Example 1 - Margins & Profitability
One issue with ROAS is it doesn’t take margins into consideration which could be a big issue for your accounts/campaigns especially if you have products that have wildly different margins.
If you have a product that has a 50% margin a 2x ROAS would be breaking even on the sales of those products once you subtract the ad spend. Whereas a product with a 75% margin and a 2x ROAS would be fairly profitable even after subtracting the ad spend.
Alright, let’s dig into some concrete numbers to see how this issue can impact marketing strategy & results:
You have an eCommerce shop online that sells two products. Product A & Product B are your only products and you have them in one campaign in Google Ads.
The campaign is hitting a 2.5x ROAS - This was your goal so you are happy with the results. But let’s dig in a bit here.
The campaign has $37,500 in revenue and spent $15,000. However, 75% of that revenue is coming from product A. That means $28,125 in revenue and with a 50% margin that's $14,062.5 gross profit (assuming all costs are lumped into the margin except ad spend). This also means that product B accounts for $9,375 in revenue and $7,031.25 in gross profit so this campaign has made $21,093.75 after taking out the costs of goods sold (cogs) but we still have to remove the ad spend. So the net profit for this campaign is $6,093.75
Now, let's say you see this and decide to split the campaign into two new campaigns so you can push more of the ad spend budget toward product B. You spend the same $15,000 but make $30,000 in revenue. Combined the two new campaigns have a ROAS of 2x - things got worse from a ROAS perspective. However, this time you pushed product B and it makes up 90% of sales ($27,000) and 10% are coming from Product A ($3,000). That means with the margins Product A accounts for $1,500 gross profit and Product B $20,250 gross profit and after taking out ad spend you pocket $6,750 in profit. So ROAS went from 2.5 to 2.0, revenue fell by over $7,000 but profit actually increased by $656.25
Focusing on ROAS and ignoring your product mix and margins could be detrimental to your bottom-line profits. This example shows that ad spend and products being equal you can actually make more profit by focusing ad spend on the higher margin product and generating less revenue. Is this the best option? The answer like so often in the marketing world is “It Depends” if your goal is to grow top-line revenue maybe pushing product A makes the most sense, if your goal is to get the most revenue for each dollar you spend on ad spend ROAS is the perfect metric to focus on, but if your goal is to make the most money in profit you should take the ROAS hit and keep pushing spend to Product B.
(This doesn’t even get into the issue of Google Pushing TROAS bidding)
Example 2 - Lower ROAS -> Higher Profit
Ok, at this point you might be saying “Yes, in that very specific example that makes sense, but my products are all the same margin (or close) so ROAS works for us”. As Lee Corso would say “Not so fast”.