Similar to a return on investment (ROI), return on ad spend (ROAS) is a key financial metric in digital marketing and is commonly used to evaluate the effectiveness of a marketing campaign for ecommerce companies.
How do you calculate ROAS? Does a high ROAS always indicate profitability? What is a good return on ad spend and what does a good ROAS mean for your business?
We’ll answer these questions and more.
The Nuts and Bolts of ROAS
Return on ad spend is a measure of generated revenue per dollar of marketing spend. ROAS can indicate that the marketing expenditure is not being recuperated through sales and the company may be spending more money than it is earning; or it can indicate that the ad spend is generating enough revenue to cover marketing costs or to deliver net profits.
ROAS, therefore, can help an ecommerce company evaluate the effectiveness of their marketing efforts and how they can improve future advertising campaigns.
ROAS is calculated with this formula:
ROAS = Gross revenue from ad campaign / Cost of ad campaign
A high ROAS does not always mean profitability; there are other expenses that have to be deducted from a company’s gross profits to determine the net profit margin. A good ROAS indicates the effectiveness of a campaign and may also provide a comparative measure of cost-effectiveness between different campaigns. Here’s an example:
Ad campaign A costs $1000 and generates a 50% sales volume increase; ad campaign B costs $200 but only generates a 25% increase. Between the two campaigns, campaign B is the more cost-efficient ad spend.
An advertising effort may boost total sales without improving profitability if the ad cost is significantly high and the profit margins are low. On the other hand, a campaign with a small budget may lead to only a slight increase in sales but a significantly high net profit if it primarily promotes the sale of products with high profit margins.
What is a Good Return on Ad Spend?
Here’s a sample calculation using the ROAS formula.
A company spends $10,000 on a Google Ads campaign. The ads directly generate $25,000 of product sales on the company website.
Gross revenue from ad campaign / Cost of ad campaign
$25,000 / $ 10,00
ROAS = 2.5
A return on ad spend that is >1 means that your revenue is, at least, covering your advertising expenses but you may be operating at a loss after other expenses are deducted.
A ROAS that is equal to or greater than 4 is generally considered good. This means that 4 dollars in revenue is generated for every dollar of ad spend. A good ROAS varies widely across industries, according to the type and size of business, and depending on other factors. A meaningful examination of a company’s ROAS can be done by comparing it against its past financial records, as well as with the ROAS of other companies within the same niche/industry.
ROAS that gradually increases from 4 to 7 during the first 5 years of a company indicates continuously improving marketing efforts and cost-effectiveness.
Keep in mind that some companies require a ROAS of 10 to stay profitable, while others can sustain growth with a ROAS of 3. A defined ad budget and established profit margins will determine a company’s ROAS goal. Big profit margins generally mean that a low ROAS goal may be enough for the company to survive; small profit margins mean that the company must maintain a low ad spend and achieve a relatively high ROAS goal to enjoy good net profits.
Other Factors that Affect ROAS
An ad campaign may involve more than just paying for a listing. When calculating ROAS, you must also take the following factors into consideration.
- Partner/Vendor costs. These are fees paid to partners and vendors — in-house advertising personnel — that assist with the campaign.
- Affiliate commission. This is paid to affiliates such as websites, bloggers, social media pages/influencers, and the like that help promote the ad. The commission fee may also include network transaction fees.
- Clicks and impressions. These are the costs associated with the metrics you select for your ad, such as average cost per click, total number of clicks, average cost per thousand impressions, and total number of impressions that were converted into sales.
ROAS is an essential metric that quantitatively measures ad campaign performance and how it contributes to a company’s bottom line. The accumulated ROAS data from multiple campaigns and when combined with customer lifetime value can provide a blueprint for future marketing strategies and direction. Closely monitoring a company’s ROAS can help one make better informed decisions on where and how to more efficiently spend their ad budget.