Just as with purchasing a stock or mutual fund, investments in marketing have an expected return and associated risk. These investments can range from launching a new product to acquiring new marketing software, organizing a major user conference or buying media time. While business managers regularly make marketing investments and often have some form of ROI calculation to justify them, they rarely quantify how likely it is for this return to materialize. For example, many companies use vendor-provided case studies to decide whether to invest in a vendor’s solutions. But these sources focus only on the success stories and do not provide an objective view into how typical the advertised results are. Taking a calculated risk is the key to good decisionmaking because it provides transparency and manages expectations about the rate of return.
As a first step, determine your organization’s risk aversion profile. How comfortable are your management and employees with taking risk? Think of the risk aversion profile as the internal risk boundaries that should not be crossed. A more risk-averse company tends to stick with tried-and-true investments that leave little room for error; less risk-averse companies are willing to experiment with new approaches and tend to be early adopters (e.g. new technology, new product categories). Examining the historical background of your company’s previous marketing investments can be very helpful in determining the risk profile. A typical indicator of a risk-averse company is a high rate of rejection for proposed new types of investments. While this exploratory work might be time consuming, the findings can be applied to a number of investment projects. However, keep in mind that a company’s risk profile may change, especially if there are changes in the management team or if the company starts to take a different business direction.
Risk is an estimate of the uncertainty or deviation from the expected ROI. Some external factors to be considered for risk assessment include the economic climate and outlook, political stability (especially for investments in emerging markets) and market availability. Project-specific risk factors include historical performance of similar investments within your company or as reported by others, vendor viability, residual value (in case an exit is required), cost volatility for ongoing investments and internal investment experience. To aggregate all of these factors, a scoring system can be used with assigned weights for each factor. The rolled-up project-specific risk should be compared to the company’s risk tolerance.
Best practice decision models used to estimate the financial and operational consequences of significant marketing investments have a risk assessment component built in. This approach is not very different from that used by professional investment analysts and includes cost/benefit calculations, probability calculations, sensitivity analysis and qualitative commentary in the form of assumptions. Rate of return and expected risk often correlate directly to each other; if an investment promises a high return, it may also have high risk. Also, a wise investment for one company may be too risky to justify for another. Marketing managers should be aware of these risk/reward tradeoffs and adopt a decisionmaking approach that evaluates project-specific risk not only against the company’s attitude toward risk but also against the risks associated with other potential or ongoing initiatives.