In my recent reality marketing columns, our fictional CMO aligned his team to improve accountability and get more value from his Web analytics data. As part of that effort, he established a 12-month series of mandates. One of them is to “create a financial pro forma for the value of site behaviors and goals.”
Pro forma statements contain the projected effect of business initiatives. In other words, if a company decides to implement changes to its Web site, it should create a financial pro forma that lays out, in dollar terms, how those changes should improve the bottom line.
We almost always begin a Web engagement by asking our client what the financial goal of the initiative is. The question doesn’t make everyone comfortable. We find marketing professionals can be intimidated by terms like “pro forma,” particularly as they involve math. But though they can be complex to implement, these documents aren’t at all tough to understand.
The heart and soul of a financial pro forma is to calculate the ROI (define) of an initiative. Basic ROI is a key financial metric that determines the value of business investments and expenditures. Mathematically speaking, it is a ratio of net benefits divided by costs and is usually expressed as a percentage:
ROI = [(monetary benefits – cost)/cost] x 100
An ROI Calculation
Let’s say a company’s e-business team wants to implement Web services technology, which will cost $75,000. They believe the initiative will result in a 10 percent increase in software automation. What does that mean to the company as a whole? Does it make financial sense to do so?
At this point, the e-business team has the Web analysis group look at other data. They learn each 1 percent increase in software automation increases overall annual profit by $25,000 per year. This would yield $250,000 in a 10 percent increase. The company can calculate this investment’s ROI as follows:
[($250,000 – $75,000)/75,000] x 100 = 233%
ROI is merely a percentage, however. To get real visibility into ROI, you also need to look at payback time. This is the time it takes an investment to pay for itself. For example, if a $100,000 investment in Web services technology generates $400,000 a year in profit, it pays for itself its three months.
Payback periods are very important. What if you make an infrastructure enhancement that will pay for itself in four years? Chances are, the particular change you made may be replaced by other systems before it pays for itself. In that case, you’d realize a net loss rather than a gain.
Payback Period Analysis
The best way to understand the value of an initiative is to use payback period analysis. This methodology looks at the entire effect an initiative will have on every aspect of a company’s bottom line. It then calculates the length of time it will take for the initiative to yield enough returns to pay for the initial investment.
To do this, you have to look at the initiative’s direct and indirect benefits. Direct benefits measure the cash flow generated by the initiative. Indirect ones include such things as overall brand impact. They’re more much more difficult to measure.
Some examples of direct benefits include:
- Visit-to-purchase conversion
- Online media units
- E-mail conversions to purchase
- Articulation and measurement only moderately difficult
- Self-serve via the Web vs. higher cost channels, such as retail or phone systems (IVR)
- Automation of services, such as account access in financial services and airlines
- Account tracking
Indirect benefits include:
- Word of mouth
- Brand affinity
- Visit length
- Product consideration
- Branded entertainment
Of course, other metrics can be useful in payback period analysis. Customer lifetime value, value of leads, and value of cost savings can all contribute to overall ROI.
With his new insistence on financial pro forma reporting, our fictional CMO will be able to understand the financial impact of every Web initiative his company undertakes. That way, he can focus on things that help the bottom line… and shelve those that don’t.
Are you doing something similar? Have questions or need clarification? Shoot me an e-mail, and I may include your story in an upcoming column.
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