Expense Justification and Return on Investment

A significant aspect in planning and executing Internet communications efforts involves the economic forces introduced in the previous lab. It is safe to say that economics drive most projects in a company or organization. Part of driving an Internet communications effort is justifying the expenses involved in developing and operating the effort.

Justification involves answering the question, Is it worth the money? In a business or organization the answer to this question will influence project funding and the future of Internet communications.

We face these types of decisions every day in any buying cycle. In the grocery store, for example, I must constantly decide if the item I am contemplating purchasing will provide a solution that justifies the purchase price of the item. Often these decisions are easy and automatic. But as prices increase (e.g., for specialty foods), the justification of the expense becomes more involved.

Another way this issue is discussed is in terms of ROI (return on investment). Building Internet communications efforts does cost money. This investment of funds and personnel resources requires some type of return to the organization to justify the effort. For example, building a basic Web site with limited database features could cost about $10,000. This is a significant investment for any company or organization. After putting this money into the effort, will the communication it provides justify the expense? Will it return valuable communication for the investment it required?

The answer to this question is yes. But providing expense justification and determining ROI are actions that you'll probably have to be involved in with your own Internet communications effort. The powers that be probably won't take my word for it.

Answering this question and others like it on your own involves examining several factors in an expense justification and ROI analysis. A large part this process involves comparing Internet communication costs and the value of that communication to other traditional media costs and types.

First you need to break down communication costs to a comparable level for each communication transaction that takes place in each specific media. Doing so is called determining the delivery cost of communication. A very basic but useful method for determining the delivery cost of communication is simply to divide the expense involved in executing a particular media effort by the number of contacts or people that are communicated with in the media effort.

For example, in a direct mail campaign that reaches 100 contacts and costs $50 to produce, the cost of communication is 50 cents each. That was calculated by dividing $50 (media costs) by 100 (number of contacts). This gave us a cost/contact of 50 cents.

Assigning value to a communications effort is another useful tool in the justification process. Value is an estimation of quality of communications. Some communication types provide a higher level of quality or value than others. Value is relative to the receiver of the communication, but properties like specific information; satisfaction of wants, needs, and desires; and personal or customized interactions will increase the value of a communication method.

Though this is not an exact science, it can be accomplished by listing all the media types used by an organization. The media types can then be ranked in value relative to the other items on the list.

The three ways I communicate most are by phone, e-mail, and traditional mail. Looking at this list, I'd say phone is of the highest value to the end user because it is personal and supplies specific fulfillment to specific needs in real time. Second would be probably be e-mail because it provides the same properties in a slightly less personal way. In some situations, e-mail may be of higher value because synchronous communication is not needed and text and other documents can be transferred easily The third method, mail, has the lowest value due to time factors and personalization factors. But mailing documents is important to some of my audiences, so that situation is also relative.

Communication value must be considered when looking at communication costs. A low-cost communication method probably delivers low-value communication. A high-cost method probably delivers high-value communication. The trick is to balance communication value against its cost. Due to the customizable and asynchronous, on-demand nature of the Internet, Internet communication is relatively high in value while low in cost.

One of the major factors contributing to the low cost of Internet communication can be defined by looking at the difference between fixed and variable communication costs. A fixed cost is an expense that stays the same in each billing cycle. At home my mortgage payment is the same predetermined amount each month. It is a fixed cost for my personal living arrangement. A variable cost for is an expense item that changes, either rising or falling, based on usage. The more it is used, the more it costs. A variable cost me at home is my personal phone bill. The more I use my phone, the more the bill costs at the end of the month.

In another example, people's salaries and the amounts necessary to design direct mail pieces or advertisements are fixed costs in an organization. But travel and other expenses are variable costs. The more the employees travel, the more travel costs. This is the case for most traditional communication methods. As space ads are placed, mail pieces are printed and sent out, phone calls are made, and travel is completed the communication costs rise. Costs are amortized and discounted at higher quantities, but, generally speaking, as communication increases so do the variable costs involved.

