What is ROAS? The Complete Guide to Using Return on Ad Spend
February 7, 2020
- Marketing •
Aden Andrus• February 7, 2020
ROAS, or return on ad spend, is one of the most important metrics for online advertisers. Essentially, ROAS answers the fundamental marketing question, “If I put [X amount of money] into this marketing channel, what will I get back out?”
This is important, because marketing is an investment. If a marketing channel isn’t paying profitable dividends, it isn’t worth the investment.
In this article, we’re going to define ROAS and how to calculate it. Then, we’ll talk about how to track ROAS and what sort of ROAS goals your business should have. Ready? Let’s dive in!
Note, this article was updated and republished on February 7, 2020.
What is ROAS?
As we mentioned above, ROAS is short for “return on ad spend”. It is a measurement of how many dollars you will receive for every dollar you spend on advertising.
In a lot of ways, ROAS is very similar to another important marketing metric, return on investment (ROI), but ROI is usually used to evaluate the overall effectiveness of your marketing. ROAS, on the other hand, is typically used to evaluate the effectiveness of a specific campaign, ad group, ad or even keyword.
ROAS is an incredibly flexible way to evaluate any aspect of your online marketing. Want to know if a particular ad set is worth your time and money? Check your ROAS. Want to know if those targeting changes you made are working? Check your ROAS.
Unlike some marketing calculations, it’s fairly easy to figure out your ROAS. There are two basic ways to calculate ROAS.
The first is to simply divide the revenue you made from your ad campaign by how much you spent on the campaign, as follows:
Revenue / Cost
As simple as this calculation is, though, it doesn’t really give you a whole lot of insight into the overall profitability of your campaigns. If you spend $100 on a campaign and make $200, you’re making $2 for every $1 you put in. That’s great, but what if it cost you $150 to fulfill your product?
The limitation of the equation above is that it doesn’t give you a sense for how much actual cash you’re netting from your campaigns. In a simple example like the one above, it might not seem like that big of a deal, but looking at your ROAS this way can cause complications when things get more complex.
That’s why some people prefer to subtract cost from revenue before dividing it by cost, as follows:
(Revenue – Cost) / Cost
Easy enough, right? You take the total revenue generated by whatever marketing component you want to evaluate, subtract what you paid to run your ads and divide the result by your ad spend.
The advantage of using this calculation is that you actually know what you’re making from your campaigns. If this is how you choose to approach ROAS, you might invest $100 and make $200, but your ROAS would only be 1x. But, that 1x means that for every dollar you invest, you end up with an extra dollar back in your pocket.
In my experience, most people seem to prefer the first equation to the second, more ROI-focused one, but they’re both viable. The important thing is to make sure that you know which model you’re using and what it means.
Of course, this ROAS calculator is only as good as the cost and revenue numbers that you put into it. Now, most online advertising platforms will track your ad spend, but it’s up to you to track your revenue.
If you’re an ecommerce company, this should be fairly easy, since you can directly track which clicks led to which purchases. For example, if you are running Google Ads campaigns, you can track purchases as conversions and then see how much money a given campaign, ad group, ad or keyword has produced. This can be a bit tricky to implement, so have your developer check out this article for more information.
Because the connection between ad spend and ROAS is so direct for ecommerce companies, many people refer to ROAS as a ecommerce metric. However, ROAS is also a great metric for non-ecommerce companies—it’s just a little harder to track.
For non-ecommerce companies, revenue tracking starts with conversion tracking. Fortunately, if you’re using an online advertising platform like Google Ads, Bing Ads, Facebook, or Twitter, tracking web conversions is quite easy (just click on the links for explanations on how to set up conversion tracking).
Phone calls, however, can be a bit more difficult. Google has a built-in solution for Google Ads advertisers (click here for info on how to set that up), but otherwise you’ll need to look into a call tracking platform.
In my experience, only about 25% of companies have call tracking in place, even when phone calls are their main source of web leads! So, if you’re looking for a way to get ahead of the competition, call tracking is a great place to start.
