I Must Not Understand The New Math

By far the most popular way to manage a PPC campaign is by ROI. That makes no sense to me. Maybe it’s the new math… \$100K Spend X 5:1 ROI = \$500K Revenue – \$100K Spend = \$400K Total Revenue \$500K Spend X 2:1 ROI = \$1Mill Revenue – \$500K Spend = \$500K Total Revenue Last time I checked \$500K was better than \$400K right? So ROI and budgets are not super awesome happy fun measures of success. So why all the focus? Has the math changed? ADDED: To be perfectly clear I’m talking about a case where increasing a spend that significantly brings your ROI down. Understanding this is harder than playing video games with elo boosting services. The point of my question is that even at a lower ROI with a greater spend if you get more to the bottom line why would you constrain yourself with ROI? Read more about this on FootwearGeek.

1. Kenny says:

That’s not fair math.

\$100K Spend X 5:1 ROI = \$500K Revenue – \$100K Spend = \$400K Total Revenue

\$100K Spend X 2:1 ROI = \$200K Revenue – \$100K Spend = \$100K Total Revenue

\$400K > \$100K

2. nicholas says:

the math hasn’t changed… the incentive basis has.

3. oilman says:

Kenny – you’re missing the point – I higher spend at a lower ROI can put more money in the bank so why not spend more at a lower ROI if it’s making you more money in the end? ROI and budgets be damned – full steam ahead.

4. Kenny says:

Todd – That doesn’t make any sense.. Why wouldn’t you spend more at a higher ROI and make the most potential income?

The point is that when you do comparative mathematics, you must assume that variables are equal. You can’t allow for one equation to start with more capitol, that is an unfair advantage. If 2 ad campaigns have equal amounts of money to spend, which return would you want?

5. oilman says:

Kenny – my point is that that typically when you start raising budgets by that magnitude often ROI goes down. I’m stating a very specific case and will endeavor in future to provide more detailed background.

You are talking about an entirely different situation than I am presenting here.

6. Laura (a.k.a. la'dork) says:

I think I get what you’re saying, assuming you are limited to spending your ad \$\$\$ on PPC, but I would venture to say that perhaps the opportunity cost of not using a higher ROI alternatiive would be bad for the 500K guys… so ROI may perhaps still retain the title of super-awesome-happy-fun-measure of projected and real success… no?

7. aldigital says:

When I work with ROI, we’re looking at profit margin and not just revenue. We measure ROI as a % and a total dollar amount and the two aspects need to be balanced to insure the business objective. We manage with the ultimate goal of a net 10% ROI (net profit return) and will take that any and every time no matter the amount of spend, as would just about everyone today.

Now when the ROI drifts below 6%, thats where we’re looking at it and saying we won’t increase spending to obtain more because we feel it is possible to receive a similar return in more safe environment elsewhere. Money finds its best return mitigated by risk factors.

8. Dave Child says:

Your maths isn’t flawed, just incomplete. Orders for most businesses entail a 30 to 50% profit:

At 50% profit:

\$500K Revenue – \$250K Cost – \$100K Spend = \$150K Profit

\$1000K Revenue – \$500K Cost – \$500K Spend = \$0 Profit

At 30% profit:

\$500K Revenue – \$250K Cost – \$100K Spend = \$150K Profit

\$1000K Revenue – \$500K Cost – \$500K Spend = \$0 Profit

You would need a profit margin of 80% or above to warrant spending more with the lower ROI:

\$500K Revenue – \$100K Cost – \$100K Spend = \$300K Profit

\$1000K Revenue – \$200K Cost – \$500K Spend = \$300K Profit

9. Dave Child says:

Sorry, I managed to miss out the numbers for 30% profit level:

At 30% profit:

\$500K Revenue – \$350K Cost – \$100K Spend = \$50K Profit

\$1000K Revenue – \$700K Cost – \$500K Spend = \$200K Loss

10. oilman says:

Dave – thanks for the great response. That’s the kinda stuff I was hoping to trigger ๐

11. tom pitts says:

just because PPC touched an order doesn’t mean the revenue was incremental. orders attributed from search engine or search management pixel tracking is vastly different than orders that would not have happened without the PPC spend.

maintaining a certain margin on the spend might help insure the spend results in incremental revenue rather than just spending more to make one marketing channel look better.

12. And what if you don’t have the extra \$700,000 you need for your example?

13. Kenny – youre missing the point – I higher spend at a lower ROI can put more money in the bank so why not spend more at a lower ROI if its making you more money in the end? ROI and budgets be damned – full steam ahead.