Internet communication is highly attractive because it does not involve variable costs. Internet communication can be funded at a fixed level for development and operation, including staffing and updating. That funding amount will not change as the amount of communication increases. The $10,000 Web site mentioned previously can serve 100 people or 10,000 people at the same expense. Communication costs are fixed and do not rise at the same rate as usage does.

Granted, significant increases in use will require added technology expenses. If a Web site is so successful that it is swamped by users, then increased server capacity and Internet connectivity must be paid for. But this is, again, an increase in fixed costs to operate at a higher level. Once it is funded appropriately, the technology can serve the same size or even larger audience indefinitely with no need for further investment. This is a very important issue to consider when looking at ROI for Internet communication.

Looking at the communication delivery cost for each contact, the value of that communication, and the impact of fixed versus variable costs, we start to see positive reasons for justifying Internet communication. The Internet provides a low communication cost for each contact. The Internet delivers relatively high value in these communication efforts. And the Internet can be classified as a fixed cost that does not rise as communication usage increases, unlike other types of communication methods.

Using the Internet for communication could be equated to having a phone line that is never busy for the end user and is billed for each month regardless of use. The number of callers does not affect the cost. And every caller receives the same level of individual fulfillment by using the line. The Internet is good news for communication.

Another piece of good news is that Internet communication can be further justified by replacing existing media efforts and saving money by doing so. Developing and operating Internet communications efforts does incur expenses. Much of this expense is needed in the initial phases, before any communication can take place. But as Internet communication begins, it can replace other types of more expensive communication. For every e-mail message I send, I am making one less phone call or mailing one less letter.

This is an excellent justification for Internet communication. Tracking Internet use can further help justification efforts when it is directly compared to decreases in other communication media. From this perspective, Internet communication begins returning on its investment as soon as its operation begins replacing other communication methods.

Not even considering the increases in value to the end user, the use of Internet communication can be justified by comparing its fixed costs to the variable costs of the other media. Eventually, the fixed delivery cost per contact on the Internet will drop below the variable cost per contact in other methods.

A $10,000 Web site serving 100 customers once seems expensive. That's $100 for each contact. But those contacts replaced 100 phone calls at $3.50 each, or $350, so that amount of money can be seen as contributing to the expense of the Internet effort. Once this Web site has replaced about 2860 phone calls, it has paid for itself ($10,000 fixed cost/$3.50 for each phone call replaced = 2857 calls to cover the fixed cost). Once that level of communication has been achieved, the Web site is saving money for the company or organization while supplying valuable communication in the process.

Another way of looking at this point is the amortization or spreading of Internet development costs over time as usage increases. A $10,000 Web site used once by 100 people is providing a high delivery cost of $100 for each contact. But a Web site serving the needs of 1000 people 10 times has now delivered a delivery cost per contact of $1 each. And the same Web site serving the needs of 1000 people 100 times has delivered a delivery cost per contact of 10 cents each.

While other media methods would increase in cost based on their variable delivery costs, the Internet actually becomes cheaper the more it is used. For this reason and the ones discussed earlier, the Internet is justifiable economically and from the standpoint of adding value to relationships. Both issues provide return on investment for Internet communications methods.

Exercises

Understand the Cost of Communication

Determine the cost of communication for each contact in the following scenarios:

a)A print advertisement that costs $200 to produce and $550 to place once a week for four months in a newspaper with a circulation of 30,000 people
b)A direct mail campaign with 10,000 targets that costs $7500 to produce
c)Visiting three prospects in person in two days by a salesperson who, in doing so, spends about $1200 in travel expenses and wages
d)Telephone customer service calls that average 7 minutes (5 on hold, 2 in communication) at $.05/minute for the call and $.45/minute in salary and benefits for the employee
e)Communicating with 200 customers once a week for four months using a Web site that cost $10,000 to develop
f)Communicating with 2000 customers once a week for four months using a Web site that cost $10,000 to develop and maintain in that time frame