With a good CRM, you can tie all of your online marketing data (campaigns, ads, keywords, etc) to a new lead. Then, when that lead becomes paying business, you know exactly which marketing efforts led to the sale. Voila! You now have the revenue data you need to calculate ROAS for a non-ecommerce business.
Now, I’ll be honest, I’ve implemented this sort of thing before and it’s definitely harder than implementing revenue tracking for an ecommerce business. However, ROAS data is incredibly valuable, so the insights you gain are definitely worth the effort.
Why Should I Use ROAS?
At this point, you might be thinking, “Okay, tracking ROAS sounds like a lot of effort. Can’t I just watch my click-through rate or my conversion rate and use that information to optimize my online advertising?”
Technically, the answer is yes, but you just might end up making the wrong decisions.
Remember, the point of online advertising is to make money, not to drive traffic or even conversions. If your online advertising isn’t producing revenue, you need to change something. But, if you aren’t tracking ROAS, you won’t know where you need to make changes.
What Click Data Tells You
To show you how this works, let’s run through a hypothetical scenario where you are a partner in a law firm that averages $3,500 in revenue per new paying customer with a 50% profit margin.
The data for your top 5 campaigns looks like this:
Based on these results, Campaign 3 seems to be the clear winner—it has the most clicks, best click-through-rate (CTR) and the lowest cost-per-click (CPC).
That’s nice, but it doesn’t really tell us anything about the quality of those clicks. If campaign 3’s clicks are all coming from people who searched for “lawyer jokes”, not “law firm near me”, it’s not a good campaign—no matter how cheap the clicks are!
What Conversion Data Tells You
Since our click data doesn’t really give us a lot of insight into the quality of our traffic, let’s take a look at our conversion data:
Despite its relatively poor conversion rate (CR), Campaign 3 still seems to be outperforming all the others. In this case, the cost-per-click was low enough to overcome the effects of the low conversion rate.
Campaign 4, however, continues to take last place. Between its lousy conversion rate and high cost-per-click, it’s producing leads at nearly 9x the cost of a lead from Campaign 3.
Now, given the fact that the conversion rate for Campaign 3 is about half the conversion rate for Campaign 1, Campaign 3 could probably be performing better. Maybe a good chunk of the traffic doesn’t find the site relevant or the campaign is pointing to a landing page that converts poorly. Or, maybe the traffic really is low quality and we just have so much traffic that we’re still getting a solid number of leads from the campaign.
But, if the traffic is low quality, does that mean our leads are low quality, too? To answer that question, we need to know our ROAS.
What ROAS Data Tells You
Let’s take one last look at our law firm and see how their sales data panned out:
Looking at this information, it suddenly becomes clear which campaign is actually benefiting the company the most.
Campaign 3, our winner for traffic and conversion metrics, has the worst sales rate (SR) and the highest cost-per-sale (CPS).
Even more importantly, since fulfillment eats up half the revenue from a sale and the ROAS for this campaign is only 92%—the firm is losing money on cases from this campaign.
On the other hand, Campaign 4, which had looked like our biggest loser, is actually the most profitable campaign.
Perhaps traffic to Campaign 4 is lower in the sales funnel than traffic in Campaign 3, which is why cost-per-click (and the sheer number of clicks) was lower. Maybe the landing page for Campaign 4 traffic does a better job of filtering leads, resulting in a lower conversion rate.
Regardless of the specific reasons for Campaign 4’s profitability, this sort of scenario is not uncommon, which is why ROAS data is so important. Based on our click and conversion data, we might have made sweeping changes to Campaign 4 or put a lot more budget into Campaign 3—both of which would have been bad decisions.
What is a Good ROAS?
Now, all of this begs the question, what is a good ROAS? Knowing your ROAS is nice, but how do you use it to decide which marketing elements are working…and which ones aren’t?
