Changes have been in the works over the past few years, dramatic changes and challenges are beginning to have an effect on traditional business. You look at software as a service (SaaS), service oriented architecture, and especially Web 2.0 and how organizations are trying to define new strategies. From my perspective, I focus a lot of time around discussing Web 2.0 and the value to traditional business in our services consulting for Telligent. Some of the common questions that are raised are: how do I calculate ROI around community? What are the contributing factors? How do I know that it is truly beneficial for me to have a community vs. not having one? The most common mistake when calculating ROI around community is to focus solely on the activity of the community. Things like unique visitors, page views, session time, community click throughs, read-to-post ratios, are all very useful in defining the health of a community, but they alone do not translate into a tangible business value that you can hang your hat on. When reviewing ROI you have to look at economic indicators such as the incremental value of the community and conversion rates.
Incremental Value is the difference between the value created by a business with an online community and the estimated value that the business would generate in the absence of community. There are a few guidelines that serve as baseline factors when calculating ROI. Research shows that Community members make up only 5% of the overall customer base, but this group accounts for 30% of the purchases and average transaction size is twice as large for community members as for non-community members. One of the biggest factors in calculating Incremental value is the referral factor. Community members are twice as likely to refer others to the site and the retention rates are 50% longer for community members than for non-community members.
With that in mind we (a very special thank you goes out to David Penton and Bill Robertson of the Telligent Development team, they are the mathematical genius behind assisting me with tying the variables together into a reusable formula) began the process of creating a formula that took into consideration variables such as Advertising Dollars, Potential Market, Current Market Over Time and Direct and Indirect Growth to both Community and Non-community Members as well as accounting for retention and Word of Mouth. The end result is the following:
(A+(Nt/M) (b)) (M-Nt) = Community Member
(A'+(Nt'/M') (b')) (M'-Nt') = Non-Community Member
Here are the variables
A= Advertising Dollars
M=Potential Market
Nt=Current Market over time
b= Direct Growth + Indirect Growth (CMs)
b'= Direct Growth + Indirect Growth (NCM)
r = Retention = 10% or .1
w= Word of Mouth Referral = 5% or .05
c= Content = 5% or .05
b = referral + 2(.005) = r + 0.0115
b' = referral + (.005) = r + 0.01/2
So with this in mind you can look at this practical example:
Nt/M (M-Nt)
Nt= 10,000
M= 1,000,000
10,000/1,000,000 (b) (1,000,000 - 10,000)
b/10 (990,000)
b=.1 + 2(.05) + .05 = .25 b= r + 2w + c
b'= .1/2 + .05 = .1 b' = r/2 + w
CM (10K, 1,000K) = (.25)(99,000) + 10,000 = 34,750
NCM (10K, 1,000K) = .1(99,000) + 10,000 = 19,900
Thus based on the criteria referenced above, having a community will yield a 74% increase over time as compared to not having a community based on the sample size.
In future posts I will look at another example of ROI calculation based on the average value of a Non-Community Member compared to the value of a Community Member. This will focus on monetizing the community and assumes a product based community. This requires an understanding of the average transaction per customer, total customers (projected or actual), potential market and the current conversion rates of the product. I will also review how Subject Matter Experts and Word of Mouth is calculated to come up with the 5% referenced above.