcement of the availability of the product to the closing of the last upsell. A B2B company’s sell cycle, for example, typically starts with its marketing team promoting a new product, stimulating demand, and generating leads. At some point prospects are identified, and they’re turned over to someone in sales who attempts to qualify and close them.

For example, marketing might send out a batch of emails, generating “opens,” which they then turn over to sales. They might write and post a whitepaper on the company’s Web site, and whenever someone requests one, marketing turns the contact information over to sales for follow-up. They might send out a direct mail piece and turn the BRCs over to sales. They might exhibit at a trade show and come home with a stack of business cards that they give to sales. Or they might conduct a telemarketing program and actually book appointments for the company’s salespeople.

If each of these leads had the same qualification and close rates, then there wouldn’t be a problem. But they typically don’t. So, you need to consider the cost of conversion to the initial appointment (or some other common event) in order to accurately calculate your ROI. This cost (where smaller is better) is the true measure of the value of any marketing program.

Depending on your company’s sell cycle, it may be easier to calculate the cost of conversion in terms of what it costs to convert the lead to an initial appointment or foot traffic, which is what we typically recommend. Or it may be easier to go all the way to closing. But as long as you’re consistent, the method works.

To be abundantly clear, lead scoring--to the degree that it attempts to measure attributes of leads other than the cost of conversion (or closing)--is precisely the wrong approach. The only way to measure your marketing ROI is to include the expense associated with converting the leads by type of lead.

Once you add that cost of conversion to your denominator, you’ll be able to calculate your true marketing ROI. Ignoring that cost will cause you to misrepresent the return on your marketing investment, leading to bad decision-making and, ultimately, failure. Considering the cost of conversion lets you compare apples-to-apples and make better decisions.

About Jeff Josephson
Jeff Josephson is CEO of LeadGen.com in Moorestown, N.J. Email him at Jeff@LeadGen.com.



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