Have you ever implemented a new tactic that seemed like it was really paying off well, but then you wake up a year later and realize it’s not coming close to what you thought it would? Or even worse, you are actually losing money? I know I have.
It comes down to effectively evaluating return on investment, both with hard dollars and the not so easy to quantify use of resources.
Listen to this episode to find out how to keep this from slowing you down and vastly increase the speed of your company’s growth.
Hi everyone. It's Robert Poole with Growing your B2B Small Business Podcast. Let me ask you a question. Have you ever implemented a new tactic that seemed like it was really paying off well, but then you wake up a year later and you realize that you're actually losing money or it's just not coming close to what you thought it would? I know I have. Let's talk about the concept of ROI and how we can use it to vastly increase the speed of growth of our companies.
Do you have a small business that sells to other businesses? If so, you probably know that there are plenty of resources for companies that market to consumers or companies that sell to large and Fortune 500 type companies. But what about the small businesses in the middle who sell to other companies, where do we go to get answers? How do we grow our company consistently while still keeping our sanity? That's the question and this podcast is the answer.
If you listen to this podcast, you're part of an elite group of achievers who aren't willing to settle for just a 9:00 to 5:00 job, you're one of the heroes in our society and you should be proud of it. Welcome to the tribe and welcome home.
Okay everyone, I hope you're having an awesome day. In the last couple of episodes we talked about how to effectively get in front of decision-makers, which is sort of the Holy Grail in sales. Today, I wanted to talk about something that's really bitten our company over the years and cost us a lot of money, quite frankly. I also see this very frequently with our clients, so I know it's not just us, and that issue is return on investment or ROI.
That may sound simple or trivial, but if you stick with me, I think you'll see that some of the potential problems, the consequences of not having a handle on it and some of those solutions how to mitigate those problems. So, let's start with some basics so we're all on the same page.
So, what is ROI? In its simplest terms, basically it's what do you get in return for an investment in your business? Basically you put in a unit of value into something and you get X units out of it. So, what do I mean by unit? I mean, this could be dollars. The easiest way to quantify, you put it in $100, you get back $110 and your ROI is 10%. But harder to quantify, but just as important are things like reputation changes, internal morale, financial stability, room for growth. Then you have to look at opportunity cost, which we'll talk about in a minute.
But one of the really main components of ROI that you have to start with is what I call LTVC, which is lifetime value of a client. Yet very few owners could tell you off the top of your head what that value is, you kind of get that famous blank stare or the pause on the phone. It's so important that we've started asking it as part of our client interview process if we'll take on a client, and almost no one can tell us with certainty what it is. I mean, it's not a dig on business owners, but it's just reality, because I've been there.
There are two parts to the ROI equation and one is the investment you're making, of course, and the other's a pay off. If you don't know the payoff, you can't complete the other side of the equation and you really know nothing. We'll talk about how to determine this in a second.
Let's take an example. Let's look at any current marketing tool you use. I mean, do you know what the ROI is on that strategy versus another option? I mean, most people couldn't tell you that, including me in some areas of our company. So again, like I talk about in this podcast, I always like to look at problems or challenges in sort of a four process or four step framework.
First, we've got to identify the problem. Sounds simple, but the bigger the investment of resources, the more time should be spent on identifying and solving the problem. We tend to jump into solutions without spending enough time on actually identifying all the issues with the problem, which is kind of a backwards way of looking at it. So if you look at that lifetime value of a client or customer, every investment is really dependent on this. The more accurate this number is, the better you're able to figure out where to put our resources, which we'll talk about in a second.
This can take some work. I mean, the first time especially, but it's well worth the time. In simple terms, you can take a look at your QuickBooks or whatever software you use or ask your accountant, and take your total revenue over a year or whatever, and divide it by the number of clients who account for that revenue. If you have repeat clients that are on some kind of recurring subscription or repeat buyers, you could have maybe multiple years you may even look at.
So for instance, we have clients who just engaged our company, and then we have those who have been with us for two decades. Pick the same period, add up all the revenue from the clients who account for that revenue and divide it by the total of those clients, and there you have it. I mean, that's kind of a rudimentary and quick and dirty, but it is a baseline to start with to give you an idea.