14. What if you could spend more than \$100k for that? How about \$250k, would it have a bigger effect? Or the ratio would still be the same?

15. Brian Mark says:

Don’t forget that if you’re sending out more orders, you’re going to (most likely) need more employees to handle the orders, more people to answer phones, and just generally increase payroll to accommodate. ROI is a healthy measure, but only if you’ve got set margins. All of these numbesr are useless if you don’t know what you’re making on a conversion.

In online retail, many commodity items are in the 10 – 15% margin range, so even a 10:1 ROI leaves you losing money by the time you pay 3% credit card processing fees, labor, carrying costs, and other overhead.

I can’t understand that math, seems like an unfair math.

17. Trendsetter says:

Is that not expensive???

18. marcelino says:

Great discussion, but I have always used a very simple approach. The least amount of investment that gives me the highest return always works.

19. Rob Woods says:

I agree with Dave’s point above that gross margin has to be a part of the equation. We use margin on ad spend as a metric rather than ROI based on gross sales. To Tom’s point above, we also apply an attribution model which allocates the margin generated for a sale across the various sources which generated it. We then set a target ratio for how many \$ in profit margin we need a campaign to generate. The ROI number doesn’t matter as much as the margin ratio. If we set a target of \$2 in margin for every \$1 we spend, we’ll spend as much as we can until that margin starts to diminish. The target should be the most total net margin dollars the campaign can generate, not the highest ROI ratio.

20. Jet Lag says:

The bottom line is that you are right, far too many businesses are run on “vanity” statistics that look and make them feel good, when at the end of the day, money is being left on the table and the real statistics sit idle. Good post.

21. babanner says:

No math never changes. Business plans change only. You shouldn’t focus only on one type of plan to make money: more is better and risk free.

22. Todd says:

Great point. The only thing that should matter is how much is going to the bank. It’s crazy when people get hung-up on sticking to an ROI percentage! Not only is it more money in the bank, but potentially more returning customers or more people on an email list etc… – Todd: good seeing you again the other night in downtown LA by the way

23. Joanie says:

I think of ROI not just in terms of money but also time, workload, etc. You may spend twice as much and still make more profit overall, but are you working harder to manage ads, spending more time, etc. If you’re working twice as hard and not making twice the money, is it really a great investment after all?

24. All this numbers are confusing… ๐ I need to read some accounting books..

25. Leopold says:

Damn numbers( I always have problems with them.

26. Aspire says:

\$100K Spend X 5:1 ROI = \$500K Revenue – \$100K Spend = \$400K Total Revenue

\$100K Spend X 2:1 ROI = \$200K Revenue – \$100K Spend = \$100K Total Revenue
At 30% profit:
\$100K Spend X 2:1 ROI = \$200K Revenue – \$100K Spend = \$100K Total Revenue

\$400K > \$100K
ROI and budgets be damned – full steam ahead.

27. gurgle says:

28. bytovki says:

ROI depends on very many factors, it can be improved.

29. Trent says:

Because if you can find an optimal ROI level for your investment, then you can repurpose excess funds not achieving a better ROI and place them in other campaigns that may achieve better success. ๐

30. Gui Ambros says:

As Dave pointed out, revenue is just part of the story. Any serious advertisers would do the calculation based on orders, profit, ROAS. ROI is not a flawed methodology; it just doesn’t tell the whole story.

Going beyond profit, you should also look at overlapping mediums and develop multi-channel attribution model to judge which channel really impacted the performance. Just because someone clicked on your paid-search ad doesn’t mean that it was really effective. Probably he’s just lazy to type your site’s url, like 80% of us. You need to understand all the historical impressions AND clickstream data over multiple channels: display media, search, email, affiliates, etc, so you can refine your attribution model and give proper credit to who the credit is due.

btw, great talk today at #Gnomedex.

31. Scrabble says:

If you take in risk to account too it makes more sense, I’d rather risk 100k at 5x ROI than 500k at 2x. Making just another 100 doesn’t call for the investment of 400k more.

32. Incentive is absolutely correct.

33. bali fishing says:

Thats not fair math bro..

34. ROI will do for online pureplayers. Profit comes at a later stage. Nice article, had to read it a few times though.

35. Kathy says:

Wouldn’t you continually put money in (as long as you have it) until you are closest to the 1:1 ratio that you can get, presuming we’re talking about contribution dollars rather than gross sales? Anything more than breakeven is profit. Unless you have another marketing investment that performs better than the 1:1 at the same spend levels.