Assign Value to Communication

Determine the relative value of each communication method:

a)Space advertising
b)Direct mail
c)Personal sales calls
d)Telephone customer service
e)Internet communication

Understand Fixed Versus Variable Costs in Traditional and Internet Communication

Identify the fixed and variable costs for each communication medium:

a)Space advertising
b)Direct mail
c)Personal sales calls
d)Telephone customer service
e)Internet communication

Justify Internet Communication Based on Delivery Costs and Value

Answer the following questions:

a)How does the old adage of quality versus quantity play a role in this discussion?
b)Is the variable delivery cost of Internet communication low?
c)Does the low variable cost and relatively high quality of Internet communication justify its use?

Assign Costs to Traditional Media

Base your answers on Exercise 3.2.1.

a)What was the cost of each contact for space advertising?
b)What was the cost of each contact for direct mail?
c)What was the cost of each contact for personal sales calls?
d)What was the cost of each contact for telephone customer service?
e)What was the first cost of each contact for Internet communication?
f)What was the second cost of each contact for Internet communication?

Justifying Internet Communication Based on Replacing Current Communication Efforts

a)Can Internet communication replace the four other methods discussed so far in this lab?
b)Will replacing communication methods which are viable to do so, make communication cheaper?
c)Does this situation justify Internet communication financially?

Exercise Answers

Answers

Determine the cost of communication for each contact in the following scenarios:

a)A print advertisement that costs $200 to produce and $550 to place once a week for four months in a newspaper with a circulation of 30,000 people
Answer:The cost for each contact is about $.19. This is computed by multiplying the $550 cost by 16, the frequency of placement, and adding the production cost of $200 to equal $9000 (550 x 4 x 4 + 200 = 9000) Multiplying 30,000 by 16 equals 480,000, the total number of contacts. Dividing $9000 by 480,000 equals $.01875.
b)A direct mail campaign with 10,000 targets that costs $7500 to produce
Answer:Dividing the cost of $7500 by the number of contacts gives us a cost per contact of $.75 ($7500/10000).
c)Visiting three prospects in person in two days by a salesperson who, in doing so, spends about $1200 in travel expenses and wages
Answer:Dividing the cost of $1200 by the number of contacts gives the cost per contact of $400 ($1200/3).
d)Telephone customer service calls that average 7 minutes (5 on hold, 2 in communication) at $.05/minute for the call and $.45/minute in salary and benefits for the employee
Answer:The cost per contact is $3.50. Adding together the communications costs equals $.50 per minute ($.05 + .45). Multiplying this cost by the number of minutes gives us an average cost per contact ($.5 x 7 = $3.50).
e)Communicating with 200 customers once a week for four months using a Web site that cost $10,000 to develop
Answer:The cost per contact in this scenario is $3.125. It is found by first multiplying the 200 customer contacts by the frequency of 16 to calculate the total number of contacts. Then divide the $10,000 cost by the total number of contacts to get the cost per contact ($10,000/200 x 16 = $3.125).
f)Communicating with 2000 customers once a week for four months using a Web site that cost $10,000 to develop and maintain in that time frame
Answer:Using the same equation with an increased number of customers drops the costs to $.31 for each customer contact ($10,000/200 x 16 = $.3125).

Answers

Determine the relative value of each communication method:

a)Space advertising
Answer:The relative value of this type of communication is the lowest of this group.

Though space advertising can reach a large number of contacts, only a very small percentage of the audience actually looks at or reads the advertisement. Of that small percentage, an even smaller amount may be members of the actual audience you are trying to communicate with. As it is not personalized, this method is not very useful for building relationships beyond initial levels.

b)Direct mail
Answer:The relative value of this type of communication is much higher than space advertising and not as high as more personal methods.

It is personalized and targeted at a specific member of a specific audience. Though it may not be read by that audience member, it is at least delivered to the right person and can carry an offer aimed at that person's audience. It can be used to build and continue relationships in general ways.

c)Personal sales calls
Answer:This type of communication has the highest value possible.