If your product or service is usually a one-time or an infrequent purchase type of thing, then you can do a similar analysis, but over a shorter period of time. I mean, and you can go crazy with this and get very specific on it, but on a basic level you have to absolutely know what your average customer's value is to your company. What's the average revenue for each product or service that it brings in and a few other numbers? These are really the lifeblood of your company.
As a business owner, you can't really use the cop out that you're not a numbers person and that's something the accountant handles. I mean, this is your main role as a leader of your company, knowing where to put your resources. Without having this background knowledge, you're just gambling and kind of guessing, and you'll eventually get bit and probably go out of business at some point.
So, we talked about that's one half of the question, the other half is what are the investments that you're making and what type of investments are we talking about? I mean, the obvious one is money. How much in real dollars does this particular tactic or strategy cost us? We need to factor in not just upfront costs, but things like maintenance of keeping that strategy going. Then I always put in a significant fudge factor. I mean, this can be adjusted over time, but you have to start somewhere and with a guess based upon experience and research, but that fudge factor is usually ... typically what I use is 20% to 30%, because it can be that far off when you're starting out until you have those numbers.
The second category of investments I'd say is time. We tend not to look at this very closely, because again, it's a little bit harder to track, but in past podcasts I've talked about how really everyone at your company has an hourly rate, and that includes you. Basically it's the time each person is involved in, that should be quantified in dollars. Money is really a time accelerant. The more we can invest prudently, the more time we can save. The faster we can do things, the greater the return is, and vice versa. A lot of times we think, "Well, I'll just do it myself or Mary can do it on top of her other stuff," but there really are consequences to that and there's real cost involved in it.
Then there's sort of the category of resources that are not monetarily. Besides time and labor, you have to take other things into account. Things like the effect on your reputation as a company, the morale of your current customers, how they feel about your company, and the internal team, what effect does this have on them? Because they really are the lifeblood of your company. Have to look at things like liquidity of resources. I mean, if you invest in a very expensive piece of equipment that you find out doesn't pay off the way you thought it would, very hard to dump it and get our money back, or at least it's going to be a huge hit to the value.
Finally, there's opportunity cost. I mean, this is a big one that I know I forget and a lot of our clients that we deal with forget about. Opportunity cost is really using a resource, whether that's money or time or general resources. If you took the same amount of resources and put it into something else, could you get a better return on that alternative? By choosing one, you're necessarily not choosing the other. So if we look at them, we might find that we're getting a better return on print ads, for instance, than we are online ads. We're burning money if we throw resources at the wrong tactic. So that's kind of identifying the problem, but, I mean, why is that a problem? Let's start with why do we not track the ROI sometimes?
Let's face it, sometimes reality really kind of sucks, and we don't want to hear the bad news as long as we're [inaudible 00:08:03] moving forward and we want good stuff to happen. Sometimes it's easier to just stick our heads in the sand and I don't want to know the numbers. But if the ROI isn't good, we've got to find something else that's superior, and that again isn't always easy, so it can be kind of depressing if you look at it that way.
ROI can also be tricky to figure out and really a pain initially to track. So I found when we were starting out as a company, I didn't feel like we needed to track all these numbers, because my business partner and I, we kind of went by the philosophy of, hey, let's increase the rate of water coming out of the spicket to outpace what's going down the drain. That works for a while, but it'll catch up with you before you know it.
Like a lot of things in business, it's about the basics. If you don't do it when you're starting out and you're only making $50K, it's unlikely you're going to be doing it when you're making $500K and it's a lot harder to change. Not to mention, you probably could have gotten to $500K much faster by consistently evaluating things. Sometimes we feel like we even have to diversify our marketing, so we'll do print or online ads, cold calling and content marketing, because our ego says, "Well, I should be doing all these things. If it brings in a few customers, it's worth it, or this is a big one." I know I've fallen for it early on particularly.
We feel like kind of big shots, because we're advertising on TV or The Wall Street Journal, or whatever. Again, it tends to get more small business owners early on, as we're looking for some kind of affirmation of our success. Sometimes the investments sort of boost our ego, but they don't make sense if you look at the ROI.
