Ad Budget Is A More Likely Predictor Of Profit Growth Than ROI.

Various research studies show that return on investment is not the profit generator marketers believe it to be. According to the Institute for the Practitioners of Advertising, since COVID, advertising ROI has improved by 4% while ad-driven profit has declined 11%.

“The data reveals a dangerous trend: advertising is getting less effective,” Cumulus Media/Westwood One Audio Active Group Chief Insights Officer Pierre Bouvard says in Westwood One’s blog. “The advertising world’s myopic focus on ROI is causing sales and profit growth to erode. ROI is mistaken for business outcomes such as sales growth, profit growth and customer growth. ROI is none of those things. It is simply a ratio of revenue/profit generated by ad spend.”

The blog notes that ROI is actually a measure of efficiency as opposed to effectiveness, computed by dividing a campaign’s short-term revenue or profit growth by its ad spend. “The biggest ROI would seem desirable,” Bouvard says. “However, ROI does not tell you anything about actual revenue growth, profit growth or customer growth. It’s just a ratio.” 

Therefore, Bouvard ads, “The most important number that really determines sales and profits is not ROI. It’s the budget. The advertising profit is the result of budget and ROI. This is why your ROI obsession can cripple revenue and profit growth. If you keep optimizing for a higher and higher ROI, you could cause real harm to your firm’s sales and profit growth.”

A Medialab survey of 500 Chief Marketing Officers found that 65% believe ROI trumps budget in driving profit growth, while IPA data shows 89% of profit variation is due to ad budget vs. just 11% for ROI. “The pattern is consistent across consumer-packaged goods, retail, services and durables,” Bouvard says. “Thus, your ad budget is nine times more important to your company profits than your ROI.”

“ROI and profit move in the opposite direction,” Bouvard says. “The bigger the ROI, the smaller the profit. The greater the profit, the smaller the ROI. To grow profit, increase your advertising budget.”

A World Advertising Research Center (WARC) study found that brands devoting most of their marketing budgets to performance tactics see the lowest growth. Over one month, a balanced 50/50 mix of performance and brand building experiences 27% greater revenue growth than brands that put all their money into performance marketing, while over six months that mix generates 40% greater growth, and up to 50% over 6-12 months.

What drives growing sales is not ROI but rather share of voice, which is brands ad spend divided by ad spend for the category. Using market share, a business’ revenue divided by category sales, the results show that if share of voice exceeds share of market, sales tend to grow, while if smaller they tend to shrink, and if similar, sales are flat. “To grow [sales], budget for ‘Extra Share of Voice’ — implement a larger share of voice than your market share,” Bouvard says. 

The research shows there are three ways for brands to set their ad budgets: aim to spend above ad spend ratio for the category; use task-based budgeting by setting targets for customer acquisition and churn, conversion benchmarks to estimate how many exposures you need, and CPM to calculate budget requirements; and share of voice analysis, comparing share of advertising expenditure against its market share.