At first glance, the question ‘what is a good return on investment (ROI)?’ seems like a no-brainer. I mean, let’s be honest, it is a silly question, isn’t it? The answer is so obvious. But then it hits you and you really start to think about it.
No, seriously. What exactly is a good ROI?
The utopian in you knows that any investment that leads to investors making a profit is a good investment. Not losing money is good. Losing money is bad. But that also challenges the skeptic in you.
Is that really true? How little is too little? How much is too much? What about Uber?
According to a CBC news report, the ride-hailing company loses about 58 cents each time someone orders a cab. Yet, surprisingly, it keeps attracting investors to invest in the company, which since its inception in 2009 hasn’t once turned a profit.
On the other end of the spectrum, there’s the story of how a marketing agency was able to provide a 4,381% ROI to one of its clients — Cafe Mexicana. Through white-label advertising campaigns, the restaurant was able to earn nearly $30,000 in revenue from over 300 new customers in a span of just 28 days.
So, would that make investing in Uber an example of a bad ROI?
Before we answer that question, let’s first understand what one of the most widely-used terms in the business world exactly means.
What is ROI?
In the traditional sense of the term, a return on investment means exactly what it sounds like. It’s a return that investors expect on the investments they make. For years, the metric has been used to analyze how profitable an investment is.
Most businesses around the globe use ROI as an integral metric to analyze the efficiency of an investment over time and decipher whether the strategy behind the decision was productive. Using these findings, businesses can make a decision on whether to follow the same investment strategy in the future and/or compare different options to determine the best one.
Recommended Reading: What is ROI and How to Calculate It
In terms of putting a numerical value on it, ROI can be calculated by taking the difference between the current value of the investment and the cost of the investment, and dividing that value by the cost of the investment. Needless to say, the higher the number, the better the ROI.
But, is the expected return from an investment supposed to be monetary?
That’s where it gets tricky. Gary Vaynerchuk, the CEO of VaynerMedia and chairman of VaynerX — a media and communications company — might have the answer to that question. He says:
Based on Gary’s logic, the investors investing in Uber seem to be making an intelligent choice, even if they’re not earning profits now. They’re taking a chance by hoping that the company one day would monopolise the market and therefore start delivering a return on their investments.
However, since ROI depends a lot on the type of industry a business operates in, the return on investment for a company operating in the taxi and limousine industry might differ significantly from that of a marketing agency servicing its clients.
What is a Good ROI for an Agency?
Truth be told, a good ROI for an agency would be to ensure that their clients make a profit. That’s it. Apart from that, there is no correct answer. Some agencies might be content with a 5% ROI, while others might be on the lookout for a higher number like 20%.
In fact, looking at our earlier example of Cafe Mexicana, for the agency involved there to facilitate an ROI of 4,381% is staggering considering that the average ROI for a full-service restaurant is around 6%.
In reality, there is no set value or percentage that agencies can (or more importantly should) guarantee their clients. They do, however, need to keep track of some important factors before estimating the ROI for their clients. Factors that they might either forget or miss looking at.
Don't Forget Your Taxes
Picture this. It’s Black Friday and you’ve been standing in line at the electronic store for two hours waiting for it to open. You know that the new LED 4K smart television is going to be on sale. It’s everything you’ve ever dreamt about. It has ultra HD display, Wi-Fi connectivity, and those pristine curved edges that make your heart skip a beat.
The retail price is close to $800, but the special sale price of $200 is what inspired you to wake up at 3am, drive for 20 minutes, and wait in line until the pigs start flying. You even have the money ready in cash so that you don’t waste time and can get away from the chaos as soon as possible. You check your top pocket and see those two crisp $100 bills. Leaving your cards behind was a wise move since you would have less things to worry about.
The bell rings and the door finally opens. A bevy of people that have been waiting with you start gushing towards the television section. But you’re on top of this. You know exactly where to go and what to do. You quickly pick up one of the televisions and place it in your cart. As you head towards the cashier, you overhear people showing discontentment about how all the televisions were taken away in record time. A smile comes across your face and you feel proud.
“That will be $222. Would you be paying by cash or card?” asks the cashier. Wait a minute, what just happened? Your bubble bursts and you realize that you forgot to incorporate taxes. Ugh!