So, next step in the framework of problem solving is look at the consequences of not fixing the problem. I mean, what happens if we don't know or analyze our ROI? If we're figuring out the ROI on office supplies, and we find that we can do better switching to a different provider or get a discount using a different vendor or whatever, I mean, how much time, energy and dollar costs are doing the evaluation, switching vendors and so on? I mean, if you're saving $1,000 a year by switching your process and everything, and you're doing several millions in revenue, why not worth the investment of time? But if we're spending 20% of our annual revenue on marketing tactic or our labor, we'd better make sure that we're getting the best ROI possible.
There is a greater cost upfront in doing an evaluation, so you have to pick and choose which to spend your time evaluating. Office supplies, probably not worth the evaluation, but one of your major marketing or sales investments, much more likely that you have to justify that ROI and do an in-depth evaluation. If we don't know our ROI, really can get ourselves in trouble quickly.
As an example, as our company, this is probably 10, 12 years ago, but we'd looked at the lifetime value of the client, which we'd never done before, and we found out that it was actually less than what we were spending to acquire. I don't remember the exact numbers, but $5,000 was the lifetime value of the client, and the medium, not the average, again, tenure of clients was four months. Whenever you're doing these things, look at the medium, not the average. From a mathematical standpoint, it makes more sense to get better results.
I think the tenure was four months at the time, which is pretty pathetic, but it took us 4.4 months to break even. I mean, we were losing money on average, because we didn't pay attention to the numbers, because we didn't even know our lifetime value of a client at that point. The flip side is that if you inject investment into the right areas, they can really explode your company's growth and fast track things that you looked at the cold, hard numbers on, and you could see the justification.
Finally, the opportunity cost. In economic terms, that simply means if you took those same resources and put them to something else, would that other tactic be more profitable? So with going one tactic, you're necessarily diverting those resources that could be used for a different and a potentially better alternative. It's literally my cost lost opportunity to do something else.
For example, you have a sales and marketing budget of $100,000, you spend 35 on advertising, 60 on a salesperson and five on other related expenses, you're necessarily foregoing investing that money in something else. It may be the best use of that money or it might not be, but you can only find out with pretty deep analysis. Opportunity cost also affects, of course, your liquidity of funds and prevents you from being able to take advantage of future opportunities that aren't necessarily present at that time, but may be in the near future. Opportunity cost is really a big area that we tend to ignore, but it can be largely mitigated by doing some in-depth analysis of what we're doing.
So now that we've identified the problem clearly, why it's a problem, the different areas in it and the consequences of fixing it, let's talk about some solutions. So, I mean, how do we practically go about evaluating things? I mean, first, the most important thing is we have to commit to a process of evaluation and be brutally honest with the results. I mean, the numbers don't lie. Even if we want them to say something else, we can often be wrong, so commit to not sticking your head in the sand and be realistic.
Two, come up with a plan of what major areas need to be evaluated first. I would pick two of the easiest and biggest marketing techniques, for instance, and compare those two. Get those set up and set up a system for tracking them over time for the future, and then you can move on to other things, because like a lot of things, if you try to do too much at one time, you're just going to give up.
As far as identifying the problem areas and brainstorming solutions, you're not going to cover everything, so you have to kind of balance the evaluation, the tracking. So, make a commitment to sitting down before each significant future investment and walk through the consequences questions to determine if it's even worth evaluating. Once you get in that habit and this becomes part of your decision-making process, it's a lot easier, but like everything, it's tough and awkward the first few times you do it.
So that's kind of future opportunities, but what do you do about current investments? Of course you've got the two major areas, the dollar-related ones, which are the easier. I mean, you can literally look at the biggest investments on your P&L, and if an area has more than 10% of your revenue, it's likely that needs to be evaluated.
I mean, easy ones to start with are dollar ones like advertising or labor of a sales force to get a sale. For example, let's assume you know your lifetime value of a client is $10K. If you know the average tenure, you'll be able to figure out how much they spend in that first year as well. If you're evaluating online advertising, you can be spending $30K a year and so on, so the simple math says you have to net three clients per year to break even.
It sounds simple, but this is where you need historical data on cost to acquire that new client. Of that $30K spent on ads, how many verifiable leads it generate? How many leads did it take to get one client? How long did it take from the initial ad click to the signing of the client? Of those that became clients, how many referrals did those clients bring in that you can quantify and directly relate to that online ad spend? A lot of times, we tend to forget about referrals and sort of the third order of consequence. So, how much per client acquisition costs in terms of phone sales time, if that's your process? The process of the signup itself, anything related to that tactic to get the sale.