36. Jay says:

It’s math like this that causes financial meltdowns..

37. In your specific example if your math is correct I don’t see why you wouldn’t do that, but that’s certainly not the “norm”. More often than not, once you calculate all of the external variables in for a real world business example (as someone stated above, added employees, working longer hours to keep up with orders, answer customer service emails, any shipping/handling costs that you’re taking on the chin through free shipping offers, etc.) as the ad spend goes up and ROI goes down, you’d be silly to keep “spending more to make more”. There comes a point where even though you may be collecting more revenue, it’s certainly not profitable. I agree with Brian’s post above me 100%.

38. ROI? How much do I have in my pocket at the end of the day. Companies get so caught up in ROI and cost of sales that sometimes they can’t see the forest for the trees.

Makes no sense to me. I would rather make \$25 five times than \$100 once. New math or old math business is still measured by the bottom line of how much is left after expenses and the more the merrier.

39. Mike says:

Doesn’t the first scenario just indicate a greater efficiency? Although you make more money in the second scenario on an absolue basis, it’s not as efficient as the first scenario.

40. I see what you are saying, but they way I would look at it is, if I can spend \$100 and get a \$500 ROI, I would expect a \$2500 ROI from \$500. If I couldnt find a way of getting that ROI, I would be unlikely to invest the extra \$400 to get an extra \$100 profit.

41. Jim says:

It looks to me like you got the math down perfectly.

42. Although the ROI case 1 is more than the ROI for the case 1, how about the time spent for the case 1 and case 2? Time is also money.

May be case 1, you need to spend 3 years while case 2 you only need to spend 1 year?

Well, no matter what business that you are investing. There will be long term investment and there will be short term investment. Normally short term investment bring quick money to support the long term investment. Long term investment does not mean that it will earn more money than short term investment.

43. Dena says:

Yes, doesn’t seem worth the change to me.

44. Themescope says:

I cant understand it either. All i would care about is profit.

45. I don’t really understand this stuff as I can’t seem to make money with adwords but the way I figure it a low ROI means you are not making any money so why continue. There are just so many variables with PPC. If you increase your spend then you are paying to much per click if your ROI goes down. You gotta remember the company you are doing this with has a goal to be able to take as much of your money as possible. You got to be on top of this shit or they will just rob your ass blind. With me I just gave them a low spend per click and per day and they tried to scam me and shut me down – low quality score BS and such. I said fu you bastards, and left it as it was. They held out on me for a few weeks then figured out I was not going to budge then gave in and started giving me clicks to get what money they could outa me. I saw this and had to laugh, Bunch of Pricks. By doing this they just proved to me exactly what they were all about right there.

46. Drops says:

I think Dave child said it all. Anyway, good explanation here guys.

47. Divone says:

It’s too expensive…

48. Olivier says:

Wow give me such an income! For now i’m just using adsense, cpa-offers doesn’t really convert at my site.

49. I think if you spend anymore than a 100k (or certain amount for that matter) you will begin to experience diminishing returns at an exponential rate. This is called the game of life.

Great blog by the way.

50. Nina says:

For me isn’t easy that and think expensive!

51. Zippy says:

I agree with Brian.
Scalability is going to be a big issue.

I use ROI for like to like testing between two campaigns

52. BGN says:

I’m new to the SEO business and I’m trying hard to learn about the PPC profits caculation…However, I’m really not good in math. It is hard!!!

53. Red Fox says:

Logically thinking why would I lock up my money. I will do whatever the best bang for the buck is. If that means less money for the same gain then so be it.

54. David says:

Ok, I havent really thought about it at all, interesting stuff, but I do not understand it 100%, I will search more about this topic.

55. Profit is the major concern when we are talking about ROI and not the revenue. % change of Revenue may be going up or down by using PPC campaign but our focus must be on % change of the profit as a result of that PPC campaign.

56. roro says:

I tought everyone would want to increase their ROI and then spending more money.

57. Henry Mill says:

@Brian Mark. I totally agree with you, online retail has to have much higher ROI in order to be profitable. You have to take into account all the costs that are out there.

ROI is more precise in traditional forms of merhandise.

58. oh I hate math. I mean every time I encounter numbers, I just leave them.
I hate to count, I hate to solve.

59. Shaun says:

The maths looks a little expensive to me too. I think you’ve got your work cut out if your going to spend that much… plan first.