Database Marketing and ROI

Most database marketing programs are designed to accomplish one or more of only three basic business objectives: acquiring new customers, retaining existing customers, or cross-selling.

Measuring return on investment for customer acquisition is a fairly clear-cut proposition. Most businesses have a reasonably good idea what kind of revenue a new customer will generate in a year, and they know how much profit that revenue will create. Comparing that margin to the cost of promotion yields an allowable customer acquisition cost. If the margin is greater than the cost, the effort was profitable. Quite often it isn’t profitable because the cost of acquiring the customer is a lot higher than the expected first-year revenue, which makes retention and cross-selling a critically important objective. Some companies actually don’t expect a customer relationship to return a profit until the customer has been on the books for several years.

Measuring ROI on existing customer programs is somewhat more complex.

First, retention and cross-selling efforts are complementary, especially in multi-contact or continuity programs. In order to determine the effect of one, the calculation really needs to include both. Cross-selling programs that increase the number of purchases or relationships that a customer has will always have a positive effect on retention. Conversely, retention efforts will always create opportunities to increase the depth of the relationship through cross-selling. Your calculations should recognize that fact.

The “Magic Number” in Retention Management

The retention calculation should also recognize the fact that lost customers have to be replaced. For some reason, no one ever seems to include the cost of replacing lost customers in the ROI calculation for retention programs, but unless your objective is to have fewer customers at the end of this year than you had at the end of last year, you should include it. No company that I know of has that objective.

New customer acquisition is expensive, and that makes customer replacement cost the “magic number” that makes retention ROI calculations work. It’s a real cost, and it almost always has a significant impact on the metrics.

As a grossly simplified example, let’s say you have 500,000 customers with an average profitability of $100 per year, and your existing measurement methodology proves that your retention efforts helped hang onto 2% of them who otherwise would have become former customers. Further, let’s say that your retention marketing efforts cost $4.00 per year per customer. The calculation would look something like this:

*(500,000 customers x 2% retention x $100 profit) /
(500,000 customers x $4.00 marketing cost)

That calculation would yield a negative ROI of 0.5:1. You spent $2 million to keep $1 million in one-year profits.

But if it costs you $1,000 each to acquire new customers and you use replacement cost in the calculation, the formula would look like this:

*[(500,000 customers x 2% retention rate x $100 profits) +
(500,000 customers x 2% retention x $1,000 replacement cost saved)] / [500,000 customers x $4.00 marketing cost)

That calculation would yield a positive ROI of 5.5:1, in which you spent $2 million to keep $11 million in one-year profits. In this example, when we included the cost of replacing lost customers, the ROI magically got 11 times better. Of course, the calculations above ignore the long-term value of the customer, which you absolutely shouldn’t do. It simply illustrates the basic concept: Replacement cost is a real expense and ROI calculations should account for it.

The working ROI Calculator spreadsheet (see Figure !) includes all the calculations above, plus an additional element to the mix: the degree to which customers are cross-sold additional products during the process of retaining them and the value of those purchases. Use it to determine how including replacement costs in your own ROI calculations will affect your results reporting.

Cost Justifying a Launch

Any marketer contemplating the creation of a technology infrastructure to drive database marketing or customer relationship management initiatives usually faces the need to cost-justify the investment.

In this situation, the information that goes into the return on investment calculation falls into four general areas:

1.Cost. This is the total cost of buying/licensing the technology and deploying it. It should include the cost of personnel that will be dedicated to the use of the technology, fully weighted, unless they are already on staff. This will, of course, be the easiest number to get your hands around. In most cases, companies will amortize any initial or extraordinary setup/licensing/installation costs over the life of the vendor contract, but generally not longer than four years.