We bandy acronyms about so much that sometimes we assume everyone knows what they mean. Take the acronym ROI. While experienced business people may have an idea of what that means, I’ve had new entrepreneurs and non-native English speakers sheepishly ask me, “What is ROI?”
ROI stands for “return on investment.” Often you see “return on investment” defined for an investment in a company or a business, say as a stockholder or angel investor. For instance, if you’ve invested in a startup — someone else’s or perhaps your own startup — you probably should calculate how much of a return you have gotten on your investment in that startup company.
ROI Really Means: Are You Investing Your Funds Wisely?
Return on investment tells you if you are using your money wisely, when you invest. One thing that professional investors do is evaluate the potential ROI in a startup, compared with other investments they could make. For instance, can you get a better return investing in your nephew’s Internet startup — versus investing those same funds in the stock market?
Now, you may want to invest in your nephew’s startup just to help out your nephew — regardless of any ROI. In that case, you’re not really investing based on ROI. Your motivation is to help out a family member.
But professional investors and non-family members will most likely be looking for the ROI. As a startup entrepreneur, it’s going to be up to you to paint a picture of the potential return, calculate it realistically — and ultimately make sure there actually is a return on investment.
Fred Wilson, the well known investor in tech startups, has a helpful spreadsheet and accompanying explanation, on how to calculate a return on investment.
Get Used to Calculating ROI for Expenditures
However, ROI doesn’t need to be limited to measuring a return on investment in a new company.
Apply the ROI (return on investment) analysis more broadly to each expenditure. Ask yourself: if we spend that amount, will we really get a return, and how much can we expect to get?
As a business owner, when you discipline yourself to think about each expenditure in terms of what you get back from it, it will help keep your business profitable.
For example, if you are investing in a new advertising initiative, evaluate the results of that initiative in terms of “ROI.” Calculate how much you’ve spent on the marketing, and try to calculate the return. Calculating expenses is usually the easy part. Calculating the return just from that initiative can sometimes be the hard part.
Let’s take an easy example. If you’re selling with e-commerce, it’s usually not hard to calculate ROI on pay-per-click ads. With the right tracking technology, you can determine what you spend on pay-per-click ads, and the exact sales you get for those expenditures.
If only all businesses were that simple!
Unfortunately, they are not. In many businesses, it’s much harder to track exactly what triggers a sale. That’s because buyers often don’t make a buying decision based on a single factor or activity, such as clicking a pay-per-click ad.
You’ve probably heard the old truism that it takes a minimum of 7 marketing “touches” to get to a sale. That means it’s going to take multiple marketing activities over time to convince a buyer to buy — not just a one-time click. Before deciding to buy, a buyer may click on a search result, AND see a full-page magazine ad, AND read a blog post written by a company executive or about the company’s products, AND view some online banner ads AND enjoy the vendor’s Facebook updates — together all of those could have an impact. They could cause you to put that company at the top of your list, when you’re ready to buy.
For reasons such as these, ROI will be much more challenging to calculate in many industries and businesses.
|Evaluate All Expenditures||Don't limit ROI assessment to new company investments. Extend it to all business expenditures, regardless of the category.|
|Assess Potential Returns||Before making a financial commitment, ask whether a particular expense is likely to yield a return and, if so, how much.|
|Maintain a Profitable Focus||As a business owner, instill a disciplined approach to consider what each expenditure will contribute to your overall profitability.|
|Analyze Marketing Initiatives||When investing in marketing or advertising, evaluate the results in terms of ROI. Calculate both the expenses incurred and the anticipated return.|
|Recognize Expense Calculation||While calculating expenses is usually straightforward, determining the return specifically from an initiative can pose challenges.|
|Use Tracking Technology||For certain business models like e-commerce, calculating ROI on pay-per-click ads is relatively straightforward with tracking technology.|
|Account for Multiple Touchpoints||Acknowledge that many industries involve multiple touchpoints in the buying process, making ROI calculation more complex.|
|Understand Customer Behavior||Buyers often make decisions based on various factors and activities. Be aware of the complexity of customer behavior and its impact on ROI.|
|Adapt to Industry Variations||ROI calculations may vary significantly across industries due to differences in purchasing processes and influencing factors.|
|Invest in Data and Analysis||Invest in data collection, analytics tools, and continuous analysis to enhance your ability to evaluate ROI effectively.|
If It’s So Hard, Why Bother Calculating ROI?
Just because it’s challenging, that shouldn’t be an excuse to throw in the towel. You should still attempt to calculate ROI. Even if you can’t attach a precise dollar number to a marketing activity, say, you may be able to determine that in general sales went up after you initiated a certain marketing campaign. You may be able to collect anecdotal stories or testimonials that a particular sale came as a direct result of a particular marketing activity (that’s why you should always ask new customers how they learned of you).
Track your expenditures in as detailed a way as possible. Identify expenses related to certain activities, or certain products or services you deliver. Use — really use — analytics tools. And calculate as best you can the value your business gets specifically after certain activities, or that certain products or services bring.