Face-to-face personal communication provides opportunities to build and maintain professional relationships and deliver targeted offers and information. This does require scheduling meetings, and the communication is controlled by the availability of the parties involved. Though this is the most valuable type of communication, outside factors, including time and money, make this type of communication increasingly difficult.

d)Telephone customer service
Answer:This type of communication is probably second in relative value after sales calls.

It is personal in nature and provides opportunities for individual attention. It allows for individual fulfillment of wants, needs, and desires. But this method does tend to frustrate the customer if these needs can't be met efficiently, the process is dependent on the company's needs regarding time and availability of service. Customers can get what they want but not when they want it.

e)Internet communication
Answer:This type of communication is relatively high in value. Depending on the situation, it may be as valuable as telephone or even personal sales calls.

Though every situation is different, Internet communication may be as high in value as telephone customer service or even higher. Though Internet communication may not bring the same personal value to communication, customized interfaces can provide immediate fulfillment of wants, needs, and desires. More important, these efforts are driven by the end users, giving them immediate involvement and satisfaction.

Answers

Identify the fixed and variable costs for each communication medium:

a)Space advertising
Answer:The fixed cost of space advertising is the expense of producing the advertisement. The variable cost is the money spent for each placement of the ad in a publication.

Though it wasn't mentioned earlier, the fixed cost should include the salary of the person coordinating the effort. Space advertising utilizes frequency of placement in publications to reach audiences. Each time the ad runs, the publisher charges a fee. These fees are discounted for frequent placement. A one-time placement may cost $500. But a three-time placement may be discounted to $400 each.

Regardless of the discount, the higher the frequency of placement, the higher the cost. As this communication increases, the variable costs increase as well.

b)Direct mail
Answer:The fixed cost of direct mail also involves, salaries and production costs, such as graphic design and copy writing. Variable costs involve printing, mailing, database purchasing, and postage charges.

Developing a direct mail campaign costs the same regardless of the number of pieces being sent. The piece must be written and designed. But the variable costs increase for each piece sent. Again, discounting occurs as quantity increases. But, generally speaking, as communication increases so does the cost involved. Each piece must be printed, addressed from a database, mailed, and carry postage.

c)Personal sales calls
Answer:Fixed costs include the salary and benefits of the sales representative. All other costs are variable.

As the salesperson travels to meet with customers, costs are incurred. The more meetings that take place, the higher the variable costs. This type of communication is extremely expensive since the amount of people that can meet face to face is small, time available to do so is limited, and travel time and expense is considerable. If the number of salespeople is increased to meet customer needs, these costs increase exponentially.

d)Telephone customer service
Answer:Fixed costs involve the salary of the representative. Variable costs center around the phone call. Increasing service to meet customer needs also involves increasing employees and salaries, making salaries a variable cost as well.

This communication method is similar to the personal sales call except that people can communicate with significantly more customers at much lesser expense. But as communication increases, variable expenses increase as well.

e)Internet communication
Answer:Internet communication primarily involves fixed costs.

Unlike other types of communication, the Internet does not incur variable costs. Developing and maintaining Internet communication are fixed costs. As communication increases, these costs do not increase. If communication becomes so frequent that technology upgrades are needed to meet demand, then costs will increase. But these increases will involve higher fixed costs.

Answers

Answer the following questions:

a)How does the old adage of quality versus quantity play a role in this discussion?
Answer:Your answers will vary, but here's mine. The Internet provides a high quality of communication in large quantities.

A Web site can be visited by millions of people, 24 hours a day, and each one can receive the information he or she seeks. The medium can serve one person and one million people in the same way, with each person receiving individual attention and fulfillment as long as the effort is developed to do so.

b)Is the variable delivery cost of Internet communication low?
Answer:Yes. The variable cost of Internet communication is nonexistent.