The answers to this question will vary from business to business, but to give you a feel for what you need to take into account, let’s consider another hypothetical scenario. Let’s say you started a small business a few years back giving aerial tours of the Grand Canyon.
Your plane seats one passenger, and you charge $150 per flight. You haven’t done much marketing, but you have a steady flow of about 20 ticket sales per month from talking to people yourself (direct sales), loyal repeat customers and word-of-mouth referrals.
You’re making $3,000 a month before you factor in your expenses.
Unfortunately, each flight costs you $75 in airplane fuel, wear and tear and other flight costs. That leaves you with $1,500 in profit.
That might be a nice little business, but your costs don’t stop there. You also spend about $2,000 a month on your airstrip mortgage, office utilities and plane maintenance. We call these fixed costs because you have to pay them whether or not you’re making sales.
At the moment, you’re in the hole by $500. You decide to run some online ads to help, but you want to know, what sort of ROAS do those ads need to have to be worth the investment?
What if you made one $150 sale for every $150 you spent on marketing? That’s break-even, right?
Remember all those fixed and variable costs that were eating up your profit margin in the first place? If you spend as much as you make, you’ll never make any headway against your $500 deficit.
You might have a 1:1 ROAS, but you end up losing money on every sale in fulfillment costs ($75, to be precise).
But what if you had a 2:1 ROAS? If you spend only $75 on marketing to make a $150 sale, you’ll offset your fulfillment costs, right? That’s true, but you still won’t be making any progress against that $500 deficit in your budget from your fixed costs.
Unfortunately, it’s not enough to simply break even with a marketing campaign. You need to make more than it costs you to acquire and fulfill a new sale. You also need to cover your fixed expenses.
But what if your marketing was even more efficient? What if you spent $50 on marketing to produce a $150 sale? At a 3:1 ROAS, you could end up breaking even as long as you can get at least 20 sales from your online marketing efforts.
Even after you hit a 3X multiple, though, it’s still slow going. Your marketing is sustainable, but you can’t really grow your business on this sort of margin. After all, you can probably only make around 40 flights in a given month, which just gets you to your break even point.
If you really want to make a profit from your online marketing campaigns, you need to get them to produce at least a $4 in revenue for every $1 you spend on advertising.
Once you hit a 4:1 ROAS, your business covers its expenses after 14 flights. If you make 40 flights in a month, you only have to pay for marketing and fulfillment on six flights. At $37.50 of profit per flight, you make $225 per month. All of a sudden, your online marketing is starting to make a lot more sense.
Once you get to a 5:1 ROAS, you are finally in a good position to start using your online marketing to actually grow your business. You break even at about 11 sales, which means that your last nine sales net you $405 in profit each month.
With that kind of profitability in hand, you may be able to take out a loan, and get a bigger plane, allowing you to book two to four times as many tickets. Your expenses might go up a bit, but if you can fill between 80 and 160 seats a month, you are in a good position to really start making some money.
A Rule of Thumb for ROAS
Is this whole ROAS thing starting to make sense? Good. Let’s boil all that math down into a simple rule of thumb.
- If your ROAS is below 3:1, rethink your marketing. You’re probably losing money.
- At a 4:1 ROAS, your marketing is turning a profit.
- If your ROAS is 5:1 or higher, things are working pretty good.
Essentially, if a given element of your digital marketing (be that a campaign, ad group, ad, etc) is producing at least $3 for every $1 you invest, you’re probably doing okay. Obviously, the right minimum threshold for profitability will vary with every business, but this rule of thumb is a good place to start.
ROAS is one of the most useful metrics for gauging how well your marketing is doing what it’s supposed to do: drive new revenue. If you’re accurately tracking your online marketing efforts through to the sales they generate, calculating ROAS is fairly easy, but how you use your ROAS data can have a huge impact on your business.
Incidentally, if you’d like help calculating out your own ROAS or using it to make marketing decisions, let us know here or in the comments. We’d love to help!
What do you think of this advice? How do you track the performance of your marketing campaigns? Do you think ROAS is a useful metric to watch?