eCommerce ROI Calculator
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Understanding ROI in E-commerce
In e-commerce, Return on Investment, usually abbreviated as ROI, is a common, widespread metric used to evaluate the forecasted profitability of various business activities. Before any major business decisions are made, ROI serves as a solid foundation to proceed. The metric can be applied to anything from marketing campaigns, website improvements, inventory purchases, to even customer service initiatives; anything that has a cost with the potential to derive gains can have an ROI assigned to it. While more intricate formulas exist to calculate the rate of return on these activities accurately, ROI is lauded and still widely used due to its simplicity and broad usage as a quick-and-dirty method. Many e-commerce strategies are discussed among team members, with someone often exclaiming about a high ROI after doing the calculations on a whiteboard or a spreadsheet.
ROI might be confused with ROR, or rate of return. Sometimes, they can be used interchangeably, but there is a significant difference: ROR can denote a period of time, often annually, while ROI does not necessarily include a timeframe.
Basic Formula for ROI
ROI = (Gain from Investment - Cost of Investment) / Cost of Investment
Example
As a most basic example, Alice wants to calculate the ROI on her new e-commerce website. From the beginning until the present, she invested a total of $50,000 into the project, and her total profits to date sum up to $70,000.
ROI = (70,000 - 50,000) / 50,000 = 40%
Alice's ROI on her e-commerce website is 40%. Conversely, the formula can be used to compute either gain from or cost of investment, given a desired ROI. If Alice wanted an ROI of 40% and knew her initial cost of investment was $50,000, $70,000 is the gain she must make from the initial investment to realize her desired ROI.
Difficulty in Usage
It is true that ROI as a metric can be utilized to gauge the profitability of almost anything. However, its universal applicability is also the reason why it tends to be difficult to use properly. While the ROI formula itself may be simple, the real problem comes from people not understanding how to arrive at the correct definition for 'cost' and/or 'gain', or the variability involved. For instance, for a marketing campaign, marketer A might calculate the ROI involving the cost of ads, creative development, and analytics tools, while marketer B might only use the ad spend. For a new product launch, marketer A might calculate ROI including logistics and promotional discounts, while marketer B may not. Also, does an ROI calculation involve every cash flow in the middle other than the first and the last? Different marketers use ROI differently.
However, the biggest nuance with ROI is that there is no timeframe involved. Take, for instance, a business decision between a marketing campaign with an ROI of 1,000% or a new website feature with an ROI of 50%. Right off the bat, the marketing campaign seems like the obvious choice, but is it true if the ROI is calculated over 50 months for the campaign as opposed to the website feature's ROI calculated over several weeks? This is why ROI does its job well as a base for evaluating business activities, but it is essential to supplement it further with other, more accurate measures.
Annualized ROI
The ROI Calculator includes an Investment Time input to hurdle this weakness by using something called the annualized ROI, which is a rate normally more meaningful for comparison. When comparing the results of two calculations computed with the calculator, oftentimes, the annualized ROI figure is more useful than the ROI figure; the marketing campaign versus website feature comparison above is a good example of why.
In real life, the business risk and other situations are not reflected in the ROI rate, so even though higher annualized ROI is preferred, it is not uncommon to see lower ROI activities favored for their lower risk or other favorable conditions. Many times, ROI cannot be directly measured, such as the investment in improving customer satisfaction. The ROI in such situations is normally estimated via the marginal sales benefit or enhanced customer loyalty.