The estimated digital ad spending in the US will be around $190 billion in 2021, a 25% growth from last year. Although ecommerce brands are diversifying their acquisition channels, ads (mainly on FB, IG, TikTok, and Snapchat) remain the top channel.
And, the best metrics to figure out whether an ad is working? Return on ad spend.
That’s right – ROAS can help you figure out answers to burning questions like
- How do you find out the cost of paid traffic?
- How much revenue is generated from every penny that you shell out to get shoppers to your website?
- What is the first metric that marketers measure to define the success of an ecommerce ad campaign?
- Goes without saying, you need to keep a close eye on your return on ad spend, but that’s only a part of the larger picture.
Digital ad spending is rising at a steady pace. As a result of this heightened competition, few retailers witnessed an increase in their online ad costs by 89%. If you notice that your ROAS is dropping, this could be one of the contributing factors.
When it comes to budget planning and ecommerce strategy, ROAS is often viewed as a north star metric (a myth we later debunk). That shouldn’t be the case as ROAS is not equipped to handle these areas.
As a marketer, you are always looking to positively influence the behavior of consumers. ROAS falls short here and does not help you gauge if consumer behavior has changed in the first place.
In this blog, we are going to take a closer look at
- what ROAS is,
- what is a good ROAS,
- how it is different from ROI,
- why ROAS isn’t the ultimate metric
- and how to accurately measure ecom success
Unfolding the concept of ROAS for ecommerce stores
Return on Ad Spend (or as we lovingly called ROAS) is a marketing metric that evaluates how effective an advertising campaign or strategy is. ROAS is a key metric that lets you know if your marketing channels are worth the investment or not.
The metric can also be used to compare one marketing campaign with another to help you identify which one of them is performing better.
The ROAS calculation is fairly simple. All you have to do is divide your ad campaign’s total revenue by the total cost incurred on it.
ROAS = Revenue/Cost
For example, if a clothing line spends $ 20,000 on a Facebook Ad campaign and generates $80,000 in revenue.
ROAS = 80,000 / 20,000 = 4:1, which simply means that for every dollar spent on the campaign, $4 was generated as revenue.
The ROAS calculated for a single channel like a Facebook Ad campaign is known as single channel ROAS.
But, if you want to know how all of your paid channels have performed you will need to calculate the blended ROAS.
In this ROAS calculation, you take into account total revenue earned from all your paid channels like Facebook, Google, or Snapchat and divide it by the total ad spends incurred on those channels.
The formula for blended ROAS is pretty straightforward.
Blended ROAS = Total paid revenue / Total ad spend
What counts as a good ROAS?
It is not easy to define what a good ROAS is. For some a ratio of 4:1 is brilliant, for others, it might indicate failure.
There are a few factors to consider to determine what a good ROAS is. They are:
- Your profit margins
- The industry you belong to
- The average cost per click
Most companies aim to achieve a ratio of 4:1. However, the average ROAS is around 2:1 which means you make $2 in revenue earned for every $1 spent in Ad costs.
While startups may need a higher ROAS to cover costs and achieve financial growth, established companies can survive if the ROAS is low.
ROAS vs ROI
There are quite a few ways in which ROAS differs from ROI. Before we take a look at the differences, let’s understand what ROI is. ROI stands for return on investment. It is a metric used to determine the total profits made from investments.
A business needs to track both these metrics. The ROAS lets you know if a campaign has been successful in creating clicks, impressions, and revenue. What the ROAS fails to reveal is whether your paid ads department is profitable for the company. This is where ROI steps into the picture.
The importance of ROAS for ecommerce
Not sold on how ROAS can be an important metric for your online business? Here is why you need to keep track of this metric:
- It monitors the average performance and returns on your ad campaigns
- You will obtain accurate data to support changes in the campaign budget or an increase in ad spends
- It will help you identify which campaigns are performing well and which are not
- Advertising is often the most expensive component of an ecommerce strategy. If a campaign isn’t doing well, your marketing team needs to know that quickly and ROAS gives you that information
ROAS isn’t the ultimate metric (and why)
Here’s the thing: I know multiple agencies and in-house marketers reported on ROAS as their primary metric. Now, this was fine as long as attribution was alright.
However, now the variations in reporting are so large that the metrics are causing a misdiagnosis of true channel health. This leads to the inefficient deployment of spending, causing even further performance degradation to the ecosystem.
Attribution is broken (and will be so in the foreseeable future).
Also, ROAS cannot be used for fixing budgets either; especially when you have promotional events or a sale underway. During a sale, most of the people you target will find your product affordable and will click through your ads. ROAS calculation done in this case will be inaccurate.
ROAS is important but if it is the only metric you calculate, the results will be misleading. The ROAS calculation only takes into account the advertising costs but there are many other expenses that a business incurs like shipping, storage, production & maintenance. You need to optimize every area of your business to make a profit.
That is why you need to calculate it alongside other important ecommerce metrics like cost per click, ROI, and AOV.
The (new) three types of ROAS and why you should care
Once Triple Whale went through inordinate amounts of data from a kaleidoscope of Shopify stores and millions of dollars of ad spend, we identified a new growth formula:
Ecom Success = ncROAS x eROAS x POAS
Let’s look at each of these ROAS types and understand why they’re the right choice in 2022 to measure ecom success.
eROAS or MER
eROAS or Ecosystem ROAS is more popularly known as MER (marketing efficiency ratio). It gives you an indication of how successful your marketing ecosystem is. It shows you how effective your ad dollars are.
eROAS = Total revenue / Total ad spends
With eROAS you can approach the head of finance or the CFO of your company to understand how much money can be spent to earn X amount in revenue.
If they say you can spend up to $50,000 a month and earn a revenue of $250,000, you will know that your eROAS target is 5 [eROAS = Total revenue ÷ Total ad spends = 250,000 ÷ 50,000 = 5]. If your eROAS dips below 5, you have overspent, above 5 and you are underspent.
New customer ROAS shows you how efficient your marketing efforts are in generating revenue from new customers.
ncROAS = New customer revenue / Total ad spend
If your new customer ROAS is diminishing you are not successfully adding customers to your business.
Profit on Ad Spend or POAS
POAS indicates the total profits generated from the existing marketing efforts.
POAS = Gross profit / Total Ad spends
This ROAS calculation is going to tell you if you are driving the right products. It helps you understand if you are allotting ad spending for the right products to drive profitability for you or your clients’ business.
Tools to track the ROAS on your store
Let’s get to the most important part now. We are going to give you the two best possible ways to track the ROAS. Here they are
- The old-school way of using a spreadsheet
This is the standard way of computing the ROAS where you add all the figures to a spreadsheet and obtain the result using formulae in a spreadsheet.
- Using Triple Whale
Triple Whale is the #1 ecommerce analytics platform that centralizes important metrics like all three types of ROAS, net profit, AOV, email marketing sales, and a lot more.
That’s not all – you get to see all the metrics in one clean dashboard, send daily reports to your email/slack channel, or simply check out the health of your store right from your mobile app.
ROAS all the way!
There are a lot of strategies to improve this metric. Lowering your ad spend and reviewing your ad campaigns are ways to improve the ROAS. Optimizing landing pages, using the right keywords, and including a strong CTA are other tactics known to improve ROAS
Once you start tracking this metric you will know how effective your marketing efforts are. Take time to look at how you can get the best return on your investment through the ROAS calculation.
Link to Original Blog: https://trytriplewhale.com/blog/unbundling-roas-for-ecommerce-stores