Have you heard about ROAS? Better yet: do you know how to calculate ROAS?
If the answer to either of those questions is “no,” then you might not understand whether your investment in online advertising is paying off.
That’s a bad thing because you’re in business to make a profit.
In this article, we’ll cover the concept of ROAS and give you some insight as to how to calculate it.
What Is ROAS? – How to Calculate ROAS
ROAS stands for “Return on Ad Spend.” As the full name implies, it tells you how much money you’re earning as a result of the amount you spend on advertising.
The formula for ROAS is simple: divide the total revenue you earned from advertising by the amount you spend on advertising:
ROAS = Revenue Earned From Advertising / Advertising Expense
For example, if you spend $2,000 on Google AdWords ads and earned $4,000 from people who clicked on those ads, then your ROAS is $4,000 / $2,000 or 2. In accounting terms, that 2 means 200%.
Isn’t That ROI?
No. ROAS is not the same thing as return on investment (ROI).
That’s because ROI is a measurement of strategic investment while ROAS is a measure of tactical spend.
In business, strategy usually refers to long-term objectives while tactics usually refer to short-term objectives.
You can think of ROAS as more of a short-term measurement while ROI is a long term measurement.
Also, the ROI formula is different:
ROI = (Gain From Investment – Cost Of Investment) / Cost of Investment
For example, if you spent $100,000 on online marketing last year and earned $150,000 from your marketing, then your ROI is ($150,000 – $100,000) / $100,000 or .5. In accounting terms, that’s 50%.
How to Calculate a “Good” ROAS?
That’s a little like asking “how long is a piece of string?” A “good” ROAS for your business model or industry might be different from the overall average.
If you’re running a business that’s marketing a cash cow with high margins, you ought to have a very high ROAS. If not, you probably need to improve your landing page, or hire a pay-per click agency.
On the other hand, if you’re running a business in a competitive industry with low margins, then you’ll likely have a lower ROAS.
Here are some ROAS figures for various categories:
- Baby products: 371%
- Pet products: 306%
- Health and beauty products: 282%
- General merch: 278%
- Food: 267%
- Beverage: 260%
Keep in mind that your ROAS is derived from your conversion rate. Since you only earn revenue when people make the purchase, that’s the number you should really be looking at.
What’s a good conversion rate? Again, your mileage might vary. However, there are some channel-related benchmarks.
- For Google AdWords accounts, the average conversion rate is 2.45%
- For the top 25th percentile of AdWords accounts, the conversion rate is 5.31%
- For the top 10th percentile of AdWords accounts, the conversion rate is 11.45%
As you can see, there’s a wide diversion. That’s no doubt due to the fact that marketers at the top know how to reach exactly the right people using AdWords ads.
If you find that you’re hitting a great conversion rate and yet you’re still not generating a positive ROAS (that’s anything higher than 1 or 100%), then that usually means one of two things: you’re spending too much on advertising or you’re not charging enough for your product.
If you find that your product is priced competitively and you’re not offering any additional value over others in your industry, then you can probably eliminate the possibility that you’re not charging enough. Of course, if you’re selling the same thing as everybody else at the same price, then it’s likely you’re offering something on the down side of the product cycle and that could be the problem in and of itself.
On the other hand, you might just be spending too much on advertising. To determine that, take a look at your targeting practices.
Are you advertising only to people in your market? Have you segmented your market and run ads to people in specific segments? If you’re using search marketing, have you added negative keywords to ensure you don’t attract people who aren’t in your market?
Keep in mind also that many online ad services operate on a bid model. That is, you bid a certain amount for a click or an impression.
If you haven’t optimized your campaigns for just the right bid, then you could be spending too much on pay -per click advertising. That will affect your ROAS.
Of course, there are other factors that go into online ad spend. We’ll cover those in the next section.
How to Calculate ROAS and Ad Spend?
You might think that a business calculates ad spend by just adding up the total dollars spent on advertising as reported by various online ad services.
If only it were that easy.
Fortunately, those services do make it easy to calculate the cost of clicks or impressions. You can usually find that value in any report that shows ad performance over a series of time.
But there’s more to the story.
Did you hire someone to create ad copy? That’s an expense.
Do you have employees who track ad performance and adjust ad spend accordingly? That’s an expense.
Did you hire someone to create a graphic for a banner ad? That’s an expense.
There might even be administrative costs associated with the campaign. Those should be factored in as well.
You see where this is going. You need to consider all operating costs associated with online advertising (and, usually, with a particular ad channel) before you can properly calculate ROAS.
Let’s look at an example. John runs a business that sells high-end fashion clothing. He wants to calculate ROAS for an ad campaign that promotes top-notch blue jeans.
