“Return On Investment” (ROI) is a key number used to assess how much return you can expect on the money you are putting into any individual project. This figure is obviously impactful when negotiating ceiling and floor prices with vendors, employees, and overall company expenditures. Whether it’s a real-estate purchase, a stock market play, technology project, or any other type of investment, investors are always looking to gain a positive ROI on the the spend.
Some quick calculations:
- ROI = % of gain/loss on investment made
- ROI = (Net Profit / Cost of Investment) x 100
It is important to note, however, that chasing a positive ROI for any project or company at an early stage can be tricky (and even dangerous). Unlike long-standing infrastructures that have an extensive amount of historical data, young organizations may need to use other key guide posts, such as unique user size / engagement, specific conversions, and initial signs that people are willing to spend money on the idea. These guide posts will help solidify the concept viability and give investors signals that the project is worth spending more on to get to scale.
MICRO ROI FOR TECH PROJECTS
While there are endless articles and bogs discussing macro investments into companies of all stages, you also have to consider the micro-investment strategies at a product level. I mean, you have some money to spend, but how do you know the best thing to spend it on. A simple early-stage startup example might look something like:
- Total Budget: $100,000
- $15,000 – R&D/ Design
- $50,000 – Technology
- $20,000 – Sales & Marketing
- $15,000 – Customer Support
The overall budget is the key number you are looking to see at an overall positive rate. However, each of the line items rolling up into that number will effect the final result. In the example above, it’s safe to say that sales and marketing will have a strong immediate ROI – it is the division that is going to generate leads, opportunities, and ultimately close deals. However, other cases may not be quite so obvious. For instance, you might expect to see a weak immediate ROI on Customer Support (since there is no immediate revenue generated); however, you probably want to keep in mind an extended horizon since this department may have significant impact on re-engagement and re-purchasing. So setting estimates for these line items might be stronger if you use a variable time horizon vs focusing on an immediate month-over-month expectation.
DO I NEED TO THINK ABOUT AN ROI FOR MY APP?
A lot of initial business and product meetings focus on determining if there’s a genuine ROI on the idea. Whether it’s yourself, friends and family or a successful friend providing part of an angel round, you will probably spend a lot of time assessing how to round up the money to build your big idea. But these conversations are usually meandering at best and often just a way to justify sharing it with people. Many entrepreneurs at this stage don’t bother asking the hard question – “is this concept really worth it?” And to be fair, that’s often because it’s hard to figure it out.
When I work with someone who is assessing whether not they can make a case for the expense, I get them some basic tools to help determine a pass for finding the actual value. In reality, the true value or true ROI have a new project is not usually clear until the product is in the market. At that point you’re able to begin determining the conversion metrics it will tell you the truth about the potential audience that really exists. But like many chicken and egg scenarios, entrepreneurs need to have an understanding well before they get into the market if their project is worth investing in.
ESTABLISH AN AUDIENCE BEFORE COMMITTING
Since most people with a great idea don’t have a massive R&D budgets or full Business Analyst teams, I like to spend some time looking at a few basic commonsense rules that can help determine whether you should keep pushing forward on a project for pivot the idea and something more manageable. Below are some steps to can quickly give you some basic perspective as to whether you want to keep moving forward or take a moment to reassess.
If you’re working on a tight budget, one of the early challenges is figuring out a way to assess the actual potential audience for mobile app or website. If you’re at a large company that is flush with resources you may have access to specialized reporting that can help structure useful business intelligence.
But since you probably don’t have access to this, take a read of our article on informal audience sizing and competitive assessments. are some creative ways to determine numbers that have some sense of reality built into them.
Once you have some estimates on both audience size and search volume, you can start to think about the conversion volume that may result from displaying these ads. While this is not the only way to garner an audience, it will give you some direct perspective on general desire for the potential product you have.
To figure out the best case scenario, I first look at a Target ROI:
To start the calculation, I like to think about the average price of widget or service and the total number of sales needed to reach an ROI I am satisfied with. For example…
- Average price is $100
- Each product has cost of $30 to produce
- Fixed Cost of running the business monthly is $10,000
In this case:
- You profit $70 on each sale
- And you need roughly 143 sales to break even
- And if I want to have a 150% ROI, I would need 1000 monthly sales
Let’s then say that my Target ROI is 150%. Once I have this, I then like to try and use standard conversion rates that run across advertising.
1 Impressions > 2 CTR > 3 Landing page Conversions > 4 Final sales
A pretty standard conversion estimate might look something like:
- Total Impressions (x)
- CTR = 3%
- Landing Page Conv = 10%
- Actual Sales = 8%
Thinking about the backwards calculation, that would mean I need the following:
- 1000 monthly sales
- 12,500 Landing Page Conversions
- 125,000 Clicks
- 4,166,1666 Impressions
From this you can clearly see you are going to need to spend some money to get there. You have a) the costs of creating a truly valuable product or service, b) the costs of supporting that service, and most importantly a pretty sizable sales and marketing campaign.
Additionally, using the ad targeting tools in the previously mentioned article, you can see a rough perspective as to whether those audience sizes even exist.
Perhaps the price has some flexibility and you can lower the number of sales necessary to meet your Target ROI. Or maybe you have a much higher converting sales process. While this is a very simplified version of a model, it can still provide you with some early stage perspective on goal setting and actual reality. And taking a few minutes to, think a bit about what it will take to hit a worthwhile ROI can give you some perspective on whether you should begin the journey and investment required to launch your big idea.