ROAS stands for “return on ad spend,” which is the amount of revenue generated from each dollar spent on an advertising or marketing campaign. While return on investment (ROI) can be applied to an entire marketing strategy, ROAS focuses on one specific campaign at a time.
How to Calculate ROAS
Some advertising channels, like Facebook, can automatically calculate ROAS for you, but you should still know how to do it if you’re using other channels, as well as for determining what an optimal ROAS is for your business.
To calculate ROAS, simply divide the amount of revenue an ad campaign generated by the cost of the ads. If you had $5,000 in sales due to an ad campaign and it cost you $1,000 for those ads, then the cost per dollar would be $5,000 divided by $1,000, or $5, giving you a ROAS ratio of 5:1.
ROAS as the Great Equalizer
Organizing ads in different campaigns makes it extremely easy to compare one ad or ad set to another using ROAS. The costs of ads, and the results of those ads, varies widely from one channel to another, as well as within the same channel when you’re using different types of ads, or targeting different segments of your audience. How you define each campaign is up to you. It could be for one specific ad on one channel, or a group of ads in one campaign.
The number of variables you can find between ads is nearly unlimited. Some different common variables include the following:
- Costs between channels
- Costs between different audience segments
- Costs based on keywords
- Revenue amounts based on multiple purchases
- Revenue amounts based on ad offers, like free shipping or discounts
When you use ROAS, you can bypass all of these variables. If you spent $500 on one campaign and brought in $2,000, then the ROAS ratio is 1:4. If another campaign cost you $800 and brought in $3,000, then the ROAS ratio is 1:3.75, making it less effective than the first campaign.
Revenue vs. Profits
Unlike the Fibonacci sequence, ROAS provides no “golden ROAS ratio” that fits every company, or even one that fits every scenario for one company. A 5:1 ratio may be great for one company, but could be disastrous for another.
One of the main reasons for this is that ROAS, by itself, doesn’t take into account profit margins. If your company operates at a 20% profit margin across the board, it’s easy to determine what ROAS ratio is acceptable. If your company works with varied margins, which is extremely common for eCommerce companies, then you might want to factor this into your ratios by using a profit-based ratio.
Using POAS to Measure Profitability
POAS stands for profit on ad spend and is a slight modification of ROAS. Instead of comparing revenue to the cost of your ads, first subtract the cost of materials from your revenue to determine your gross profit Then divide this profit by the cost of the ads.
If $2,000 in sales costs you $500, leaving you with a gross profit of $1,500, then the $500 you spent on ads means your POAS ratio is 3:1. If those goods cost you $1,500, then your ratio is only 1:1, which essentially means the ads are costing you more than they’re worth — unless you’re banking on subsequent sales from your new loyal customers.
Choosing ROAS or POAS
There’s really no consensus on whether ROAS or POAS is better, although most companies still use ROAS. One of the reasons for this could be that calculating profits for every ad campaign you’re running can be time-consuming, particularly if your margins vary.
If you routinely add discounts or free shipping to your ad campaigns, you would have to take these into account for each ad, and then calculate your costs on top of that. If your eCommerce software doesn’t do this automatically for you, you would have to take a few minutes to do it yourself.
Using ROAS is much more straightforward. Your total sales from each campaign should be right at your fingertips, along with the cost of each campaign. As long as you have an idea of what the range of your profit margins are, then it’s very easy to select an acceptable ratio and then terminate any campaigns that fall below that number.
What Is a Good ROAS for Your Brand?
One thing everyone can agree on is that a higher ROAS ratio is always better than a lower one. That being said, the real issue is what constitutes an acceptable ROAS and what does not. It may be tempting to find an industry average and use that as a standard for your company, but don’t do that. Every market, every business, every season can be different.
If you’re just getting started in eCommerce, or if you’re launching a new product for a new target audience, a low ROAS is often very hard to avoid, unless you have someone on your marketing team with significant experience with your market and the channels you’re using.
It takes time and some money to get acquainted with your target audience, to determine what they respond to, and in which channels your ads work best. It also takes time to train your pixels and to generate data that the advertising algorithms can use to serve ads to the most likely prospects. And it takes time to start generating a loyal client base that will drive your advertising costs down with repeat purchases.
Do lots of small tests with small budgets, eliminate campaigns that aren’t performing and increase your budget on those that have a positive ROAS. Once you start to accumulate some winning campaigns, then you can start establishing what an acceptable ROAS is.
Experience Reduces Costs and Increases Success
Too many companies take a roulette approach to their advertising campaigns, hoping that the numbers will eventually sort themselves out, while spending thousands on underperforming campaigns.
If you’re just starting out, or if your ROAS ratios aren’t where you think they should be, you should consider talking to someone with experience who can help you avoid costly mistakes. Talk to an experienced e-commerce consultant at Hawke Media. Your first consultation is free.
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