What is ROAS or Return on Ad Spend?
Marketing is fundamentally all about understanding data and metrics. Whether you’re a professional marketer or an entrepreneur doing the marketing for your own business, it’s very difficult to understand if your marketing and advertising efforts are making a difference if you don’t know how to collect and interpret the relevant data.
There is a range of metrics that can be used to measure the effectiveness of an advertising campaign. It’s helpful to look at as many as you can since they each offer a slightly different piece of information. Return on ad spend, or ROAS, is a particularly useful metric. Digital marketers can use ROAS to adjust their campaigns and make them more profitable, shut down campaigns that aren’t delivering results and divert those funds elsewhere, and boost spending on very successful campaigns to increase profits for the business.
Without knowing the ROAS calculation, you might misinterpret the data about your campaigns resulting in less effective ad spending. Understanding ROAS is a powerful tool for taking your advertising campaigns to the next level.
What is ROAS, exactly?
ROAS measures how much your business makes for every dollar spent on marketing or advertising. It is a metric that helps businesses understand if they are spending their advertising dollars efficiently, or if they could be better spent on an improved ROAS.
ROAS alone can’t tell the whole story of whether your business is operating efficiently, but it is a powerful metric that can help you increase your bottom line. Together with other useful metrics, it can help you make sure your business is profitable and sustainable long term.
How can I calculate the ROAS of my business?
You might look at the term “return on ad spend” and be reminded of “return on investment, or ROI, another important and widely used marketing metric. The two are similar but distinct.
A helpful way to think about the distinction between ROAS and ROI is that ROI is a more birds-eye-view metric that you can use to gauge overall efficiency of your marketing efforts or a whole marketing department, while ROAS is a more zoomed-in metric that can help you understand each campaign or even a single component of a campaign.
Let’s take a look at the difference between how ROI and ROAS are calculated. By comparing the calculations, the usefulness of gathering return on ad spend data will become clearer.
To calculate your return on investment, the formula used is:
(net revenue / cost) * 100 = ROI
Let’s say you make a product that sells for $500. You spend $1000 on an ad campaign, and as a result, you sell ten units of your product, for a total of $5000 in revenue. Let’s say the cost for you to produce each unit of your product is $100, so the cost to produce the ten units you sold is $1000. The cost of your campaign plus the cost to produce the items you sold is $2000. Plugging these numbers into the equation for ROI, you get
($5000/$2000) * 100 = 250%
You can interpret this by saying that your investment in your business has a 250% return. This means you are making a profit. If your ROI were 100%, you would be simply breaking even. In other words, a dollar spent on your business would return a dollar to you.
To calculate return on ad spend, the formula used is:
Revenue from ad campaign/cost of ad campaign = ROAS
Using the same scenario from the ROI calculation, we can plug the numbers into the formula and get
$5000/$1000 = 5
As you can see, ROAS isn’t stated as a percentage return. Instead, it tells you how many dollars in revenue your business makes for every one dollar spent on advertising.
Comparing the ROI calculation with the ROAS calculation, you can see how ROAS focuses on revenue rather than profit, and how the relevant cost is just the spending on a specific ad campaign or component of that campaign, rather than on all of the costs associated with selling a product. They are both useful, but ROAS helps you get a more granular understanding of the effectiveness of your advertising and marketing spending.
Is ROAS the same as CPA?
Maybe you’ve come across the term “cost per acquisition,” or CPA. Isn’t that basically the same as return on ad spend?
Well, not exactly. If every acquisition had the exact same value, the two metrics would be similar. But for most businesses, acquisitions can vary in their value.
Let’s first consider a scenario in which the CPA is the more useful metric. Consider a business whose product is an online course, and each new person who registers to the course pays the same amount. There are no price tiers for different levels of access or different courses offered at different prices. In this scenario, each new acquisition actually has the same value, so knowing your CPA is a very useful piece of information.
Now consider an eCommerce business. If you have an online shop, one new customer who found you through an ad might spend $50 while another spends $300. When calculating the cost per acquisition, you might find out that it cost you $10 to acquire each new customer.
The CPA will tell you how much it costs to acquire each customer, but it doesn’t tell you how much revenue your business brings in from each acquisition. Clearly, the 10$ spent acquiring the second customer was better spent than the 10$ spent acquiring the first customer since it returned $300 to your business instead of just $50.
