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.
2. Process Improvement Savings. Quite often, the updating process in a marketing database will obviate the need to run separate processes used in implementing stand-alone campaigns. For example, people with marketing databases no longer need to run separate merge/purge processes, because matching multiple files is always a part of householding or consolidation. Since the money you’re presently spending to do merge/purge will go away, you can count those dollars as part of your cost-justification.
Another factor to consider in process improvement is the benefit of quality assurance. If you have real examples of programs that did not work because of quality control problems (mailed to the wrong people, late execution, etc.) and can put a dollar cost on those problems, it is reasonable to assume that your new technology will save you money because you will not incur those problems going forward.
And, finally, many companies spend an enormous amount of marketing department time in the give-and-take of deciding what to do. New technologies should make that a much more efficient process. Marketing people should spend less actual time in those pursuits, and fully weighted hourly costs should produce significant dollar savings. Of course, this has to be balanced against the cost of any additional personnel you might plan to hire to work with the technologies. Still, the savings might be significant.
3. Information Technology Savings. If your marketing people will be creating segmentation and extracts using the technology in the campaign management or CRM tool you’re deploying, that might free up personnel and machine time in information technology and might mean that you no longer have to license separate programs for those purposes. Often, this benefit alone is enough to cost-justify an investment in new technologies, especially if you (like many companies) have interdepartmental billing. Over the course of my career, I have seen many instances in which a company’s IT department has purposely inflated intercompany billing costs to shift budget dollars to other departments. As a result, the intercompany savings in marketing are enough to buy the technology without including any other revenue sources. Of course, if IT has done that, they might fight your initiative to secure database marketing tools externally because it will shift those budget dollars back to them.
Assuming your IT department has not done that, though, you can still ask them for an accounting of the machine and people time they are expending on your behalf that will be supplanted by the implementation of your new technology. If you properly weight that time to include benefits and share of general/administrative expenses, it is usually a very significant number.
4. Time to market. Aside from the obvious benefit of addressing competitive challenges and opportunities, getting to the marketplace more quickly with new initiatives produces real revenue. Let’s say you have a new product to launch that you expect to generate an average monthly revenue stream of $100,000. If you can get it to market 45 days faster, then there would be a $150,000 revenue bump for the year at launch that you would not have gotten any other way. If faster time to market allows you to implement more programs over the course of a year than you would be able to otherwise, you might be able to logically include all the revenue from one or more additional programs in your calculation. If you want to make that a believable benefit, though, you need to show historical examples of programs you had to abandon or delay significantly because you did not have the technology to get them done on a timely basis.
There are dozens of mainstream ways to make money with a marketing database. However you decide to cost-justify your investments in database marketing, it is important that you state those justifications in easily-digested, real-world, dollar-oriented benefits that the bean-counters in your company can easily grasp.
One word of caution, though. Before you submit such justifications for budget review, make absolutely, positively certain that you’re going to have a way to measure them on the backend. Design exactly what the reports will look like with your analysts or vendor, and insist on an accounting of the source of each and every data point and how the fields they use are going to be populated. This is one time when being obsessive about the details can pay big dividends, and it’s worth the effort.
And finally, if you have an ROI case that you really believe is going to deliver $10.00 in measurable revenue or profit for each dollar invested, don’t just automatically send that number up the food chain. If you know $6.00 will get your budget approved, cut everything by 40% first. No one gets bonuses or promotions because they’re really, really good at making projections. The big money goes to the people who deliver more than they promise.
In addition to the hard numbers, there is the additional benefit of basic empowerment. Having access to database marketing technology and processes will allow you to do some things you would not be able to do otherwise, at any cost. Quite often, companies justify their entire investment based on there being no other way to do the things they have to do to take their business to the next level. There is a hard-dollar benefit to this, of course, but it is somewhat harder to quantify.
You have to put a dollar figure on what it is worth to you to be able to implement better targeted communications and/or customer dialogues more frequently and efficiently; but of course you cannot test to arrive at that figure until and unless you make the investment. In that case, your best bet might be to say you think it is reasonable to assume it will allow you to generate incremental revenue in the “X” percentage range, if you need dollars from this kind of benefit to make your ROI calculation work. But if you must do that, keep the percentage small—less than 1%, if possible. Otherwise, your chief financial officer might consider it padding.
More marketers than you think run multi-million-dollar budgets without first establishing the methodologies needed to make judgments about the value of those investments. It’s not a big stretch to believe that branding and general advertising might be difficult to quantify, but honestly, there simply isn’t any excuse for a lack of metrics in a database marketing program. The entire process is built on the premise that it has to be measured, and the tools to do so are readily available. If “lack of information” is the problem (as it usually is), then the data usually wasn’t properly sourced or efficiently organized to begin with, or the premise was based on data that simply can’t be made available. This is more often a planning problem rather than a technical one.
Measurement is at the heart of everything we do as database marketers, so when you first contemplate the creation of a database marketing program and its component parts, begin with the end in mind.
This piece is excerpted from “The Business of Database Marketing,” by Richard N. Tooker. It will be published in October by Racom Communications (www.Racombooks.com). Richard N. Tooker is vice president and solutions architect at KnowledgeBase Marketing Inc. in Richardson, TX.
