Take Credit for Your Work: ROI for Marketing Directors

How much money should firms spend on marketing? Is there a good rule of thumb? Is it 2% of revenue? Or 5%? Should it vary based on the practice specialty areas? Digital marketing even further complicates the equation, since we have data available on everything we do online. What is important and what is not? Instead of simply choosing a percentage based on conventional wisdom, this article will show you three simple calculations to use when you're trying to determine how much money your firm should spend on marketing.

Calculating the Average Close Rate

Look at your last four quarters of lead conversion. Said another way, how many of your prospects actually became clients over the past year? As this article is published, it's the beginning of August, so if you're like most businesses, your 2nd quarter just ended on June 30. Regardless, start with the most recent data available from the most recent quarter. Here's a sample of what you should write down 2nd Quarter (June 30) ' 4 clients and 23 total prospects = 17.4% closing rate

“Wait a minute,” you might be thinking, “During that quarter, some prospects were added the last week of the quarter, while some were there for months.” Don't worry about the timing of the clients and the prospects right now. It's important, in using these calculations, that you just consider the 2nd quarter numbers all on their own. If you get too complicated with these calculations, they'll get overwhelming. We're not doing a full analysis of your firm's sales cycle. Just ask yourself, “During this period of time, how many prospects became clients, and how many additional prospects did we add to our list?” For purposes of determining our marketing budget, we use our average closing rate. Here's a sample of what this could look like over four quarters:

2nd Quarter (June 30) ' 4 clients and 23 total prospects = 17.4% closing rate

1st Quarter (March 31) ' 3 clients and 32 total prospects = 9.4% closing rate

4th Quarter (December 31) ' 8 clients and 19 total prospects = 42.1% closing rate

3rd Quarter (September 30) ' 2 clients and 27 total prospects = 11.1% closing rate

Average closing rate over one year (four quarters) = 16.8% (17 clients from 101 total prospects)

Notice how the closing rate was dramatically higher in the 4th quarter? This sample is from a very cyclical firm, so it's important to have at least four quarters of data to accommodate this fact. Now that we know how many of our prospects actually became clients (16.8% of them), how much revenue did these 17 new clients from the past year generate?

Calculating Client Current Value

For purposes of this sample, let's say the 17 new clients spent a total of $94,308. This means that each client's current value to your firm is $5,547.53. Each prospect, then, is worth $933.74 of revenue. Since we don't know which of our prospects will become clients, it's important we pay attention to both of these numbers.

Now, we just need to determine the profit per client and prospect. In this sample, we'll say the firm's profit margin is 38%. The profit per client, then, is $2108.06 ($5547.53*.38), and the profit per prospect is $354.82 ($933.74*.38). A lot of firms ' if they get this far at all ' stop at this point. They say, “If we're making a profit from each prospect, then we're okay.” They then estimate they can spend anywhere between $0 and $354.81 (literally one penny of profit) on marketing to each prospect.

This is fine if you're running a one-and-done business. If you're going door to door selling candy bars as part of a fundraiser, or renting umbrellas on the beach to tourists on a sunny day, this might be a good approach. However, I'm guessing you're not in that situation. You want to earn the business of clients that stay clients. This next calculation will help you dramatically outperform your competition.

Calculating Client Lifetime Value

This is the most important number that most firms don't consider ' client lifetime value. Look back over your historical records. How long do clients typically stay clients? Three years? Eleven years? Let's say for this sample firm, the typical time period is seven years. If we look back over this period of time and build a profile, here's what we find:

Average client duration ' seven years

Spends $38,832.71 with our firm

Based on current profit margins, this client is worth $14,756.43 of profit

Why is this so important? Have you ever looked at a company and said to yourself, “How are they spending this much money on marketing?” Amazon famously did this when founder Jeff Bezos told his sales staff they could spend $33 per new customer, even if that person only bought something for $1. Starbucks spends enormous amounts of money on each new location, based on their calculated customer lifetime value. You can use this same strategy from these famous brands too.

How much money should your firm be spending on marketing?

The answer is, it depends. Using these calculations will give you much, much more confidence when it comes to your budget, instead of simply allocating 2% or 5% of gross revenue to marketing. Based on the sample firm numbers we're using, if each client is not just worth $5547.53 (the current amount) but actually worth $38,832.71 (the lifetime value), do you see why the sample firm can justify spending more money on marketing using the lifetime value approach? What about in your case? What is the lifetime value of your clients?

I've seen many firms ' after doing these calculations ' say, “We realize now we don't need to generate a profit the first year of a client relationship. Since our clients stay with us seven years on average, the profit will come.” Without this pressure of first-year profits, you can be more selective when choosing new clients. If you do this homework, you can confidently spend more marketing money (and time) attracting the clients you really want. Instead of looking at current value alone, be sure you determine the value of that relationship in its entirety.

[IMGCAP(1)]

Spencer X. Smith is the founder of Spencer X. Smith Consulting. He is also an instructor at the University of Wisconsin, where he teaches classes on Business Plans, Lean Business Tools, Internet Marketing & Strategy, and Teaching-Based Marketing. He may be reached at spencerXsmith.com.

