I recently wrote about the limitations of one of the most widely-held marketing KPIs: ROAS (Return on Ad Spend). The main limitations with ROAS are that it is a measure of efficiency and not magnitude and that the efficiency it measures is revenue generation, not profit generation.
Yet creating revenues without profit, or efficiency without magnitude is not creating success, and we want KPIs that are tightly aligned with success. In fact, that is the sole purpose of a KPI.
So if ROAS sucks at being an indicator of the magnitude of profit, what KPI does work?
I’m going to go out on a limb here and say all marketing metrics are poorly aligned with business success. Which is why your marketing KPI shouldn’t, in fact, be a marketing KPI at all.
It should be a business KPI.
In fact, it should be a really specific business KPI and that is a form of profit measurement called “Contribution Margin”. Contribution Margin is pretty simple to calculate, it is just Revenue – Variable Costs. In this respect it’s a close relative of a metric we like a lot: Gross Profit (Revenue – Cost of Goods). But the key to a good Contribution Margin calculation is what’s included in the variable costs. For us, the biggest variable cost is Ad Spend. But in actuality, we also add in cost of goods and any other per-unit costs if they exist.
If it sounds complicated, you can probably simplify it. If you want to call it Post-Marketing Gross Profit that works, and in many cases may be close to the same number as Contribution Margin, depending on what other Variable Costs exist. Frankly, we find the hardest part is to get this information from clients, as it’s unusual for Marketing to know these numbers and Finance may need an explanation on why it’s important to share them.
So why is Contribution Margin a good KPI? Well, first, it doesn’t just align with the magnitude of profit, it IS the magnitude of profit. Second, if you’re looking at actual profit, a false read on efficiency can’t cause you to make bad decisions in the name of efficiency (this is called the local optima effect and I’ll post about this in the future). If you use Contribution Margin as a KPI, you actually see the drop in profit. And lastly, it lets you do two very exciting things in growing a business, and those are that the investment in marketing becomes a profit center and not a cost, AND it allows you to have a business metric that transcends channel complexity, but how that works is a topic for another time.