Many marketers consider Return on Ad Spend (ROAS) the ultimate measure of campaign success due to its direct correlation with revenue.
Though ROAS provides a straightforward metric for evaluating campaign effectiveness, it sometimes gives a partial picture. Often, these issues become clear only when it’s too late.
This article explains why ROAS might not always be the best metric and highlights other crucial factors to consider for a more comprehensive evaluation of marketing performance.
What is ROAS, And How Is It Calculated?
ROAS is calculated as the revenue earned for every dollar spent on ads using the formula below.
For example, if you spend $1000 on ads and generate $7000 in ad revenue, this means you’re receiving $7 on every $1 spent and your ROAS is 7.
ROAS Works Best For Campaigns That Aren’t Profitable
Let’s consider a scenario where a campaign generates $100 in revenue from a $1,000 ad spend.
This means the campaign earns $0.10 for every $1 spent on advertising, which indicates a net loss, as the company is spending significantly more on advertising than it is earning in revenue.
Here, the ROAS for the above campaign is 0.1.
Note: The ROAS is always less than 1 when your revenue generated is less than your ad spend.
So, this means that to stay positive, your ROAS needs to be more than 1.
So, Why ROAS Isn’t Always The Best Metric?
Now, imagine a jewelry company that is spending $10,000 on ads everymonth. The campaign generates $20,000 in revenue, resulting in a ROAS of 2.
At first glance, a ROAS of 2 appears to indicate a successful campaign. However, when we account for the cost of goods sold (COGS) and shipping costs, which is, say, about $11,000, the picture changes.
Let’s break it down:
Ad Spend: $10,000
Revenue: $20,000
COGS and Shipping: $11,000
Net Profit = Revenue – (Ad Spend + COGS and Shipping)
= $20,000−($10,000+$11,000)
= $20,000−$21,000
Net Profit= −$1,000
So, despite achieving a ROAS of 2, the company incurs a net loss of $1,000 from this campaign.
This situation highlights that while ROAS indicates efficiency in ad spend, it doesn’t account for high production costs, making the campaign less profitable in reality.
What to do?
In addition to ROAS, it’s crucial to consider Return on Investment (ROI) to understand the overall financial health of a campaign.
ROI is the metric that considers all the costs associated with the campaign and tells you how much profit or loss you have made from an investment compared to the amount of money you spent.
It is calculated as,
Using the jewelry example above:
Total Revenue = Ad Spend + COGS and Shipping = $10,000 + $11,000 = $21,000
Net Profit = −$1,000
And,
ROI will be −4.76%.
Here, despite a ROAS of 2, which is positive, the ROI is -4.76%, negative, indicating a loss. This demonstrates that the campaign is not financially viable.
How to Solve The Positive ROAS, Negative ROI Situation
As we saw, achieving a positive ROAS can be misleading if your ROI remains negative, indicating that despite efficient ad spending, overall profitability is not achieved.
To make these campaigns profitable, it’s essential to study cost management, make strategic adjustments, and implement innovative optimization techniques.
Let’s take it step by step.
In the following steps, we will explore how to transform campaigns with positive ROAS but negative ROI into profitable ventures, ensuring sustainable growth and long-term success.
Calculate your net profits margin (before taxes)
Understanding your net profit margin is the first step towards making your campaigns profitable.
Here’s how to calculate it:
- Net Profit: The total revenue minus all expenses, including cost of goods sold (COGS), operating expenses, and any other costs.
- Revenue: The total amount of money earned from sales or services before any expenses are deducted.
Example:
If a company has a net profit of $10,000 and its total revenue is $50,000, the net profit margin would be 0.2.
This means that for every dollar of revenue, the company retains $0.20 as profit margin after all expenses.
It gives a clear picture of how much money you’re actually making, which is crucial for assessing the effectiveness of your advertising campaigns.
Find your Break-even ROAS
Break-even Return on Ad Spend (Break-even ROAS) is a critical metric that determines the minimum ROAS needed to cover all costs associated with a campaign, ensuring no profit or loss.
It helps businesses understand the efficiency required in their ad spend to avoid financial losses and maintain sustainability. It is calculated using the following formula,
For example, if a company’s profit margin is 25%, the break-even ROAS would be 4. This means the company needs to generate $4 in revenue for every $1 spent on advertising to break even.
Understanding the break-even ROAS is essential for setting realistic advertising goals and making informed decisions.
Analyze and Optimize
In our earlier example, where the company’s profit margin is 25%, the break-even ROAS would be 4.