The more you communicate, the more you amortize the initial development and operating costs. Successful situations may require technology upgrades to meet demand. But increases involve fixed costs and are low relative to the amount of communication they enable.

c)Does the low variable cost and relatively high quality of Internet communication justify its use?
Answer:Hopefully, your answer is yes.

The basic justification of Internet communication is its delivery of valuable communication with no variable cost increases. Though other types of communication are more personal, the Internet delivers individual attention and customizable interfaces to information in an on-demand format for the end user.

As the number of users who access this information increases, the costs to deliver the information do not. No other method communication method can deliver this high-value, low-variable-cost formula. In any other communication method, costs increase with use.

Answers

Base your answers on Exercise 3.2.1.

a)What was the cost of each contact for space advertising?
Answer:The cost per contact was $.01875.
b)What was the cost of each contact for direct mail?
Answer:The cost per contact was $1.33.
c)What was the cost of each contact for personal sales calls?
Answer:The cost per contact was $400.
d)What was the cost of each contact for telephone customer service?
Answer:The cost per contact was $3.50.
e)What was the first cost of each contact for Internet communication?
Answer:The cost per contact with 200 customers was $3.125.
f)What was the second cost of each contact for Internet communication?
Answer:The cost per contact with 2000 customers was $.3125.

Note that in this scenario the cost per contact was developed using the fixed costs of development and use. In the other situations variable costs were heavily involved in the equation. In this last scenario (f) communication costs decreased 100% from the previous scenario (e). The amount of communication, however, increased 100% from the previous scenario (e). This is not possible in any other method discussed.

Answers

a)Can Internet communication replace the four other methods discussed so far in this lab?
Answer:The answer is a qualified yes. Though not all uses of these media can be completely replaced, many communication functions can be shifted to Internet methods.

Space advertising can be eliminated except for new business solicitation. The same is true for direct mail. Customers can be contacted via e-mail instead of traditional mailings. Personal sales visits can be decreased by using individual interfaces via the Web. Interpersonal relationships can be maintained in less frequent but more satisfying meetings, with additional communication via e-mail as well. Customer service needs can be served almost completely via the Internet, with an option for telephone communication available for special circumstances, although e-mail is probably a better, more satisfying option for the customer due to its asynchronous aspects.

b)Will replacing communication methods which are viable to do so, make communication cheaper?
Answer:The answer is yes. Looking at the previous exercise shows us that shifting each communication activity to the Internet makes it cheaper to communicate overall.

Shifting communication to the Internet helps in two ways: (1) by decreasing the variable costs incurred in traditional methods, and (2) by further amortizing the fixed costs of Internet communication.

c)Does this situation justify Internet communication financially?
Answer:Another yes answer. The basic justification of Internet communication is its delivery of valuable communication with no variable cost increases. The more advanced justification involves the replacement of other, more expensive, and less effective communication methods with cheaper, more valuable Internet communication.

Though not all traditional communication costs can be eliminated completely, every interaction completed over the Internet can decrease the variable costs in other media while adding value to the relationships involved.

Self-Review Questions

In order to test your progress, you should be able to answer the following questions:

1)What is the cheapest communications method based on delivery cost per contact?

  1. _____ Personal sales calls
  2. _____ Telephone customer service
  3. _____ Web site communication
  4. _____ Space advertising
2)What method of communication is least valuable relative to the others?

  1. _____ Personal sales calls
  2. _____ Web site communication
  3. _____ Telephone customer service
  4. _____ Space advertising
3)Internet communication delivers relatively_____.

  1. _____ High cost and high value
  2. _____ Low cost and high value
  3. _____ Low cost and low value
4)Internet communication involves variable costs.

  1. _____ True
  2. _____ False
5)Internet communication can replace existing communications methods.

  1. _____ True
  2. _____ False
6)Internet communication can cut communication costs while increasing communication value.

  1. _____ True
  2. _____ False


Exploring Web Marketing and Project Management
Exploring Web Marketing and Project Management
ISBN: 0130163961
EAN: 2147483647
Year: 2000
Pages: 87

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