Use lean analytics to calculate your ROI correctly (Part 1)

Consider this: you’ve just spent $100 on a Facebook ad campaign which generated $300 of direct revenue for your company. You also recently spent $100 on a Google Adwords promotion, which generated $200 of direct revenue. Which marketing channel is more effective?

It’s easy to conclude that Facebook is a more effective promotion channel because, based on the aforementioned figures, it generates a 200% return on investment (ROI) while Google Adwords has an ROI of only 100%. However, the reality is much more complex.

Customers from Facebook, after claiming your promotion, may never come back and make another purchase. In contrast, oftentimes customers from the Adwords campaign not only return for more purchases they also refer many new and high-quality customers who contribute more revenue to your business in the long run.

Without analyzing the full customer journey, hasty ROI conclusions can lead a business to pursue a less profitable channel, harming its long-term revenue prospects. The important thing to note is that due to modern e-commerce and digital technology, most of the information needed to identify the long-term revenue potential of your customers is already present in your existing technology systems — you’ve just never bothered to look at it. This article will provide a simple framework to help you change that.

Lean Analytics Can Help You Simplify ROI Calculation

The process of calculating the total revenue a specific customer cohort brings to a business is called customer lifetime value (CLV) analysis. Even though analyzing CLV is extremely valuable to a business, very few companies, particularly small and medium sized businesses, implement this strategy .

This is due to the fact that CLV calculation is usually a painstaking process that requires both advanced technical and statistical expertise. However, as I will soon show with my model, small and medium sized businesses can use a lean analytics model in order to achieve the same results using a much simpler analysis.

A diagram of the model is displayed below. This model is an improvement of the classical AARRR (Pirate) model first developed and popularized by Dave McClure at 500 Startup. Compared with the initial model, this model is more generalizable and utilizes some principles from system thinking in order to illustrate the importance of constant customer engagement in a company’s marketing process.

The basic assumption of this model is that customers go through five key steps when engaging with a business — Acquisition, Activation, Retention, Referral, and Revenue. As customers interact with the business at each of these steps, they contribute revenue through three primary pathways — the “First Purchase” pathway, the “Repeat Purchase” pathway, and the “Referral Purchase” pathway. Whereas the “First Purchase” pathway indicates the direct revenue benefit a customer cohort contributes to a business, the “Repeat Purchase” pathway indicates the long-term revenue potential of this specific customer cohort. Finally, the “Referral Purchase” pathway indicates the value of the customer cohort’s ability to organically bring additional customers to the business.

The second part of this blog post is going to drill down into more detail about what each step and pathway of this model means and how you can quickly collect metrics to measure your business’s performance through each of these steps. If you have any questions meanwhile, please feel free to email bill@humanlytics.co or visit humanlytics.co.