In the example of the ecommerce store, wouldn’t you want to know how to spend your ad dollars so that you make $250 for every $10 spent, instead of just $50? This is where return on ad spend comes in. You can use the ROAS calculation above to calculate the return on a specific campaign, a specific ad, or even a specific keyword. By getting very detailed in this way, you can optimize your spending for the highest ROAS possible.
How is click through rate (CTR) related to return on ad spend?
Another performance metric that you may have come across when learning about marketing metrics is the click-through rate, or CTR. The CTR should also be considered when you’re evaluating the success of your ad campaigns, but it becomes much more valuable when you look at your CTR in combination with your ROAS. The more data you have, the more powerful your marketing strategy becomes.
Consider a scenario in which you run ads on three platforms to see which one is best for your business. Your click-through rates for the three platforms are as follows:
If you only know the CTR and nothing else, you could reasonably conclude that your Instagram ad is the most effective since it’s getting the most clicks. However, the click-through rate alone can be deceiving. Adding the ROAS might provide a different story.
In this example, while Instagram has the highest click-through rate, it has the lowest conversion rate out of all three platforms. It also has the lowest ROAS, meaning that for every dollar spent advertising on Instagram, your business makes less than it does for every dollar spent advertising on Google or Facebook.
Although Facebook has a lower CTR, it has a much higher conversion rate, and your ad dollars are well spent there because for each dollar spent, your business makes five dollars back.
There are lots of possible explanations for the high CTR on Instagram, resulting in lower conversions and a lower ROAS. Digging into possible explanations can help you improve your ad strategy. For example, maybe something about your Instagram ad is appealing to the wrong kind of customer; that is, someone who isn’t actually interested in the product you are selling. You may not be reaching your niche market. They see your ad because your keywords match their interests, and they like the ad enough to click it, but there is some disconnect between what made them click and what makes them choose not to convert.
A potential strategy would be to change the keywords you use in your Instagram ad so that you can get in front of a higher converting set of potential customers.
You might look at the metrics for your Google ad and conclude that your ad dollars are better spent advertising on Facebook or Instagram.
What makes ROAS such an important metric?
At the end of the day, entrepreneurs are in business to make money. While other performance metrics can help you gauge how much interest there is in your product or how successful your campaign is in creating awareness about your brand name, ROAS is uniquely useful in helping you understand if your advertising efforts are actually making money for your business.
As you can see in the example above, looking at your ROAS for individual advertising campaigns can give you valuable insight that you won’t find simply looking at CTR or CPA. Of course, all of these performance metrics have value, and the more data you can collect the better your decision making will be.
Regularly doing a ROAS calculation can help you do more than just shuffling around your advertising dollars until you increase your return on ad spend. It can help you improve the ads themselves. For instance, you can run A/B tests on the same platform to see which converts better, and continually do this to improve your results.
You can also use ROAS to improve your website’s landing page, product pages, or even pricing structure. For example, if you’re getting a very good click-through rate but low return on spend, you might want to look at what customers are doing when they actually land on your website. Do they click away shortly after they land on your home page? If so, that page may need an update to appeal to the people who are being drawn in by your ads.
It’s also possible that they stay on your website and click on your various product pages but leave without buying. Perhaps your prices are too high, or maybe it’s as simple as updating the copy or product photos on those pages to entice visitors to purchase. Using a website builder, you can easily update these pages yourself.
You might even find yourself in a situation where your click-through rate is high, your CPA is low, but your ROAS is still not very high. In other words, people are clicking your ads, enough of them are convinced by your value proposition to convert so that your cost to acquire each customer isn’t too high, but your return on ad spend is still low. What could be going wrong? It’s possible that in this case, your prices are actually too low for your target market. You might have better ROAS, and better margins overall, if you increase prices or increase your MOQ.
All of this analysis becomes possible when you have this handy bit of data, making it an important tool for any marketer or entrepreneur.
What should my ROAS be?
If you’re calculating your ROAS for the first time, you might be wondering what that number should actually be. While a higher ROAS is, of course, preferred, the ideal number will vary from one business to the next. There is no one size fits all expectation that can be applied to all businesses in all situations.
Businesses often have varying goals for the outcomes of their advertising campaigns. For example, the purpose of your advertising campaign may be to raise awareness of your brand and logo. In this scenario, a low ROAS may not be such a big deal, since there are still many people seeing your ad and becoming more aware of your product or service each time.
