News Column

Calculating Your Roi

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Cannes, France The locale of this year's most important global wireless conference was calling Fernando Corona. But Mr. Corona, CEO of California-based V-Enable, couldn't justify spending three months' worth of his company's marketing budget to rent booth space. So instead of forking out $50,000 for a stall at the 3GSM World Congress show, he corralled some of his telecom colleagues into renting a yacht in Cannes.

V-Enable had to pay only a few thousand dollars for the vessel, but it gave the company great exposure. The 65-foot V-Enable yacht, which was moored right next to Microsoft Corp.'s 125-foot yacht, became the venue for business meetings and parties.

The mental exercise behind Mr. Corona's marketing decision involved the accounting concept of return on investment (ROI). In Cannes, V-Enable spent between $5,000 and $10,000. For that money, the company wined and dined three potential customers.

"I said, 'I'll feel comfortable that it justifies this level of investment if we get these three people to show up,'" Mr. Corona says. "When you pull the trigger on an event, advertising campaign, or direct sales, you need to know what your return is going to be. … If you have a very targeted account, $5,000 goes a long way you can hop on a plane, take the client to dinner, and get a deal. If you are prospecting, you have to go to some of these trade shows. We knew our competitors were not exhibiting [at the GSM show], so we had a lot more traction."

In this rough-and-tumble economy, ROI calculations play a key role in controlling expenses. CFOs and other managers must prove they are getting the biggest bang for the buck on expenditures like advertising and information technology. But many experts warn that ROI deals with more than number crunching it requires a lot of homework to get the numbers right. (For a primer on ROI calculation, see the accompanying story "The Math Behind ROI.")

For advertisers, a high ROI begins with choosing the right medium. "In the dot-bomb era, companies basically said, 'I built www.barbeques.com and I'm going to get as many people to come to my Web site as possible, and I don't care if I spend $50 per person,'" says Tony Dieste, president of Dallas-based advertising agency Dieste Harmel & Partners. "If you looked at their ROI, you'd see it would take 50 years to make up that $50 per person. So the ROI was upside down."

Mr. Dieste says that sometimes the right medium depends on the distribution channel. Dieste Harmel has developed a "Hispanic Intensive Targeting" program that isolates a client's stores and reads the sales volume in each of those stores. This type of data allows for correct calculation of ROI.

"If the general market is growing at 2 percent to 3 percent and the Hispanic market is underdeveloped in that market, then you would expect the Hispanic market to grow at higher levels," Mr. Dieste says. "In order to measure that you have to isolate the Hispanic volume in that market."

Easy calculation of ROI explains in part the popularity of direct marketing. "If you see a commercial for a telecom company with an 800 number, and you call that number if the company is doing its job right you are tracked, so they will know how many people actually bought the product or service," explains Hector Orcí of La Agencia de Orcí y Asociados in Los Angeles. "Advertising has the purpose of getting the person to dial the number. The smart companies track every campaign. They can tell what results the four o'clock soap opera delivered, and what the six o'clock news delivered."

For ROI on information technology, the basic principles remain the same but both the investment and the return grow more complicated. Bill Kirwin, vice-president and research director of the Connecticut-based IT research firm Gartner Inc., says companies should look not just at the immediate costs of hardware and software, but also at expenses such as training and the impact on the end user. One of the things left out of a traditional financial ROI is the risk of an investment, he adds.

"In the free-spending days of the late 1990s, a lot of these things were poorly thought out. Before, anything over $1 million was run through the higher financial [executives]. Now, if you want to get a pencil sharpener you have to justify it. One million dollars is a lot of money, and I think spending $50,000 to do the analysis on a million-dollar investment is very prudent. That should be built into the cost of doing business," Mr. Kirwin says. "You can even do the risk analysis on doing the financial analysis. If we make a bad decision, what are the risks? Are we going to lose customers? Are we making a million-dollar decision that will put us out of business in a year?"

In figuring out IT costs, the human factor looms large. A typical mid-sized company might spend $5 million on technology and barely $200,000 on implementation, according to Theresa Welbourne, CEO of Michigan-based eePulse. Ms. Welbourne, who is also a professor of entrepreneurship at the University of Michigan, says her company has developed software to measure the ROI of intangibles such as morale, productivity, and other employee-based factors.

On the return side of the equation, Mr. Kirwin says ROI should consider the full life cycle of an IT investment strategy. The CFO and technical staff must analyze how they will optimize business processes to take advantage of a piece of software, for example. Often, such projections are left out of the initial funding request. "It seems that the project sponsors keep going back to the well for more money that should have been thought through in the beginning," Mr. Kirwin explains. "Then it's called overspending, when it actually was underfunded in the beginning."

"I think that the real ROI comes from what's in the black box, and that's your employees," adds Ms. Welbourne. "If a company says, 'Implementing the technology resulted in laying off a lot of people and that's how I got my savings,' that's not how ROI works. The ROI is people transforming the technology and doing something with it. If you don't understand the black box, then you really don't understand ROI."

Although calculating ROI is a financial function, responsibility for it rests on all employees, including the CEO. Some chief executives love to see high-tech equipment in the office, regardless of the financial results. But such ego-pleasers aren't confined to IT. Mr. Orcí warns businesses against getting caught up in the flashy images of a marketing campaign. It's very unusual, he says, for a CEO to determine the return on investment of a million-dollar TV spot during the Super Bowl. "A rule of thumb is: What is the good business reason for doing this? It isn't because I did it last year," Mr. Orcí says. "There is no excuse for not knowing the bottom-line impact."



The Math Behind Roi

For the non-mathematical, figuring out Return on Investment can loom as a daunting task. Here are a few methods to help with the calculation.

As a Percentage. If your return is $1 million in 12 months on a total investment of $250,000 in the same time period, the ROI can be calculated as follows:
ROI = (Return Investment)/(Investment) x 100, or
ROI = ($1 million $250,000)/($250,000) x 100 = 300%

As a Ratio. Divide the return by the investment:
ROI = $1 million /$250,000 = 4:1

Break-Even Time. If you are trying to determine the break-even ROI, you want to find how long it takes to make back your initial investment. You can calculate it in days, weeks, or months. For break-even ROI, follow this formula:
ROI = (Investment)/(Return) x (Time Period), or
ROI = ($250,000)/($1 million) x 12 months = (0.25) x 12 = 3 months

More complicated versions of ROI usually involve adding elements to the "return." For example, when figuring ROI on a marketing campaign, a company might value new customers more than old ones, on the assumption that new customers will buy again in the future. Therefore, the new-customer purchases may be multiplied by a certain factor to reflect future returns on the investment.

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