The IPA has produced a best practice guide on effectiveness...

The IPA has produced a best practice guide on effectiveness...

Chapter 05

Return On Marketing Investment (ROMI) is the financial measure which provides the ratio of profits generated by a marketing investment.

The calculation is:

ROMI = (net profit generated) / (cost of campaign) x 100

The first step is to calculate the revenue generated for the client, remembering to take into account any effects on price.

Suppose that a marketing campaign for Brand X generated 1,850,000 extra sales.

If the average retail price paid for each unit was £1.49, what were the incremental retail sales worth?

- Incremental sales volume (units) A = 1,850,00
- Average price paid per unit B = £1.49
- Value of incremental retail sales C = A x B

Then the incremental retail sales were worth a total of £2,756,500

Table 1 shows a worked example.

A | Incremental sales volume (units) | 1,850,000 |

B | Average price paid per unit | £1.49 |

C = A x B | Value of incremental retail sales | £2,756,5000 |

D | Retailer gross margin (%) | £12.5 |

The next step is to calculate how much of that money goes to the retailer. Suppose the retailer takes 12.5% of the retail price. This percentage is called the retailer gross margin:

Retailer gross margin (%) D = 12.5%

To calculate the size of the retailer’s cut (called the retailer’s cash margin) you simply multiply your first answer by 12.5%.

Retailer cash margin E = C x D

Retailer cash margin E = £2,756,500 x 12.5% = £344,563

So, the retailer takes a 12.5% gross margin, which amounts to £344,563 in cash terms.

To calculate the incremental sales revenue to Brand X (which in table 1 is step F), we need to subtract the retailer’s ‘cut’ (E) from the value of incremental retail sales (C):

So the Incremental sales revenue to Brand X is £2,411,938.

As it’s often difficult to get exact data on intermediary margins, in table 2 there are some rules of thumb based on experience.

Product & channel | Retailer's gross margin on retail sales | So, for every £100 of retail sales, the client sells: | ...and the intermediary's cach margin is |
---|---|---|---|

Foods in a supermarket | 25% | 75% | 25% |

Computers in a high street retailer | 10% | 90% | 10% |

New cars in a dealership | 5% | £95 | £5 |

Remember that some brands are not subject to retail margin as they sell the product direct to the end user, rather than through an intermediary e.g. their website, through their own retail infrastructure, or by their own sales teams.

The next step is to calculate the contribution that those sales make to profit. To do this, one needs to take account of the incremental costs incurred. As sales go up, clients need to buy more raw materials and pay more wages. These variable costs need to be deducted in order to work out the payback:

Incremental costs (H) = variable cost per unit (G) x incremental units (A)

For instance, suppose that for Brand X the variable cost per unit was 57p. Then Table 3 below shows that the 1,850,000 of extra sales that we generated would mean £1,054,500 of extra costs:

A | Incremental sales volume (units) | 1,850,000 |

F = C - E | Incremental sales revenue to manufacturer | £2,411,938 |

G | Variable cost per unit | £0.57 |

H = G x A | Incremental variable costs | £1,054,500 |

I = F - H | Contribution margin from incremental sales | £1,357,438 |

J = I + F | Contribution margin (%) | 56% |

Subtracting these costs from the incremental sales revenue gives the contribution margin to profit:

Contribution margin (I) = Incremental revenue (F) – Incremental costs (H)

So, for Brand X in Table 3, subtracting £1,054,500 of incremental costs from £2,411,938 of incremental revenue gives a contribution margin of £1,357,438.

Alternatively, rather than using unit costs, one can do exactly the same calculation using the contribution margin, if this is known. The calculation then becomes:

Contribution margin (I) = Incremental sales revenue (F) x contribution margin% (J)

For instance, for Brand X in Table 3, the contribution margin is 56%. So the contribution margin to profit will be 56% of the incremental sales revenue (56% of £2,411,938), which is £1,357,438. This is exactly the same result as before.

Remember that some brands will not be subject to variable costs on a sale, this is particularly true when it is a service based business e.g. Insurance. ROMI calculations only look at the variable cost, so the cost associated with that incremental sale and not the cost of the running of the business, because these cost would be attributable to the company whether the incremental sale happen or not.

Having calculated the contribution margin, the final step is to subtract the cost of the campaign to calculate the net profit it generates.

Net profit generated (L) = Contribution margin (I) – Cost of campaign (K)

For Brand X, the contribution margin of the campaign was £1,357,438. But suppose the campaign cost £1,150,000. Subtracting the cost of the campaign off, we find that the net profit generated by the campaign was £207,438.

A | Incremental sales volume (units) | 1,850,000 |

F = C - E | Incremental sales revenue to manufacturer | £2,411,938 |

I = F - H | Contribution margin from incremental sales | £1,357,438 |

K | Cost of campaign | £1,150,000 |

L = I - K | Net profit generated by campaign | £207,438 |

M = L + J | Return on marketing investment (ROMI) | 18% |

The net profit generated is the ultimate measure of effectiveness, the measure of how much money the campaign made for the brand’s owners.

The ROMI calculation is presented as a percentage to show the ratio of net profit generated from the marketing investment.

So if the net profit generated is £207,438 you must divide this by the cost of the campaign £1,150,000 and multiple by 100 to create a percentage.

ROMI (M) = Net profit generated (L) / cost of campaign (K) x 100

A | Incremental sales volume (units) | 1,850,000 |

B | Average price paid per unit | £1.49 |

C = A x B | Value of incremental retail sales | £2,756,500 |

D | Retailer gross margin (%) | 12.5% |

E = D x C | Retailer cash margin (£) | £344,563 |

F = C – E | Incremental sales revenue to manufacturer | £2,411,938 |

G | Variable cost per unit | £0.57 |

H = G x A | Incremental variable costs | £1,054,500 |

I = F – H | Contribution margin from incremental sales | £1,357,438 |

J = I ÷ F | Contribution margin (%) | 56.28% |

K | Cost of campaign | £1,150,000 |

L = I – K | Net profit generated by campaign | £207,438 |

M = L ÷ K x100 | Return on marketing investment (ROMI) | 18% |