The return of investment is crucial KPI for many marketers when they optimize their campaigns. In this post, I want to show that this is important, but should not be used for campaign optimization planning.
A short explanation of what this ROAS is. Return Of Ad Spend is – translating from marketing to English – the revenue generated by the budget utilized. It’s calculated in the simplest of possible ways – by dividing the first value by the second value and for easier interpretation, we multiply by 100%. For example, we spent 100 PLN on the campaign, sold the product for 200 PLN – substitute this for the formula: 200/100 * 100% = ROAS 200% – yeah – the customer left us more money than we spent on advertising. Profit? We will see. Theoretically, any value > 100% means that the customer gives us more money than we spent to attract him our offer.
ROAS in numbers
Of course, this statistic does not take into account the cost of buying/producing a product/service, which in practice means that the campaign is profitable with much higher ROAS values. So let’s assume the cost of my product is 150 PLN and the margin is 50 PLN (25%) for example. It comes out that we spent on advertising 100 PLN and we earned 50 PLN, with ROAS = 200% – a campaign is still not profitable! In this case, only after reaching ROAS = 400% we break even because the margin (25%) from the sale will be an equal to the amount of our advertising cost – 100 PLN. Calculating and using ROAS is easy and obvious in this case, but e-commerce is no longer that. Since an ad group or even a keyword can generate sales for several different products, for example, the landing page is a category where are different products – a some at a promotional price, several in a bundle, etc., with different margins = different Profit = different minimum ROAS profitable. Of course, to simplify calculation we can use an average that gives us information how much profitable (or not) is currently advertising.
Of course, ROAS can be easily calculated in the AdWords dashboard – again I’m surprised that this column is not available as a standard – but it’s just a few clicks away:
Create a ROAS column in the AdWords panel
But… get back to the answer the question: how ROAS is connected to revenue and campaign profitability? Check out graphic down below:
Graph showing the ROAS and the campaign revenue connection:
It shows that advertising revenue grows as a ROAS only go some far. Later, the cost of acquiring each subsequent conversion increases, ROAS falls, but advertising continues to generate more revenue than cost. This happens until the marginal cost of acquiring another conversion exceeds its value – then the ad will become loss-making. At this point, you will no longer need to increase your bids and/or reach of your ads. How much is ROAS then? Exactly 100% – the return on investment is equal to the cost and the profit reaches the maximum value (green line).
How to use it in practice. We now know that low ROAS means we are far away or far behind the point of maximum profit. To see if you need to increase or decrease your bids and/or budget for a campaign, we use graphs in AdWords considering the average position and impression share. Low share values show that our ad is showing relatively rare and probably does not pursue its full potential. You should test it, by progressively increasing your bids and observing your ROAS. If we see that visibility increases and we have more conversions at an even higher cost, and ROAS grows, it means we increase our profitability. You should increase your bids until you notice that your ROAS decreases to 100%. This will give us the point at which a given keyword achieves its maximum effectiveness. It may turn out that the impression share is, for example – 70% – and the average position is 2.3, and this state we should try to maintain. However, if similar statistics show that ROAS is less than 100%, you should limit your campaign bids and test most profitable settings.
It’s not everything
Since we have already reached the point at which our advertising is the most profitable, can we do anything else? Of course! In campaigns that targeted to search results, test new keywords, locations, or display times. For display campaigns, look for new ways to target – interests, topics, or placements. Of course, AdWords advertising is a living organism, so you should monitor your ROAS regularly and improve your bids to maximize your profit.
The main goal of this article is to show that by limiting budgets or bids in campaigns we de facto reduce profits. This is, therefore, a behavior that is contrary to the interests of the advertiser, who may just not be aware to. So if you ever hear, “I can not afford such a big campaign,” I would suggest: “Can you afford to limit your profits?”
The above assumptions are mostly just a model. They do not take into account the impact of competition, ad content, seasonality, quality of landing page, and other factors that affect conversions and campaign success. So you are welcome to the polemic in the comments.