This overview at the Marketo blog outlines different methods of calculating a return on marketing, for instance. It points out the level of detailed analysis you need to get into.
The more data you collect and analyze, the better you will get at figuring out ROI. And the better you will get at spending your money wisely in your business.
Understanding ROI and Its Application in Business
ROI, or return on investment, is a crucial concept in business that evaluates the effectiveness of expenditures and investments. It goes beyond the financial jargon and is applicable to various aspects of decision-making within an organization. Here’s a breakdown of ROI’s significance and how to apply it:
- Evaluating Wise Fund Allocation: ROI helps determine whether your money is being used wisely in investments. It’s not just about financial gains; it’s a tool to assess the comparative advantages of various investment options.
- Professional Investors’ Perspective: Investors, especially professionals, often assess the potential ROI before committing funds. They weigh the ROI of investing in a startup against other opportunities, ensuring they maximize their returns.
- ROI vs. Personal Motivations: While some investments may not have a substantial ROI, personal motivations or family considerations can drive funding decisions. However, non-family investors typically prioritize ROI.
- Calculating Realistic ROI: Entrepreneurs must paint a realistic picture of potential returns on investments. Accurate ROI calculations are essential in persuading investors and ensuring actual returns.
- Calculating ROI for Expenditures: ROI analysis isn’t limited to investments; it can apply to expenditures as well. Businesses should evaluate every expense by asking if it will yield a return and, if so, how much.
- Advertising Initiative Example: When investing in marketing, calculating ROI is essential. Expenses and returns must be assessed. While some calculations are straightforward, such as pay-per-click ads, others can be challenging due to complex buyer journeys.
- Multiple Marketing Touchpoints: In many industries, multiple marketing activities and touchpoints influence a purchase decision. Tracking the exact impact of each activity on ROI can be challenging but valuable.
- Why Calculate ROI: Even if calculating ROI is challenging, it’s crucial. It provides insights into the effectiveness of various activities and helps identify what contributes to business growth. It allows for better expenditure tracking and informs decision-making.
- Collecting Data and Analytics: Detailed data collection and analytics are essential for accurate ROI assessment. The more data you collect and analyze, the better you become at gauging ROI and making informed financial decisions.
|Aspect of ROI||Description|
|Wise Fund Allocation||ROI evaluates fund usage effectiveness beyond financial gains, aiding in comparing investment options.|
|Professional Investors||Investors, especially professionals, prioritize ROI when allocating funds, maximizing returns across investment opportunities.|
|ROI vs. Personal Motivations||Personal motivations may lead to investments with lower ROI, but non-family investors typically prioritize returns.|
|Calculating Realistic ROI||Entrepreneurs must provide realistic ROI projections to persuade investors and ensure actual returns meet expectations.|
|Calculating ROI for Expenditures||ROI analysis extends to expenditures, prompting businesses to evaluate expenses and determine potential returns.|
|Advertising Initiative Example||ROI is crucial in marketing investments, assessing expenses and returns. Some calculations are straightforward, while others are complex.|
|Multiple Marketing Touchpoints||In industries with numerous marketing touchpoints, assessing the impact on ROI can be challenging but valuable for decision-making.|
|Importance of ROI Calculation||ROI, despite its challenges, offers insights into activity effectiveness, contributes to business growth, and informs decision-making.|
|Data Collection and Analytics||Detailed data collection and analytics enhance ROI assessment accuracy, aiding in making informed financial decisions.|
Navigating ROI for Business Expenditures
Understanding ROI (Return on Investment) isn’t just for evaluating investments in new companies; it can be a valuable tool for assessing the returns on various business expenditures. By applying ROI analysis to your spending decisions, you can make more informed choices and contribute to your business’s profitability. Here’s how to navigate ROI for business expenditures effectively:
- Broaden the Scope: Don’t limit ROI analysis to just investments in new ventures. Extend it to all expenditures. Ask yourself if a particular expense will yield a return and, if so, how much you can expect.
- Advertising Initiatives: When investing in advertising or marketing initiatives, calculate ROI by comparing the amount spent to the revenue generated. For instance, with pay-per-click ads, it’s relatively easy to determine how much you’ve spent and the exact sales attributable to those expenditures.
- Multiple Touchpoints: Recognize that in many businesses, buyers don’t make decisions based on a single factor. They often require multiple marketing touches before committing to a purchase. Consider the cumulative impact of various marketing activities, such as search results, ads, blog posts, banner ads, and social media updates, in influencing a buying decision.
- Challenges in Calculation: Calculating ROI can be challenging in industries where tracking specific sales triggers is difficult. However, even if you can’t assign an exact dollar value to each marketing activity, you can still gather anecdotal evidence, collect testimonials, and observe general trends in sales after implementing certain campaigns.
- Detailed Expense Tracking: Maintain a detailed record of expenses related to specific activities, products, or services. Utilize analytics tools to gain insights into the effectiveness of each expenditure.
- Continuous Improvement: The more data you collect and analyze, the better you become at evaluating ROI. Regularly review your spending decisions and adjust your strategies based on ROI insights to optimize resource allocation.