Even if the purpose of your ROAS is to generate awareness, you still don’t want to be losing money on your advertising efforts. A ROAS of one means you’re just breaking even, so anything below that indicates that your business is losing money through its advertising efforts.
However, a ROAS above one might still not be helping your business. For example, you might get one dollar in sales for every dollar spent on advertising, but lose money once you factor in the cost of delivering the sold goods to your customer. In this case, it may be that a ROAS of 1.5, or even higher, is your actual break-even point.
As a general rule of thumb, a ROAS of less than three is considered too low to be worthwhile. At this return on ad spend, considering the other costs that you likely incur in order to deliver your product or service, you may be losing money or barely breaking even. Again, variation from business to business is significant, and you know your business best.
For example, if you sell a digital product that costs nothing extra to deliver each time someone orders it, a ROAS of 3 might be perfectly sustainable for your business.
A ROAS of 4 is profitable for most businesses, while a ROAS of 5 or higher is considered very good.
How can I increase my ROAS?
So, what can you do if you calculate your return on ad spend and find that it’s low? What if it’s under three, and likely costing you more than it’s worth? With digital marketing being as sophisticated as it is today, there are many tweaks you can make to improve your return on ad spend and make more money for your business.
To improve your ROAS, consider:
- Double-checking for accuracy. It is possible that you are not capturing data correctly. For example, the attribution model that you use in Google Ads can impact your ROAS significantly. If you are using a last-click attribution model, it might look as though your ad is not converting, even if it actually did make an impact on your customer’s decision-making process. Consider switching to a linear attribution model.
- Make use of negative keywords. Did you know you can add negative keywords when you create your google ads? Populating the negative keywords field when you create an ad will help you avoid getting low-quality clicks and blowing through your budget. Find out which keywords don’t convert for you and add them to the negative keywords list.
- Bring your advertising in-house. If you’ve hired an employee, agency or virtual assistant to manage your advertising and aren’t seeing a high ROAS, it may benefit your business to bring these activities in-house or do them yourself for now.
- Improve your website. As we explored in an example above, you may be getting lots of clicks but poor conversions. Consider how you can improve the conversion rate of your website or landing page.
How can I make the most of Google AdWords to improve my ROAS?
In addition to the two tips we’ve already covered, optimizing your homepage and making strategic use of Google ads negative keywords, try these ROAS Adwords tips to improve your ad performance and increase your bottom line:
1) Modify general keywords with branded terms. The goal for good ROAS Adwords is to achieve a high “Quality Score” from Google. A high-quality Score means Google will boost your ad ranking, and your overall cost per click will be lowered. Boosting your ad ranking means more people who are interested in your business will see it, and a lower cost per click will help reduce the “cost” side of the ROAS calculation. So, how can you boost your Quality Score? Branded terms tend to perform well when used properly, so try modifying your keywords with branded terms. For example, a camera accessories company called Smith’s could use the term “+ Smith’s + camera + straps.” This way, they would get hits from people searching for them specifically, as well as from people searching for the general terms after the brand name. Those keywords should also be used as SEO terms when optimizing your website.
2) Increase bids for the regions where your ads are performing well. In your “Dimensions” tab, you will be able to sort your ad results by geographic performance, and you might be surprised by what you find. Increasing your bid for those areas could result in higher visibility, precisely where people are the most interested.
3) Keep an eye on what people type into the search field when they convert. You might find new terms that you hadn’t considered yourself, that you could build into your ROAS adwords for better results.
Are there any important limitations or considerations I should take into account when calculating my ROAS?
There are a few important dimensions of your business that aren’t captured by return on ad spend alone, and that you should keep in mind when calculating your own ROAS and deciding what to do with the data.
For example, every business will have a different profit margin when they sell their product or service. If you have very large margins, you can get away with a lower ROAS and may even increase your bottom line significantly by doing so.
Another consideration is your production and operating costs. For instance, the operating costs for a home-based business may be much lower than those for a business that has to rent an office and hire employees. Ecommerce shipping costs may vary depending on the type of product a business produces. These costs may increase with each additional unit you sell, and the increase in revenue must cover these costs in order to be worth pursuing.
Your ROAS should be considered holistically, along with all the other data and metrics you have for your business. Taken in this context, it is a valuable metric that can take your business to the next level.
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