Don’t you hate it when you forget to take taxes into consideration and end up getting the wind taken out of your sails? Unfortunately, that’s what many agencies forget as well. Not thinking about the taxes can have a drastic impact on the estimated ROI and lead to businesses losing out on profits.
As the old saying goes, if there were three things that were inevitable in life, death and taxes would take up the first two spots. Therefore, while estimating the ROI, it is imperative that agencies always incorporate the taxes that they would have to pay on the profits they make.
Keep Inflation in Mind
The concept of inflation talks about real returns versus nominal returns. It states that the value of a dollar is worth more today than what it will be as time progresses. If we take the example mentioned above, while $800 would surely get that LED television from the store straight into your living room today, five years from now that won’t be possible since the price would inflate.
Therefore, while estimating ROI, agencies must ensure that they incorporate at least 2-3% inflation (or the appropriate standard industry average) each year into their calculations.
Taking inspiration from Benjamin Franklin who said, “I'd rather be a pessimist because then I can only be pleasantly surprised,” agencies can also choose to use a higher than normal inflation percentage while making their financial projections for the future.
Such a conservative approach would motivate them to target a higher return on their investments, since what seems to be a great return today might not be so great in the future when businesses finally receive their payout.
Time is Money
While time might be the perfect remedy to heal a broken heart, when it comes to investments time can be your worst enemy. Let’s take a look at an example to understand this factor better.
Imagine your agency is given an option to double the value of your investment and thereby generate an ROI of 100%. Will you take it? Of course you will. Only a fool would pass up such an opportunity.
Now, what if we tell you that you would only be able to double your value after a span of five years? Does that change your answer? Maybe. But, what if it would take you 100 years to get that 100% ROI? Does the offer still sound exciting? Probably not.
Time is of the utmost essence when it comes to investments. What agencies must keep in mind is that the longer they plan to invest money in a project, the higher their return expectations should be.
Furthermore, another disadvantage with time is how it combines with other factors to produce horrible concoctions. For instance, adding inflation with time is as bad as dipping french fries in apple sauce. While the idea might intrigue you, in reality the combination is a horrible idea.
Know Your Opportunity Costs
Have you ever found yourself in one of those tense situations where you’re battling your instincts to make a decision? How about at the grocery store when you have to choose a cashier line? While the current line that you’re standing in has just one person in front of you, the number of items in their shopping cart is colossal. The line next to you has several people in it, but they each have just a handful of items. Which line would you choose, and why?
Similarly, it can be very challenging for an agency when it comes to making a decision about an investment. Would the business be better off with investment A or investment B? What about investment C? Investment D promises good returns, but investment E means a quicker payout.
One can weigh the pros and cons and look at the historical data, but in the end what matters is the cost of opportunity. What an agency is willing to sacrifice, as opposed to what it would gain elsewhere is one of the most crucial factors that it must consider while making these decisions.
Just like at the grocery when you dive deep into your subconscious and start wondering whether the line you joined will suddenly start moving faster once you leave it, agencies too need to think about what they would do with the money if they decide not to make a specific investment.
But don’t beat yourself up too much about it. In addition to a well-thought out investment strategy, the ROI can depend a lot on luck and other external factors as well. Ever heard of Murphy’s Law?
Neal Polachek, former CEO of The Kelsey Group and founder of ThinkLikeAnApp — an initiative that empowers teams to compete in the market — made an interesting point when he talked about ROI on the Conquer Local podcast presented by Vendasta.
Having one quality customer, who can help improve the customer journey process for your business, is better than having 20 people who sign up as customers and do nothing. Investing in something that leads to a quality customer helping your business increase awareness, improve findability, and build a reputation, as well as becoming an advocate for the business, is the ROI that agencies must aim for.
Therefore, when it comes to ROI what matters is not how much you get back, but what you get back. Apart from making a profit on your investment, there can be no dollar amount or percentage value that can justify the ROI for an agency.
What is certain, however, is that agencies must always strive to increase their ROI. They must think about the factors that affect the return on investment, and reduce their costs as much as possible to increase the profitability of their business.