ROAS VS ROI: How to Use Return on Ad Spend and Return on Investment to Measure Advertising Success.
What Is Return on Ad Spend?
Return on advertising spend (ROAS) is the amount of revenue generated by a specific ad or ad campaign vs the amount of money spent on that ad or campaign. ROAS allows you to assess the effectiveness of a given ad or ad campaign, allowing you to determine whether to continue investing in the ad or campaign.
How to Calculate ROAS?
ROAS is calculated using the following equation: Revenue Generated by Ad / Money Invested in Ad and is most often expressed as a multiple of the revenue generated to the invested amount. There are other ways to express ROAS: a ratio, percentage or a comparative dollar amount. The below example highlights each form of ROAS.
Your company spends $10,000 on Facebook ads in a single month which generates $60,000 in revenue. Using the formula noted above, ROAS is calculated to be 6x, 6:1, 600%, or $6 for every $1 spent.
ROAS vs. ROI (Return on Investment) and Which is Most Important
ROI is often (mistakenly) calculated for ROAS, however the correct formula for ROI is: (Revenue – Cost of Ad) / Cost of Ad. Using our previous example above, where the hypothetical ad’s ROAS was 600%, the ROI would be 5x and calculated as follows:
($60,000 – $10,000) / $10,000
The difference between ad-centric ROAS and ROI is that ROI is a macro metric that measures how a specific ad affected the company’s overall profits, while ROAS is a micro metric that evaluates the effectiveness of the ad itself regardless of the impact it had on your business’s profits.
CPA (Cost Per Acquisition) and Why It’s Too One-Dimensional Compared to ROAS or ROI
CPA (Cost Per Acquisition) is simply the amount of money it takes you to acquire a single transaction, regardless of the revenue value of the transaction. For most entrepreneurs and business owners, CPA is a good barometer of success, but doesn’t paint the full picture of how your advertising is performing.
A simple example to highlight this: A business sells a high-performance, luxury winter coat for $1500. On the same website, they sell a winter hat for $95. If their CPA was $300, but 99% of their transactions were for a single hat, the company would be losing money. It’s only when you begin to assess ROAS and ROI that the true advertising and business performance come to light.
ROAS Is NOT a Business Metric
The problem with being hyper-focused on ROAS, is that it’s incredibly easy to lose sight of all the other costs associated with running your business. Recall in the example above in which your company develops and runs a marketing campaign for $10,000, which generates $60,000 in a month. Using our ROAS formula, we find the return on ad spend for this campaign to be 6x.
While celebrating the success of your latest advertising efforts, you still need to keep a keen eye on your COGS (Cost of Goods Sold), Salaries, Shipping and Returns. An example to extend the use case above:
- Your cost of goods sold for the month were $25,000
- Cost to develop the creative for your campaign was $10,000
- Ad Spend $10,000
- You paid your employees $10,000
- Shipping and returns cost $5,000
This leaves your profits at month’s end being $0.
$60,000 revenue – $25,000 COGS – $10,000 creative – $10,000 ad spend – $10,000 salaries – $5,000 Shipping and Returns.
This isn’t sustainable for growth and can lead to significant losses or even bankruptcy if your main focus is on ROAS.
ROAS Can’t Be Applied to All Marketing Activities
For the sake of showcasing examples throughout this article, we’ve assumed that the ROAS of all marketing activities can easily be defined. However, this is far from the case. For a marketing campaign to be assessed using ROAS, the true cost of that campaign must be absolutely concrete, which is atypical for most marketing campaigns.
For example, you create an automated cart-abandoner email campaign focused on getting 7-day cart abandoners back to your site. How are you going to determine the cost of ad spend here? It’s nearly impossible; you’d have to consider the monetary cost of:
- Creating the email copy
- Implementing the automation flow
- The deal or promotion you may offer within the email
- The cost of sending each individual abandonment email
You could attempt to figure all of that out, but the insights and data won’t tell you much in the long run. In fact, the ROAS of such a campaign will shift over time and eventually become meaningless.
Think about this. If the cost of creating a cart abandonment campaign is $1,000 and you generate $3,000 in sales from cart abandonment emails within the first month of the campaign, the ROAS of the campaign is 3x. The next month, you generate another $3,000 from the same email sequence, but you haven’t spent any time or money on it since the previous month. This type of revenue is great for your business, but the ROAS of your email flow in the 2nd month is virtually undefinable. There are a variety of other metrics to measure the long term success of these types of email campaigns; ROAS just isn’t one of them.
Not All Ad Campaigns Contribute Directly to Sales
As you know, not all marketing is “direct response” marketing in efforts to drive a purchase conversion. Billions of dollars in brand advertising are spent each year with the intent to gain attention of a target audience, change or reinforce a perception of the brand and ultimately get people to change their behavior (to make a purchase) towards a brand.
It would make little sense to assess the top-of-the-funnel marketing initiatives with the ROAS metric as the intent is not to drive a purchase. While brand advertising certainly plays a role in a person’s buying decision there’s no real reason to even assess ROAS when determining the effectiveness of brand campaign.
Attribution and Why It’s Important
A customer’s path to conversion includes almost unmeasurable touchpoints along the way. They may have first seen your video ad on Instagram Stories, then an ad on Facebook News Feed, talked to a friend who had previously purchased your product, been exposed to a google display ad, clicked on a search ad, browsed several pages on your site, added a product to their cart only to abandon their cart, receive an automated email with a discount code and finally completed their purchase on Amazon (not even your website). In this example which initiative / activity should get credit for the conversion? The answer is all of them and likely that no one interaction was more or less important than the other, but rather the series of events as a whole that lead to the conversion. We see this exact scenario time and time again with our clients. And don’t be fooled if you’re selling a product on both your website and Amazon to think that because your Amazon sales are going up and your website’s ROAS is going down that your advertising / marketing activities to your website are falling short. Your advertising is what is building awareness, intent and ultimately the purchase!
Tracking ROAS for specific ads, campaigns, keywords, etc is essential in order to ensure you’re getting the maximum possible value out of your paid marketing activities.
As you begin to assess your ROAS for various campaigns, remember to do so in the context of your overall advertising strategy and roadmap. In doing so, you’ll quickly move beyond looking at “what works” and “what doesn’t,” and start to understand of why certain ads are resonating with your audience and why others aren’t.
Advertising ultimately boils down to getting the right message in front of the right people, at the right time. Looking at ROAS, you’ll have a much better idea if this is happening and make data driven optimizations to your campaigns going forward.
Lastly, remember that advertising is just one component of delivering revenue growth and is mainly meant on driving a person your website to take an action. Once someone has landed on your site, it’s now your website’s job to sell and convert them into a paying customer…a whole other challenge we can help you solve at CommerceGarage.com.