Ecommerce Marketing: How to Calculate the ROI of Your Advertising Campaigns

John Wanamaker (1838–1922) is considered a Marketing pioneer for investing heavily in advertising and creating slogans that were known for their honesty and directness, a practice that was as rare at the time as it is today.

His retail empire was built upon the use of taglines such as, “One price and goods returnable,” which meant that there’d be no haggling (which was still common practice) and that he’d give money back to anyone dissatisfied with their purchases, which he followed religiously.

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Wanamaker hired the first known full-time ad copywriter, John E. Powers, a man celebrated for his no-bullshit copy style. One of Powers’s most well-known ads reads, “We have a lot of rotten gossamers and things we want to get rid of,” which ended up selling all of Wanamaker’s rotten gossamers (some sort of light gauze-like fabric) in a single morning.

John Wanamaker is also famous for coining the phrase:

“Half the money I spend on advertising is wasted, the trouble is I don’t know which half.”

Wanamaker ran full-page ads in the paper, praying that some of them would bring good business. But at the time it was impossible to know which ads brought good ROI (return on their investment) and which were a complete waste of money.

Apart from extraordinary circumstances, such as the morning of the rotten gossamers clean out, when he could physically see the direct impact of his campaign, advertising back then was driving as blind as Al Pacino in Scent of a Woman.

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A 1930’s ad man handling marketing budgets on the wheel, his client on the left

I wonder what Wanamaker and Powers would think if they saw how we measure every click, time spent, mouse movement and purchase of each sale today. How we are able to calculate the ROI of any advertising campaign in a few minutes, pausing and changing campaigns whenever we see fit.

We can learn a lot from Wanamaker and Powers’s direct approach to advertising. This type of upfront honesty can be just as effective today, when consumers are well aware of dishonesty in advertising, and respond gratefully when companies are – or seem to be – telling the truth.

But I’m glad we no longer manage advertising budgets like a blind man speeding around New York City corners in a Ferrari.

Today, any advertiser can measure every aspect of their advertising campaigns with just a few clicks, managing their profitability and ROI in ways that Wanamaker could have never dreamed possible.

There are three steps advertisers today take to calculate the ROI of their campaigns on Facebook, Instagram, Google or any other advertising platform. They are:

1. Calculate Your Customer Acquisition Cost

Customer Acquisition Cost, or CAC, is the amount of money spent on advertising to generate a sale. For example, if you spend $1,000 in Facebook Ads and generate ten sales from them, your CAC is $100.

While the math is easy, it can be difficult to determine which advertising campaign was responsible for each sale. This is a problem of attribution that can be (at least partially) solved by installing the Facebook pixel, if you’re advertising on Facebook or Instagram, or Adwords Conversion Tag, if you’re using Google Adwords.

It’s also important to use UTM parameters in your advertising links so you can follow their data on Google Analytics and Compass. Read more about what they are and how to use them in this article.

Compass attributes sales to its responsible advertising channels and calculates CAC for you automatically. To run a Compass CAC report, click here.

2. Know Your Average Customer Lifetime Value

Customer Lifetime Value (LTV) is the gross profit (profit before advertising spend) you make from the average customer while she remains a customer.

Your LTV helps you understand how much you are allowed to spend on advertising and still make a profit. If your LTV is $50, you’re CAC can be as high as $40 and you’ll be making a $10 profit per sale.

LTV is always a predictive number because you’re guessing how long your customers’ lifetime will be. The most complete LTV formulas can use very complex models, but the most important variables in any LTV calculation are:

LTV = Average Transaction Value X Repeat Purchases X Gross Profit Margin

The above is accurate enough to help you understand your LTV and use it to calculate the ROI of your campaigns (see more about calculating ROI below). You can read more about LTV in this article.

Compass will take your whole transaction history into account and then uses a predictive model to give you the most precise LTV calculation for your business, for free. Click here to learn more.

3. Compare Customer Acquisition Cost with Customer Lifetime Value and get ROI

Now that you know CAC and LTV, it’s time to compare them to get the ROI. The math is simple:

Channel ROI = (Channel LTV – Channel CAC)
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Channel CAC

For example, if the Lifetime Value of customers acquired via Facebook Ads is $300 and you spend on average $50 to acquire them, then the ROI is ($300 – $50 = $250) / $50 = 500%, which is amazing. It means that for every dollar you invest on Facebook you get five back.

Compass calculates the ROI of every Marketing channel you use automatically and makes data-based recommendations about where to invest your marketing dollars. You can get a Marketing Channel Report by signing up to Compass for free.

John Wanamaker would be jealous of our advertising precision. Instead of paying for an expensive full page ad in the Sunday paper, hoping the right people read it, we can now target a specific audience, or even a specific person.

Instead of spending huge amounts in ad space and production upfront and then praying for campaigns to work, we can now start with lower budgets, measure the effectiveness of our ads, then ramp up spending when we know it’s safe to increase budgets.

Most importantly, we can now calculate the ROI of each Facebook, Instagram or Adwords campaign automatically, with a click of a button. What was unthinkable in the 19th, or even the 20th, century is now accessible to anyone with an internet connection.