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# Why is ROI the wrong metric?

If you make 10,000% return on \$1, you actually make less money than if you make 1% return on \$10,000. The math is as follows:

10,000% ROI on \$1 ==> your profit is \$99
1% ROI on \$10,000 ==> your profit is \$100

Now, if you make 3% ROI on \$10,000, then your profit is more than 3 times the profit you would make with 10,000% ROI on \$1. Clearly, ROI is not a good metric.

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### Replies to This Discussion

Well, I seem to be having trouble understanding your math!

Let's see if my Math would work easier ~

ROI is the return on Investment,

ROI = (Revenue - Cost)/Cost

For the first example, 10,000% ROI = (Revenue - \$1)/\$1 or Profit = 10,000%*\$1 = \$100

Same for the second, 1% ROI = (Revenue - \$10000)/\$10000 or Profit = 1%*\$10,000 = \$100

So, the profits in both the cases = \$100 (not \$99 as you had calculated).

Instead, what needs to be considered is the initial costs/capital required to generate these profits. The way I would use ROI is to think like this -

If I can generate 10,000% ROI on my investment, I'd start to invest heavily into that medium, rather than a medium that can yield only 1%!

Be warned though, that this comparison is only possible if Investment costs are comparable and ceterus paribus! Which is generally not the case... Also, if a \$1 yielded such a high ROI, there's something to suspect and definitely expect a much lower return with increasing investment!

I'd like to hear your counter views on this...

Thanks.

The purpose of my message was to demonstrate that conditioned on investment, ROI is a good metric, but becomes useless when not conditioned. And of course, if your goal is to maximize your profit, you don't want to condition on any variable, be it principal, margin, investment etc.

Chinese optimize profit. American optimize ROI. What works best?

I didn't know that piece on Optimizing Profit & ROI by Chinese & Americans respectively! Well, wouldn't both be invalid without a conditioning on Investment, yes, ROI will be useless, but so would Profit. On your note that maximizing profits doesn't need a conditioning variable, what if I found out that maximizing my profit would be to maximize my cost? Would that be a good direction to take? I don't think so..

It's better to optimize, and by that, it involves both elements Revenue & Cost - so be it Profit or ROI, we should get the same results in different scales!

I don't know if any one metric would ever work, but if it's optimizing you're talking about, more factors will factor in, and hence that would work best.

And to me, the ROI is a neat metric that conditions your profits on the cost, which scales down to show you the relative scenario and not absolute numbers!

I'd love to hear other views....

The use of ROI as the decision factor only makes sense in linear situation, under an assumption that ROI does not depend on the amount of investment. So in your case, if you know a way to get 10000% ROI on something, just borrow \$10M and make a billion.
What you present is (finctional) anedotal evidence that has nothing to do with ROI as a metric.

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