Now, let’s say the campaign is generating a ROAS of 2.5. While this indicates that the campaign is earning more than it spends, it’s still not reaching the break-even point, meaning the company is losing money overall.
Here’s how to analyze and optimize for profitability:
Areas of Improvement
1. Try to Reduce COGS
The first step in improving this campaign is to explore ways to reduce COGS without sacrificing product quality. This is because when you scale, you will have more ROAS to spend (as you scale, the ROAS decreases; we will see this in detail later on.)
You can reduce COGS by doing the following:
- Supplier Negotiation: Find more cost-effective suppliers or negotiate better terms with existing ones.
- Production Optimization: Streamline manufacturing processes to reduce material waste and labor costs.
2. Optimize Campaigns
The next step is to optimize the campaign’s ad performance and targeting to increase revenue without increasing costs significantly. Here are key strategies:
2.1 Optimize Product Pages
A well-optimized product page can significantly increase your conversion rate. Focus on:
- Faster Load Times: Ensure your page loads quickly to avoid losing potential customers.
- Mobile Optimization: Make sure your page is mobile-friendly.
- Call-to-Action: Use compelling and clear CTA and place it above the fold to guide users toward conversion.
2.2 Refine Audience Targeting
Narrowing your target audience to focus on those most likely to convert can significantly improve ROAS.
Use analytics tools to segment your audience by behavior, demographics, and interests. Focusing on high-conversion audiences will boost both ROAS and profit.
2.3 A/B Test with New Ads
Test different ad creatives to find the best-performing elements. Create headline, visual, and copy variations to see which versions resonate most with your audience.
A/B testing allows you to optimize ads without making costly assumptions. Be sure to test and measure performance regularly to improve ad engagement continually.
Tip: When making changes to your campaign, never apply significant changes directly to the live campaign. Instead, copy the existing campaign and publish the copy with the changes you want to make.
By analyzing and optimizing these areas, you can significantly improve your campaign’s performance, reduce costs, and ultimately move toward profitability. Combining these steps ensures your marketing strategy continuously evolves and scales efficiently.
Next, Why Scaling is the Next Step Towards Growth
Once you’ve achieved consistent profitability in your campaigns, the next logical step is scaling.
Let’s say you’re currently spending $1,000 on ads, generating $4,000 in revenue with a ROAS of 4. After accounting for all your costs, your net profit is $500. Now, you want to increase that profit.
One way to try this is by improving your ROAS, which has limits—your ad campaigns might already be optimized as much as possible.
Next, a more reliable solution is scaling.
Imagine increasing your ad spend to $10,000 and generating $40,000 in revenue. With the same ROAS of 4, your net profit would jump from $500 to $5,000. This is the power of scaling—spending more to make significantly more profit.
But there’s a catch!
In reality, when you scale, your ROAS tends to dip, which can affect your profitability.
So, if scaling impacts ROAS, why should anyone scale? And why ROAS dips?
The goal of scaling isn’t to maintain your ROAS but to increase overall profits by reaching new customers and expanding your market share.
For example, earning 5% on a $10,000 ad spend gives you $500, while earning 10% on a $1,000 ad spend only gives you $100. So, even though the percentage return is lower, the actual profit is higher with the larger budget. This demonstrates that scaling allows your business to generate more profit, even with a lower ROAS.
Now, let’s explore why ROAS dips when scaling and how to navigate this challenge.
Now, Why ROAS Dips While Scaling: Using the Nurturing Process Funnel
Scaling isn’t just about increasing your ad spend—it involves reaching new audiences and nurturing them through different stages of the funnel. So, it’s important to understand how the consumer journey funnel works.
Let’s break down why ROAS dips during scaling by looking at each stage of the funnel.
Top of the Funnel (Awareness Stage)
At the top of the funnel, you’re casting a wide net and targeting a broad audience that may not yet know your brand or product. For example, let’s say you’re selling a new range of smartphones.
At this stage, you reach 1,000 people with ads introducing the idea of upgrading their phone. These campaigns typically focus on brand awareness and education—getting people to consider questions like, “Is it time to replace my phone?”
- Budget Allocation: When your budget is low, you typically don’t spend much on this broad audience because they aren’t immediately ready to convert.
- Impact on ROAS: Since few people at this stage will make an immediate purchase, spending money here can lower your ROAS. You’re investing in long-term customer relationships rather than immediate sales.
