“Exposure is what homeless people die from”
– Marketing Exec I used to work with

Every time I start working with an entrepreneur, I send them a “housekeeping” email asking them for several very important pieces of information such as business plans, mission and vision statements, organizational charts, etc. The most important piece of information that I want to see is a profit and loss statement for the past three years with columns by month. This statement helps me see where the owner has chosen to spend their money over time, and it’s the most helpful report that I know of when it comes to helping them see where their spending is either too high, too low, or simply ineffective.

The single line item that frustrates more clients than any other?

Marketing/Advertising.

They all know that they NEED marketing and advertising, but most of them just literally throw money at the first sexy idea that comes their way…and then keep spending money hand over fist hoping that something will work. By the time they get to me, this line item is often out of control and seriously bleeding the company dry on a monthly basis. In my humble opinion, the greatest culprits are:

• Yellow Pages advertising
• SEO/SEM services
• Billboards or other display advertising

None of these marketing services are simply BAD SERVICES, in fact, when used properly, each of them can be very valuable tools. However, because most business owners use the “spray and pray” method of marketing, any effectiveness these services may have is often overshadowed by the sheer amount of money being spent on the entire line item itself.

So what’s a business owner to do? How do you know where you should spend your money? What services should you definitely retain, and what should you avoid? The simple answer is all marketing can be good marketing, but it can also be bad marketing. The difference? Bad marketing wastes our money. Good marketing is marketing that we are able to measure and gives us a good return on our investment.

Return on investment (ROI) is one of the most important metrics for determining the success of a campaign or program. By tracking the level of return from investments in marketing, owners can understand the effectiveness of their marketing program. But what is good ROI for marketing campaigns? At its most basic level, “good ROI” means that for every dollar put toward marketing, the business gets more than a dollar back.

Here’s the simple equation:
(Gain from Investment – Cost of Investment)
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Total Gain/Loss of the Investment

This equation is the holy grail for me when it comes to marketing for a few reasons. 1) It eliminates marketing that cannot be measured, 2) It looks at “total gain/loss of the investment” as the goal, and 3) It allows for a negative return, which allows us to eliminate ineffective marketing. Let’s break down the three elements of the equation:

Gain from Investment. In order to calculate a true return on investment, this number MUST be gross profit and not gross revenue. Gross profit = Revenue – Costs of Goods Sold. If we only measure revenue, we are ignoring that fact that in most businesses we spend some money each time we make a sale (COGS).
Cost of Investment. This is the total external spend PLUS the internal spending increase (if any) to service the marketing. This could include staff time, if there is a requirement that internal staff dedicate time to servicing the marketing campaign itself.
Total Gain/Loss of the Investment. This one is relatively self-explanatory. It’s simply a calculation of the gross profit created by the marketing, minus the expenses incurred to produce the marketing. This gives us an amount that we can then measure against the total marketing spend and express as a ratio.

So what is the RIGHT amount for a company to spend on marketing? I don’t know that there is a RIGHT number, but I like to see a potential RATIO of at least 2:1 for most forms of marketing before I would advise an owner to spend money on that service.

Here’s an example using a fictitious HVAC service called Jake’s HVAC as the company and a fictitious service called HomeLeads, a contractor-matching service that connects homeowners with professionals who can help with home-related matters:

• The HomeLeads service is running Jake’s HVAC approximately $5000.00 per month.
• Jake’s HVAC attributes $12,000.00 of gross sales per month to HomeLeads.
• Jake’s HVAC operates at 45% Gross Profit

Is this a good investment? Here’s the equation using Jake’s numbers:

($12,000 x 45% – $5000)
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$5400

The ROI ratio on Jake’s investment in HomeLeads is $5400/$5000 or 1.08: 1. While it’s a positive investment, it hardly seems worth the effort for Jake’s to make only $400 per month in gross profit on the investment, doesn’t it? If we reverse engineer this equation using a 2:1 ratio as the ROI goal for Jake’s HVAC we come up with the following:

Total investment – $5000.00
Gross Profit – 45%
Break Even ROI – $11,111.11 ($5000 ÷ .45)
Desired ROI of 2:1 – $22,222.22
Reduced ROI of 1.5:1 – $16,667.67

To make Jake’s desired ROI of 2:1 on his marketing spend, he wouldn’t just have to return $10K in sales, but $22K. To make a reduced, but acceptable, ROI of 1.5:1 he would need to sell around $16.7K of services. In this case, unless Jake can make his HomeLeads service generate more sales than the 1.08:1 ratio that he is currently getting, he likely should invest his marketing funds on something with a better return.

So how much should YOU spend on marketing? The answer is actually pretty simple. As long as you know the ROI ratio that you are targeting and can measure the effectiveness of the service itself, you can spend as much or as little as you want. Just be sure to regularly and critically measure the success of your campaigns against GROSS PROFIT, NOT GROSS REVENUE, to ensure that you are meeting your ROI targets and actually making money from your marketing spend.