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The Pitfalls of Everyones Favorite eComm KPI: ROAS

The most common metric used in eCommerce advertising is Return on Ad Spend (ROAS), but have you ever stopped to think if this is the correct metric to evaluate your digital marketing spend? Below we will explain what ROAS is and why it may not be the correct metric for your business or at least not the only metric worth evaluating for your business.

WHAT IS ROAS

Return on Ad Spend (ROAS) - Efficiency Metric - The higher the roas the more revenue you are getting for each dollar spent on advertising - Revenue over ad spend

Some Issues with ROAS as the only metric

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There is nothing inherently wrong with using ROAS as your main metric or North Star for your account or campaigns but it does have to align with your company goals and your advertising goals. I have seen many times a small business owner or marketing manager state their main objective as growth or sales but then use ROAS as the main KPI (key performance indicator). If growing rapidly or driving sales quickly is your goal then efficiency shouldn’t be the main focus of the campaigns. Is it still good to track? Of course, but making decisions or judging the effectiveness of a sales growth campaign with ROAS is like wanting to buy the fastest car on the market and then only looking at the Miles per Gallon.

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.

  • Product A has a 50% margin

  • Product B has a 75% margin

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”.

via Gfycat

Let's take a look at your store and assume all products have the same 50% margin and run some numbers. In this scenario, your campaign is performing very well you spent $10,000 and made $75,000 which gets you ($75,000*50%-$10,000) $27,500 in net profit.

You are very happy with the results and decide you can afford to double the ad spend. So the next month you take a look at the results and you find you spent the $20,000 but made just $100,000 - $25k more than the previous month after doubling your spend. Dang, your ROAS fell 33% from that very nice 7.5x to a 5x. If you are basing the success of that extra ad spend solely on ROAS you are very disappointed and would probably decide to pull budgets back down. But you know the goal of this campaign is to maximize net profit so you sit down and do the math. ($100,000*50%-$20,000) = $30,000 in profit. ROAS fell 33% but the net profit actually grew 9% after doubling the budget.

This is when we go back to ROAS being an “efficiency” metric. It tells you how efficient you are with your ad spend, but efficiency isn't and shouldn't always be the goal when it comes to PPC campaigns. There are many scenarios where we can completely ignore ROAS when it comes to the goals of our clients or specific strategies.

Summary: Setting Goals & Using the Correct KPIs

The key to successful accounts and strategies is setting clear goals and then measuring those goals with the most relevant KPI.

There are plenty of use cases for judging your campaigns with ROAS. It can be very challenging to track profit down to the individual product sales level, which will limit your ability to report on and optimize for exact profit. Some budgets are set in stone and margins are fixed, in which case the more revenue you can drive within that budget (i.e. higher ROAS) the better.

The main takeaway I am trying to get to here is that there is no one metric that is the end all-be-all metric of eCommerce and probably not even the end all-be-all of your own business. Because when you put your whole business strategy together it will probably be a mix of being efficient with these products (ROAS), pushing these products (sales), awareness for these products (reach), etc. and each one should be measured against the goals you set for them, not against each other.