What Is Return on Ad Spend (ROAS) and How to Use It?
Understanding ROAS and how to use it is critical to evaluating the effectiveness of your advertising.
The world is full of acronyms. Here is another one: ROAS, short for return on advertising (ad) spend.
ROAS is a performance ratio that measures how much revenue you get from $1 in ad spending.
Marketers use ROAS to get an indication of an ad campaign's effectiveness. For example: Suppose you buy an ad on Facebook or Pinterest for, let's say, $20. If you get $200 in revenue from your ad, your return on ad spend (ROAS) will be 10 ($200 divided by $20). That's the theory. In practice, however, it is much more challenging to gather reliable data to calculate ROAS.
What's Your Ad Spend?
Your ad spending is more than the cost of placing an ad on social media. It should also include the cost of creating the ad, whether you do it yourself or pay a graphic designer to do it for you.
Since the return of a single ad is often tricky to calculate, marketers tend to focus on the return of an entire multi-ad campaign spanning several weeks.
What's Your Revenue?
Revenue sounds relatively easy to measure. But establishing a connection between a specific ad campaign can sometimes require a lot of guesswork.
If somebody clicks on your ad and buys a product in your online store, the link between the ad and the resulting revenue is obvious.
However, the link is much weaker when a customer only sees your ad in their Facebook feed —without clicking on it— and visits your physical store to buy multiple products, one of which may or may not be the product in your ad. Would this revenue count? How do you know if the ad was the trigger for the visit? There is no measurable trace. This simple scenario already offers plenty of reasons for long debates. And the scenarios will only get more complex and far-fetched from here.
Whatever you decide, I recommend using the same revenue components for all ad campaigns. That way, you establish consistency between your current and past campaigns, which is crucial if you want to use the ROAS metric as a performance or efficiency gauge.
ROAS Is Not ROI
ROI stands for Return on Investment. Like ROAS, ROI is also a performance or productivity ratio. While their concept is similar, measuring the ratio of output and input, they differ in what they consider a return.
ROAS uses revenue, whereas ROI uses profit.
That's a fundamental difference but not a flaw. I can only speculate on the reasons. But one quickly comes to mind; revenue is easier to extract from the IT systems than product profits. The second reason might be even more important: you don't want external marketers to know your margins. Product profitability is a well-guarded secret at many companies.
How to Use ROAS?
A single measurement of ROAS doesn't tell you much. Ratios derive their usefulness from comparing them to other data points. You can compare the ROAS of your ad campaign to
the ROAS of past campaigns;
an internal target;
an industry ROAS benchmark.
Compare the ROAS to Past Ad Campaigns
Looking at the ROAS of past ad campaigns can give you crucial context on how your campaign is currently performing.
Are the results better, similar, or worse than in the past?
To answer this question with any degree of accuracy, you need to include the same elements as in previous ROAS calculations. Without this consistency, the measurement and the comparisons simply aren't accurate enough to draw meaningful conclusions.
Compare the ROAS to an Internal Target
Some companies set a minimum ROAS that a marketer must commit to. It's an internal target or hurdle rate based on average profitability that a campaign must exceed before a decision to spend money on an ad can even be made.
To calculate this minimum target rate, divide 1 by the average profitability of your products and services.
Let's say your average profitability is 60%. Your minimum ROAS target rate would be 1.67 (1 divided by 0.6). That means your campaigns must generate at least $1.67 in revenue for every dollar of ad spending to break even ($1.67 times 60% average margin equals $1).
Compare the ROAS to an Industry Benchmark
ROAS is one of the metrics for which benchmarks are available, but not necessarily for your industry.
Therefore, the ranges of what constitutes a reasonable ROAS value are often wide. For example, the ROAS benchmark is 3 times to 11 times the ad spend. This means a return of between $3 and $11 on $1 of ad spend would be an acceptable range for a campaign. Industry-specific benchmarks can often narrow these broad ranges somewhat, but, unfortunately, they're not always available for your market.
In my experience, benchmarks are particularly beneficial as an additional data point from outside your organization that you can use to set your internal targets.
Thanks for reading Digitally Explained! Subscribe for free to receive new posts and support my work.