What Does ROI Stand For (And What Does it Mean for Your Business)?

what is return on investment

What Does ROI Stand For (And What Does it Mean for Your Business)?

ROI stands for Return on Investment.  Simply put, this is the amount of money you get back on an initial amount that you invested.  This metric is usually referenced to as a percentage and you can use the equation (Gain from Investment – Cost of Investment)/ Cost of Investment to determine this number for your business or investment opportunity.

An example of how this metric works for a business is: You invest $100 in Google Adwords to promote your local car wash business and that traffic converts to 20 sales from which you make $7 per sale in profit.  The total profit you make from the ad was $140, so the ROI would be (140-100)/100 or a 40% ROI.

The Limitations of Using ROI to Measure the Health of Your Business

One major limitation of using ROI as the main metric to compare marketing channels for your business is that it doesn’t take time into consideration. For example, if a $100 investment in a billboard advertisement returns $150 after three years the ROI would be 50% and $100 spend on Facebook ads that returns $120 tomorrow would only be 20%.  According to the ROI metric the billboard is a better investment, however as a small business owner you understand that cash flow is equally important to return as there are monthly expenses like rent, employees, and payments to vendors that must be made.

Why Sometimes the ROI of Advertising isn’t Straightforward

In today’s digital age we have access to much more data around the cost and effectiveness of advertising than ever before. Instead of estimating the number of cars that drive past a billboard and guessing about the return on investment, we are able to analyze Google Analytics dashboards to determine the exact number of sales and clicks a specific campaign generated.

This radical shift allows business owners to track and measure each campaign to prioritize the ones that are most effective at providing the best immediate returns.

While on the surface this makes marketing seem like a straightforward math problem, there are other factors that are more difficult to quantify regarding the effectiveness of an ad campaign.

Brand Awareness

An investment in advertising can not only result in a sale and direct financial return from the customer, but also increase the awareness and reputation of your company’s brand.  This value is typically harder to quantify as it can manifest as referrals to friends, making your band top of mind when a potential customer is in need of your company’s service or product, or even highlighting your brand for publicity or joint venture opportunities.

Customer Lifetime Value

When thinking about acquiring a new customer it’s important to understand the value of that customer to your business not only in the first transaction, but across the customer’s entire lifetime.  For example a consumable product like deodorant may only net a company $3 on the initial transaction, but if the customer has a good experience with the product they may buy the same type of deodorant every month for the next 5 years making the customers’ value to the company hundreds of dollars.  This company would likely be willing to take a large loss on acquiring the customer for the initial purchase if they calculate that they will make a return over the customer’s lifetime.

If your business primarily uses online channels to sell your product, you can start by analyzing historical customer data to calculate the average spend of a customer in the past and can even group these values by various segments and demographics.  Even if this number is just an estimate it will allow you to make more informed decisions when choosing advertising channels and budgets.

Multichannel Sales

Many small and local businesses are using digital advertising channels to drive in person transactions at their retail establishments.  This makes tracking the return on ad spend more difficult without large investments in point of sale solutions and monitoring.  Some brand use coupon codes or discounts to try to track the sales they drive and determine the ROI, but these measures are incomplete as they are likely not capturing a complete picture of the sales they are driving.

How to Calculate the ROI of SEO and Content Marketing.

The great thing about SEO is that it’s pretty straightforward to determine the return on investment from the service.  However, you need to have a firm grasp on a few key metrics for your business and competitive landscape in the search results to make an accurate calculation.

Customer Lifetime Value (LTV)

You need to know what a lead or customer is worth to your business over that customer’s lifetime.  Typically businesses with higher value customers who provide communized products or services in local areas can see the largest returns from SEO services.

Cost Per Click of Target Keywords

You should know the cost per click of the keywords you are trying to rank for if you were to bid for them in Adwords.  You can measure the amount of organic traffic that the SEO company has got you for your target keywords and then compare it to the cost of if you would have just purchased that traffic directly from Google.

Note: This is a slightly flawed method of calculation as SEO improvements can increase organic traffic for years to come whereas if you just rely on ads you are at the mercy of ad costs increasing and must continue to pay to get the leads.

Organic Traffic

You should be able to view and understand the amount of organic traffic your website is receiving and which keywords are driving that traffic. You can use Google Search Console and keyword tracking tools to accomplish this initial website audit.

ROI of SEO Calculation Examples

To see the return on investment from SEO services, determine a baseline of the number of organic leads/sales you are getting per month from organic traffic.

Example: A dentist is currently receiving 10 leads per month from organic search to their website.  These leads convert to customers at a rate of 50% and they have calculated the average lifetime value of their customer to be $4500.  An SEO firm charges $1500 per month of service and after 6 months they improves the organic traffic 40% and the dentist is now receiving 14 leads per week from organic traffic that is converting to 7 new customers.  In this situation the SEO firm has added $9000 per month in lifetime value to your business for a cost of $1500/month.  From this point the monthly cost will stay flat, but the amount of organic leads will increase as your site continues to build trust and authority showing a huge positive ROI over time.

Note: SEO is a long game, if you are looking for an immediate return, you should probably look into paid ads or other growth channels.  But if you have the capital to invest in a strong SEO foundation, you can see incredible returns and sustained growth for years to come. 

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