Middle of the Funnel (Consideration Stage)
At the middle of the funnel, your audience has moved from awareness to consideration. Out of the 1,000 people you initially reached, 300 might be considering whether or not they should buy a new phone.
They’ve become more aware of their need and are now weighing options: Should they repair their current phone, buy a second-hand model, or invest in a new one?
- Budget Allocation: As you scale, you start spending more on this middle stage, targeting these 300 potential buyers with ads encouraging them to choose your product over alternatives.
- Impact on ROAS: Though the audience is closer to converting, they still need nurturing. Conversions are more likely but not guaranteed, so your ROAS at this stage will still be lower than when focusing solely on the bottom of the funnel.
Bottom of the Funnel (Conversion Stage)
At the bottom of the funnel, your focus is on people who are ready to buy. Out of the 300 people in the consideration stage, perhaps only 100 are actively comparing your phone with competitors or deciding between different models.
At this stage, your ads focus on pushing for conversion—highlighting discounts, offering reviews, and showcasing why your phone is the best choice. Of these 100 people, only a few might actually make a purchase.
- Budget Allocation: When your budget is small, this is where you invest most of your money. These people are closest to making a purchase, so the return is quicker.
- Impact on ROAS: Focusing on this stage typically results in a high ROAS because you only spend on the people most likely to convert. However, when you scale, you can’t just focus on the bottom of the funnel, as it limits growth.
To make it simple, as you scale your campaigns, you begin investing more in branding, awareness, and nurturing campaigns, which won’t yield immediate conversions. So, if you move from targeting 1,000 people to 2,000, the number of immediate conversions may not double. You’re spending more money reaching a larger audience, but those new leads need time to move through the funnel.
Example For Better Understanding
Let’s break down how ROAS dips while scaling using the hypothetical smartphone campaign example we introduced above. We’ll look at how the funnel works as you increase ad spend and expand your target audience.
Initial Campaign – Small Budget Focused on the Bottom of the Funnel
Imagine you’re running a campaign with a $1,000 ad spend. You’re focusing mainly on the bottom of the funnel, targeting customers who are close to purchasing. These are high-intent users, so your ROAS is relatively high.
Ad Spend: $1,000
Conversions: 10 smartphones sold
Revenue per Sale: $500
Total Revenue: $5,000
ROAS:
Revenue/ Ad Spend = 5, 000/1,000 = 5
In this scenario, for every $1 you spend, you’re generating $5 in revenue, resulting in a strong ROAS of 5. However, the total profit is capped because you’re only targeting a small, conversion-ready audience.
Scaling the Campaign – Moving Up the Funnel
Let’s say you decide to scale your campaign and increase your ad spend to $10,000. You’re no longer focusing only on the bottom of the funnel but expanding to reach a broader audience at the top and middle of the funnel. While you’ll still get conversions, many of these new leads are not ready to buy yet, so the conversion rate drops.
Ad Spend: $10,000
Conversions: 50 smartphones sold
Revenue per Sale: $500
Total Revenue: $25,000
ROAS: Revenue/ Ad Spend = 25,000/ 10,000 = 2.5
In this case, your ROAS dips to 2.5 because you’re spending more money to attract people who are further from converting. While you’re still making money, the return on each dollar spent has decreased compared to your smaller, more targeted campaign.
Profit Comparison – Why Scaling is Still Important
Even though your ROAS has dropped from 5 to 2.5, your overall profit has increased significantly because you’ve reached more people and made more sales.
Small Campaign Profit: Revenue−Ad Spend=5,000−1,000=4,000
Scaled Campaign Profit: Revenue−Ad Spend=25,000−10,000=15,000
Even though the ROAS dropped, the scaled campaign still yielded a profit of $15,000, compared to $4,000 in the smaller campaign. Remember, the key is to focus on long-term growth by nurturing a broader audience through the funnel, ensuring sustainable profitability over time.
Key Takeaways:
- It’s easier to achieve high ROAS with a small budget, but the real challenge is maintaining ROAS while scaling, which only true experts can make successful.
- Focusing only on ROAS can be restrictive, especially when aiming for long-term business growth. As, prioritizing a high ROAS might lead you to avoid important investments in activities like branding and customer engagement—crucial for sustainable growth but not yielding immediate returns.
- To scale effectively and achieve lasting success, it’s important to accept a lower ROAS and shift your focus toward increasing overall profits. This approach allows you to nurture a broader customer base, build brand loyalty, and drive long-term profitability.