It may be different for each tactic. They have different processes like cold calling versus an online advertising, but you have to evaluate each one of them. So after you crunch all these numbers, you're ultimately going to come to a number that says, hey, for every dollar we spend on ads this year, we're going to get back $1.50, as an example. Again, this can be depressing, especially if your expense of your cost is more than what you're bringing in. It also can be very surprising on a positive sense, but either way, the numbers don't lie and we can't stick our head in the sand on it, so we need to look at the final numbers on this tactic and compare it to other tactics.
If you track this over time, you'll find that different tactics also change depending on the amount of money you spend. You may find that the first $30K you spend gets $1.50 return on $1 invested, but as you get above 30, it starts to decline, which especially seeing a situation where you have a very small market that can be saturated easily with that particular method of marketing.
Yes, this is a ton of math and data analysis and takes time, and quite frankly, it takes skill. Unless you're a data analyst for your business and that's your main core business, I really suggest you don't do it yourself, and either contract it out or hire somebody to gather, analyze and track that data. What you need is the summary of numbers to make decisions as a strategic leader of the company, you don't need and shouldn't spend time on the busy work of what's behind those numbers. I mean, that's a lot, but worth the upfront time to do the analysis.
So besides dollar type of things, which are the easier ones to quantify, you have to look at the non-dollar investments. Again, these are things like hiring and firing team members, investments in things that will generate good will or reputation, i.e. general advertising. Changes in the morale of your team, either negative or positive, again, the liquidity of resources, time, the big one. Employee time can be converted to money, as well as your time.
So, how do you evaluate? Well, the best thing to do is to try to translate it to dollars of units of value like time, if you can. The best way to look at this, so if you didn't use this tactic, didn't make that investment, what effect would that have? Often coming from the law side of things is easier to do. It's the don't know what you've got until you lose it type of thing, however that song goes. Again, it's not easy to do, but it's necessary.
As an example, let's say you've got a team member and you have one bad apple that starts to wear down the morale of other team members. People start showing up late and leaving early because of this investment of a person. How much does that loss of productivity cost you? I mean, just make a dollar guess. I mean, there's a reason that guys like the quarterback for the Kansas City Chiefs, Patrick Mahomes, the biggest paid athlete in sports right now. He's a great leader and inspires not just his physical skills, but inspires his team and helps bring people up to improve their game and their productivity. I mean, how much is that worth to you to bring in a team member that can improve the productivity of the rest of the team?
So, non-dollar related ROI analysis is important from a strategic standpoint and should be considered, but again, it's much harder and takes more work, so we want to prioritize the lowest hanging fruit, the dollar quantifiable ones first.
So, I know this is a lot and it seems like something that I know our company's struggled with over the years, but as Keith Cunningham says, which I love, we've paid what he calls a lot of stupid tax by sticking our head in the sand and going by feel and kind of winging it, instead of by reality and the numbers and the facts. But the good news is if you put in some work initially, and it's going to take time, then you're going to get a big payoff by putting your resources in the most profitable areas, and they're going to grow your business much faster than if you try to fly by the seat of your pants. I know that's certainly been true for our company over the years.
So that's all I have for today, and I will talk to you soon.
Thanks for listening today. I know your time's valuable and it's really an honor to serve you. If you found this content useful, I'd really appreciate it if you could rate the podcast on iTunes and leave a review with your honest feedback, whether it's good or bad. Also, if you're interested in growing your B2B business through direct contact marketing like we do, please call my office [inaudible 00:19:40] and speak to one of our sales representatives. We can chat for a few minutes about your business and what you need most to grow your business, even if it's not our services.
As a side note, if you listen to this podcast regularly, you probably know that I have a little pet peeve about using fancy words to talk in code, so to speak, so we're not going to do a "discovery call" or a "strategy call," just a quick question and answer call. Yes, if we think you're a candidate for our service, we'll try to sell you, but we're not going to hide behind fancy corporate muses, we know you're smart enough to see through that. We believe in telling the truth, and even if it's not what people want to hear. That said, give us a call at (480) 401-1926 if you're interested in talking about how to grow your business and have your best year ever.