How much money should firms spend on marketing? Is there a good rule of thumb? Is it 2% of revenue? Or 5%? Should it vary based on the practice specialty areas? Digital marketing even further complicates the equation, since we have data available on everything we do online. What is important and what is not? Instead of simply choosing a percentage based on conventional wisdom, this article will show you three simple calculations to use when you're trying to determine how much money your firm should spend on marketing.

Calculating the Average Close Rate

Look at your last four quarters of lead conversion. Said another way, how many of your prospects actually became clients over the past year? As this article is published, it's the beginning of August, so if you're like most businesses, your 2nd quarter just ended on June 30. Regardless, start with the most recent data available from the most recent quarter. Here's a sample of what you should write down 2nd Quarter (June 30) ' 4 clients and 23 total prospects = 17.4% closing rate

“Wait a minute,” you might be thinking, “During that quarter, some prospects were added the last week of the quarter, while some were there for months.” Don't worry about the timing of the clients and the prospects right now. It's important, in using these calculations, that you just consider the 2nd quarter numbers all on their own. If you get too complicated with these calculations, they'll get overwhelming. We're not doing a full analysis of your firm's sales cycle. Just ask yourself, “During this period of time, how many prospects became clients, and how many additional prospects did we add to our list?” For purposes of determining our marketing budget, we use our average closing rate. Here's a sample of what this could look like over four quarters:

2nd Quarter (June 30) ' 4 clients and 23 total prospects = 17.4% closing rate

1st Quarter (March 31) ' 3 clients and 32 total prospects = 9.4% closing rate

4th Quarter (December 31) ' 8 clients and 19 total prospects = 42.1% closing rate

3rd Quarter (September 30) ' 2 clients and 27 total prospects = 11.1% closing rate

Average closing rate over one year (four quarters) = 16.8% (17 clients from 101 total prospects)

Notice how the closing rate was dramatically higher in the 4th quarter? This sample is from a very cyclical firm, so it's important to have at least four quarters of data to accommodate this fact. Now that we know how many of our prospects actually became clients (16.8% of them), how much revenue did these 17 new clients from the past year generate?

Calculating Client Current Value

For purposes of this sample, let's say the 17 new clients spent a total of $94,308. This means that each client's current value to your firm is $5,547.53. Each prospect, then, is worth $933.74 of revenue. Since we don't know which of our prospects will become clients, it's important we pay attention to both of these numbers.

Now, we just need to determine the profit per client and prospect. In this sample, we'll say the firm's profit margin is 38%. The profit per client, then, is $2108.06 ($5547.53*.38), and the profit per prospect is $354.82 ($933.74*.38). A lot of firms ' if they get this far at all ' stop at this point. They say, “If we're making a profit from each prospect, then we're okay.” They then estimate they can spend anywhere between $0 and $354.81 (literally one penny of profit) on marketing to each prospect.

This is fine if you're running a one-and-done business. If you're going door to door selling candy bars as part of a fundraiser, or renting umbrellas on the beach to tourists on a sunny day, this might be a good approach. However, I'm guessing you're not in that situation. You want to earn the business of clients that stay clients. This next calculation will help you dramatically outperform your competition.

Calculating Client Lifetime Value

This is the most important number that most firms don't consider ' client lifetime value. Look back over your historical records. How long do clients typically stay clients? Three years? Eleven years? Let's say for this sample firm, the typical time period is seven years. If we look back over this period of time and build a profile, here's what we find:

Average client duration ' seven years

Spends $38,832.71 with our firm

Based on current profit margins, this client is worth $14,756.43 of profit

Why is this so important? Have you ever looked at a company and said to yourself, “How are they spending this much money on marketing?” Amazon famously did this when founder Jeff Bezos told his sales staff they could spend $33 per new customer, even if that person only bought something for $1. Starbucks spends enormous amounts of money on each new location, based on their calculated customer lifetime value. You can use this same strategy from these famous brands too.

How much money should your firm be spending on marketing?

The answer is, it depends. Using these calculations will give you much, much more confidence when it comes to your budget, instead of simply allocating 2% or 5% of gross revenue to marketing. Based on the sample firm numbers we're using, if each client is not just worth $5547.53 (the current amount) but actually worth $38,832.71 (the lifetime value), do you see why the sample firm can justify spending more money on marketing using the lifetime value approach? What about in your case? What is the lifetime value of your clients?

I've seen many firms ' after doing these calculations ' say, “We realize now we don't need to generate a profit the first year of a client relationship. Since our clients stay with us seven years on average, the profit will come.” Without this pressure of first-year profits, you can be more selective when choosing new clients. If you do this homework, you can confidently spend more marketing money (and time) attracting the clients you really want. Instead of looking at current value alone, be sure you determine the value of that relationship in its entirety.

[IMGCAP(1)]

Spencer X. Smith is the founder of Spencer X. Smith Consulting. He is also an instructor at the University of Wisconsin, where he teaches classes on Business Plans, Lean Business Tools, Internet Marketing & Strategy, and Teaching-Based Marketing. He may be reached at spencerXsmith.com.