For the past 6 months, John has run a Google AdWords campaign that cost him $10,000 in clicks.
John also has a full-time copywriter on staff who produced the copy for the ad. According to John’s project management software, the amount of time that his copywriter spent on the ad cost the business $1,000.
Also, John has a digital marketing team that tracks ad performance and adjusts ad spend. John’s project management software shows that, for the past 6 months, that team has devoted $4,000 worth of effort to that campaign.
So John’s overall ad spend for the blue jeans campaign during the last 6 months is $10,000 + $1,000 + $4,000 or $15,000.
During that same period of time, John has earned $30,000 from the sale of those upscale blue jeans as a result of that campaign.
So John’s ROAS is $30,000 / $15,000 or 200%.
After looking at that number, John wisely decides to extend the campaign for at least another 3 months.
How to Calculate ROAS From Advertising?
This is where it gets tricky.
In the example above, we greatly abbreviated the process by which John determines is revenue earned. The reality is that it’s quite a bit more complicated than it appears.
Fortunately, though, modern technology can come to our aid.
Exactly how you calculate revenue per ad channel is derived from the ad channel you’re using. It will vary from channel to channel.
For example, if you’re using Google AdWords, you can set up conversion tracking. That will give you some insight as to how many people converted once they clicked on your ad.
Keep in mind, other advertising mediums such as Bing Ads and Facebook Ads offer solutions for tracking conversions as well.
If you’re not using conversion tracking on your ad service, you’ll probably have to set up a Google Analytics campaign to track conversions. That involves creating a custom URL that’s derived from your source and campaign.
Once you’ve created the URL, you’ll need to track goals in Google Analytics. When you create goals, you’ll give each goal a value which equates to the amount of revenue earned from the sale.
As you can see, it’s not quite as easy to count beans as you’d like it to be. Unfortunately, once you’ve finally set up the process of tracking conversions, you’re still left with a bit of complexity.
Why? Because there are typically multiple touch points in the customer journey to a sale.
For example, Sally is online and she see’s John’s ad for fashion blue jeans. It’s a banner ad on one of her favorite websites.
Sally clicks on the ad and shops on John’s site. She thinks to herself: “I could use a pair of blue jeans and these look great, but I need to wait for payday.”
After payday, Sally is searching for blue jeans online and sees John’s ad. She remembers that she liked the jeans from the banner ad she saw the other day.
Sally clicks on John’s AdWords ad. She orders a pair of blue jeans from his site.
In that simple example, there were two ads that contributed to the sale. One was a banner ad on a website and the other was a search ad.
Both ads should get credit for the sale. Also, the expense of both ads should be factored into calculating ROAS.
So how do you account for revenue generated from multi-channel marketing? There are a few ways.
First, start by setting up multi-channel funnels in Google Analytics. Those reports will give you plenty of metrics so that you’re not playing guessing games.
Then, you have to pick a right attribution model.
What’s an attribution model? It’s a means of giving credit to one or more marketing channels for a sale.
Here are the most popular attribution models:
- Last Click – In this case, you just ignore all other channels except the one that got you the sale. It’s not going to give you a very accurate read of ROAS.
- First Interaction – This is the opposite of Last Click. It’s when you give 100% of the credit for the sale to the first channel that landed the customer on your site.
- Linear – You credit every touchpoint in the funnel equally. For example, if Sally had purchased blue jeans for $100, then $50 of the sale would be attributed to the banner ad and the other $50 to the search ad.
- Position-based – The first and last touch points are worth a certain value. Any touch points in between are given equal value.
- Time Decay – Touch points closest to the sale, in terms of time, get the most credit. Those farther away get less credit.
So which attribution model is best? That’s a discussion you should have with your business partners and your accountant.
Let’s look at an updated version of John’s situation using the Linear Model.
If 75% of the sales come from the search ad alone and the other 25% come from both the search ad and the display ad (as in Sally’s case) what’s the ROAS?
This is where it gets fun.
Revenue that can be attributed solely to the search ad is $22,500 ($30,000 x 75%).
What about the other $7,500? That gets split evenly between the search ad and the banner ad. So only $3,750 gets attributed to the search ad here.
Therefore, total attributed revenue from the search ad is $22,500 + $3,750 = $26,250.
Now, if we run the ROAS formula again, we get $26,250 / $15,000 or 175%.
That still looks like a pretty good return to John, so he decides to stick with his search ad campaign.
Wrapping It Up
It’s not always easy to account for return on ad spend. However, with the aid of your favorite analytics tools and a calculator, you can determine if your advertising dollars are bearing fruit.
Armed with that info, you can make the necessary adjustments to your online strategy.