Grow Smart: The ROI-Driven Marketing Playbook [Part 2]

This is the second article in a five-part series about ad spend ROI, authored by Karlon Group. In this article I’ll explain how to look at ad spend ROI in the early days, when you have a modest marketing budget, a limited marketing tech stack, and a lean team. Before diving in, let’s recap a few key concepts from our first article, The Fundamentals of Performance Marketing ROI.

Attribution: The process of assigning each customer’s order to a particular marketing channel or channels so you can connect the cost of your ad campaigns to the profit generated from each purchase.

Contribution Profit: The profit generated from each purchase factoring in all the variable costs that a company incurs to service the customer. Depending on whether you’re a consumer tech or an e-commerce business, these costs may include:

Consumer Tech: Compute costs, customer onboarding costs, promotional discounts, refunds, merchant/app fees, customer support costs.

E-Commerce: Physical product costs, product shipping costs, promotional discounts, refunds/returns, return logistics costs, merchant/app fees, customer support costs.

Purchase Cycle: How long it takes for a customer to make a purchase decision. When customers see your ad, they don’t necessarily make a purchase on the spot. In general, the more expensive a product is and the more features it has, the longer the purchase cycle. It’s important to start looking at your own business early to figure out how long it takes your customers to buy your product.

Lifetime Value (LTV): The contribution profit of a customer over the lifetime of the customer. For subscription businesses, a customer will usually make more than one purchase before they cancel or opt out. To calculate LTV, you should look at the average lifetime of a customer, factoring in the average rate at which customers cancel or “churn”.

Now let’s talk about the early days as a company and how you should measure ad spend ROI. When you’re a young startup, your tools and resources are limited. You’re probably using Shopify or Stripe as your source of truth for revenue, orders or subscriptions. You’re probably pulling marketing spend data directly from the portals for Meta, Google and other channels. You haven’t invested in marketing attribution or identity resolution software yet. Your marketing team consists of one or two people and they may rely on one or two agencies to handle media buying. You don’t have a finance team or a data analytics team to help you. With this setup, how should you look at ad spend ROI?

Let’s start with attribution. The good news is that you’re not completely in the dark here. Meta and Google both have their own proprietary models that can be used to attribute sales back to channel-level ad spend. The challenge, however, is that they only provide attribution metrics for their own channels and – no surprise – they tend to be generous in how they attribute sales back to their own channel. For instance, Facebook’s ad platform credits itself with a conversion even if a user merely views an ad, and purchases later (Facebook counts 1-day view-through conversions). In contrast, tools like Google Analytics and Shopify only count a click-through as a conversion. As a result, it’s common for Facebook Ads Manager to report more conversions than Google Analytics for the same campaign (Source). Every platform uses different tracking windows and methods, so be mindful of this when pulling data directly from the platforms. 

You also have access to Google Analytics, which provides attribution on a last-click basis for free. Last click attribution is the simplest form of attribution, but that’s okay. In many ways, it’s the most concrete method of calculating attribution.

As a startup with limited data and tools, I’d recommend you look at the ad platforms’ proprietary attributed sales numbers and the last click sales numbers, where available. I’d also strongly recommend you look at total sales vs total ad spend as a whole. I’ll come back to why this provides a critical “macro” point of view on ad spend ROI.

Once you have your attributed sales by ad platform and your total sales, the next step is to calculate the contribution profit generated from those sales. Remember, contribution profit isolates only the variable costs that a company incurs to service the customer while ignoring the fixed costs. One way to think about this is to ask: if a customer makes a purchase, what costs will my company incur as a result of that purchase? Earlier in this article, I listed the main variable costs you can expect in consumer tech and e-commerce.

A simple example: Suppose your average order value is $59 and your product cost (COGS) is $21. Assume you spend another $8 on shipping, payment processing, and other transaction-related fees. In this case, your total variable cost per order is approximately $29, leaving around $30 in contribution profit from a $59 sale. If your advertising cost to acquire that order was $25, your net profit on the first purchase would be $5.

One additional consideration is how to factor refunds and returns into your analysis. Whether an order is refunded/returned is a binary outcome. Either the order is returned or it is not. The same goes for a refund of a software subscription. This is different from the other variable costs we’ve discussed. The other variable costs are incurred on every order. But we have to account for the cost of the occasional return somehow. So we subtract a portion of sales to reflect the occasional refund/return using the refund/return rate quoted as a percentage.

For e-commerce companies, a refund/return not only impacts sales, it also results in additional reverse logistics costs to ship the physical product back to the company’s warehouse. It’s worth putting numbers to this: the average return rate in e-commerce was 17% in 2024 (Source), meaning roughly one in six orders ends up getting refunded. The company not only loses the sale but also typically bears all or most of the cost to ship the product back to the warehouse, inspect it and restock it (or scrap it). These costs can be huge, ranging from 20% to 65% of the item’s original value. We should account for all of these costs in contribution profit. To do so, we apply the return rate (quoted as a percentage) to the reverse logistics cost per returned order to reflect the proportion of orders that are returned. At Karlon Group, we typically calculate a refund-adjusted contribution profit to provide clients with a more accurate view of profitability. If you ignore returns in your ROI calculation, you could be overstating your real revenue and profit significantly.

 The end result is an equation for contribution profit that looks like this:

Now let’s talk more about contribution profit for subscription businesses. For subscription businesses, a customer will typically make more than one purchase over their lifetime. Some subscription products come with a commitment period – for example a one-year subscription – and customers can’t cancel the subscription until the end of the period. For these types of businesses, it makes good sense to calculate the lifetime value (LTV) of your customer, factoring in the rate at which customers cancel or “churn” on average. If you look up the calculation for LTV, you may come across a general equation that looks like this:

There’s nothing inherently wrong with the general equation for LTV, but I prefer to avoid it because it requires a point of view on the discount rate. That said, once you determine a reasonable discount rate for your business, the equation is simple enough to calculate.

If you don’t have a point of view on the discount rate for your business, a simple workaround is to ignore it and look at a shorter time horizon for customer orders. Many practitioners use 3 years. If you look at a 3-year time horizon and ignore the discount rate, the equation looks like this:

For businesses with churn rates in the 30-70% range, this approximation gets you pretty close to the LTV.

Continue this article and look out for the rest of the series on the Karlon Group blog.

About the Author:

Karsten Loose is co-founder and Managing Partner at Karlon Group, a fractional finance and accounting firm that helps companies build, scale, and optimize their finance and accounting functions. Karlon Group works with companies across SaaS, consumer, manufacturing and technology, offering a full suite of finance and accounting support tailored to each client’s changing needs.