Performance-Based Marketing: A Winning Strategy for Agencies and Clients

by Moses Foster, President and CEO, West Cary Group and Doug White, Chief Analytics Officer, West Cary Group

A client that offers auto refinance loans engaged an advertising agency. Working collaboratively, the agency and the client carefully designed a direct mail test. They analyzed the market and targeted a number of potentially profitable segments. They tested different creatives within the selected segments and delivered enough mail to each segment to balance obtaining statistically significant results with keeping the cost of testing manageable.

The agency analyzed the results extensively. They calculated response rates for every segment and identified the winning creatives. But their analysts went further. They developed a profitability model and, perhaps not surprisingly, determined that some segments were profitable while others were not. They made plans to mail rollout quantities to the segments that were clearly profitable. They scheduled additional testing for marginal segments and made a decision to withdraw from some initially unprofitable ones (at least for the time being).

A national credit card issuer determined to spend upward of $100 million annually on brand advertising through mass media, but selected a small number of markets to remain dark (not exposed to the advertising). Two years into the brand campaign, analysts determined that response rates to the issuer’s direct mail solicitations were substantially better in markets that had been exposed to the brand advertising when compared to similar blacked-out markets. The financial lift the company saw as a result of the brand advertising eclipsed the cost of the campaign by a factor of three.

A company marketing first mortgages and another offering personal loans secured by selected assets both tested direct mail campaigns. After several mail drops in test quantities, both companies determined that the channel economics didn’t justify further spending.

All of the above are examples of Performance-Based Marketing (PBM). The companies and their partner agencies closely examined the economics of their marketing programs and analyzed the market to target specific segments in which they hypothesized success would be more likely. They launched campaigns with multiple approaches, testing one against the other. They identified the winners in each segment and rolled them out to larger populations.

Just as importantly, they identified segments in which none of the approaches tested resulted in enough return to justify the marketing expense. This enabled them to end the unprofitable programs—to stop throwing good money after bad. Instead, that money was diverted to programs that delivered a positive return on marketing investment. Using what they had learned from the results of earlier programs, they improved targeting in subsequent campaigns. The result was a virtuous cycle of testing, learning, rolling out and making money.

In the balance of this blog, we’ll define PBM, explain why it’s good for both clients and agencies, and explore a new pricing paradigm enabled by PBM.

Defining PBM

To be sure, informing the market about a company’s product/service offering is critical. Whoever said, “If you build a better mousetrap, the world will beat a path to your door,” didn’t go far enough. The truth is, if you don’t tell the world you’ve built a better mousetrap, no one will be beating a path your door. It is essential that companies let their target market segments know about their offerings.

Doing so takes a lot of activity. Companies and their agencies need to generate enticing marketing communications that notify the world of the benefit of their products in a compelling way. For decades, advertising agencies have been paid for this activity. Yet generating marketing communications is insufficient in and of itself. The marketing communications have to deliver the desired result; most often that result is revenue.

PBM shifts the focus from activity to results. With PBM, the activity associated with running an advertising campaign means nothing. All that matters is the value the advertising creates for the client through incremental revenue. PBM shifts the focus from the activity of generating marketing communications to the results they deliver. Accordingly, PBM is defined by three primary tenets:

1. Only spend a dollar on marketing if it returns more than a dollar. You wouldn’t invest in a stock that you expected to decline in value. You’d only do so because you expected it to provide a return through dividends or an increase in the stock price, or both. Before you invested your hard-earned dollars, you would have to believe the investment would provide a return. You would monitor the investment to see if the return met your expectations. If it didn’t, you wouldn’t keep doubling down on a loser.

Dollars spent on marketing are an investment, and like any investment, those dollars should provide a return. Yet many businesses spend money on marketing without ever checking to see what kind of return they’re getting. Year after year, they set aside money in a marketing budget—perhaps using a rule of thumb that says they want to spend a certain percentage of revenue on marketing. And they spend the money because it’s been allocated to marketing without any apparent concern for the kind of return their investment is providing

This approach is despised by a performance-based marketer. It just doesn’t make sense. In a PBM program, a dollar is spent on marketing only when there is the expectation that it will return more than a dollar. Why would anyone do otherwise?

2. Continue to spend until the incremental investment isn’t justified. It’s important to understand the difference between the average and the incremental. Consider a marketing spend of $100,000 that returned $150,000 to the bottom line over six months. Not bad, you might say—on average, a dollar returned $1.50. That’s the kind of result a performance-based marketer could get behind.

However, suppose you could have spent $90,000 and returned $145,000 over the same six months. The implication is that the last $10,000 spent on the marketing campaign returned only $5,000. At the margin, a dollar of marketing spend returned only 50 cents. You don’t need advanced mathematics to figure out this isn’t a good deal.

On average, the $100,000 investment in marketing seemed like a good idea. But at the margin, the last $10,000 should not have been spent. Understanding the difference between the average and the incremental is at the heart of PBM. 

3. Results can and must be quantified. We’ll concede that there are some potentially valuable marketing programs that can be difficult to measure, and that it may make sense to pursue them. There is also marketing spend where the need is so clear, the return so obvious and the cost so small that it doesn’t make sense to spend time and effort measuring the efficacy. For example, most businesses clearly need business cards, a basic website and letterhead; it would be nonsensical to perform a cost-benefit analysis on such expenditures.

These exceptions aside, results can and should be quantified. At a minimum, when marketing spend is significant, companies and their agencies should make all reasonable efforts to measure results. It doesn’t have to be complex exercise. Take the following scenario as an example.

Moses and his wife own a rental property. The front of the house faces a street, but the back of the house is visible from a school. His wife is working to rent the property and wants to know if the sign she placed in front of the house or the one she placed in the back of the house is more effective in generating high-quality leads. She puts her home phone number on one sign and her cellphone number on the other. As the principle of Occam’s Razor points out, the most elegant solution is often the best.

Next Week: Simple Ways to Measure Results

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