What is ROAS? How to calculate return on ad spend

In digital marketing, data is everything. It helps validate your high-performing marketing activities and informs decision-making to optimize campaigns continually.

We often hear about the importance of traffic and conversions, both of which are often tracked and used to speak to the overall health and performance of a website.

But another lesser-known KPI (key performance indicator) is just as important – return on advertising spend (ROAS).

In digital advertising, measuring success is all about money. That is, how much revenue did a campaign generate and how effectively is it contributing to the profitability of our business?

This is what makes ROAS such an important marketing success metric to track and utilize. In this post, we’ll break down what ROAS is, how it’s calculated, and why it’s so essential in optimizing your paid media marketing strategy as a whole.

What is ROAS?

ROAS, or return on ad spend, is a metric used to determine advertising effectiveness. It shows how much revenue is generated for every dollar spent on an ad account, campaign, or group.

ROAS is one of the most important marketing metrics in helping digital advertisers understand what they’re getting out of their investment – and where they could be getting more.

How do you calculate ROAS?

You can calculate ROAS by taking the total amount of revenue attributed to advertising and dividing it by the dollars spent on that advertising.

While this equation is simple, it's somewhat of an oversimplification of the greater picture, however, and can be rather limiting when taken at face value. This is because measuring revenue and cost is not always a straightforward process.

Calculating the value of product purchases, for example, is easy, as they are assigned a specific worth and attributed to your business in explicit quantities. But if one of your main marketing and advertising goals is to generate leads, you’ll also need to determine the value of a lead in order to accurately track your ROAS.

Similarly, cost also has several levels to consider. Apart from the cost of running an ad, there’s also the possibility of fees paid to agency partners or vendors who help create the ad, personnel and salary costs, money spent on clicks and impressions, and more.

Attribution and ROAS

For accurate ad measurement, you need to have a way to determine when a paid channel should receive credit for a conversion. This is important for determining advertising effectiveness, especially when it comes to understanding how many sales are coming from ads.

This concept is known as channel attribution and has notoriously been a challenge for marketers to clearly measure. Why? Customers don't always (read: almost never) follow the simple user journeys needed to easily and accurately give single attribution credit. Instead, it can take multiple touchpoints across a variety of channels for a customer to convert, so advertisers have to find ways to accurately collect and measure that data.

With a variety of attribution models available to advertisers depending on the advertising platform, it's important to pick the one that makes the most sense to your business. Attribution models are also getting outfitted with AI capabilities in an effort to make them more accurate and consistent.

Common attribution models

Last-click attribution: This model was developed as a way to give full credit to the marketing channel responsible for the last customer touchpoint prior to conversion. It's also commonly referred to as "single-touch attribution", and it gives the most weight to the final channel a customer engages with before converting.

Multi-touch attribution: Multi-touch, or data-driven attribution, takes a look at the full user journey, weighing out channels and giving credit based on user and account data. Rather than giving credit to a single channel, this model weighs all touchpoints. This type of attribution is great for advertisers trying to understand the user journey and look at which ads and keywords resonate best with the user.

Typically, to get a more accurate depiction of your return and to credit your advertising efforts correctly, it makes more sense to utilize multi-touch, or data-driven, attribution. All factors of both sides of the equation need to be taken into account to properly calculate ROAS.

Calculating ROAS: A tangible example

With the right data points, calculating ROAS is pretty simple. Say a B2B eCommerce website sells products online directly to its customers while also aiming to generate leads from businesses that may lead to longer-term relationships.

The firm runs an ad campaign that spends $500 on clicks on a PPC basis. The campaign generates six new leads at $1,000 per lead in addition to selling 15 products at $100 per product.

Using the standard ROAS equation, it could be determined that the $7,500 in revenue against the $500 cost in clicks results in a ROAS of 15:1.

However, if you take into account the full picture and include the fact that $1,300 was spent on account management and $700 was spent on ad creation to an agency partner, the total cost of the campaign comes to $2,500 – resulting in a true return of 3:1 rather than 15:1 (could also be expressed as 3x, 300%, or simply 3).

This is just one example, as every campaign will have its own channels of revenue and cost depending on the unique circumstances of the business.

Keeping close tabs on your ROAS can help optimize future campaigns and budgeting. Today, there are several platforms such as Google Ads that make it relatively easy to track ROAS on different levels to quickly inform strategic changes.

ROAS vs ROI

If you're thinking "ROAS sounds a lot like ROI", you're on the right track. But there are several key characteristics that differentiate the two KPIs.

• ROI is a more full-picture metric that speaks to the success of your overall investment
• ROAS accounts for the specifics of your advertising campaigns.
• ROAS also looks specifically at revenue while ROI measures profit, meaning ROI is the return after accounting for all additional expenses your business may have. It's the money your business gets to keep.

You should measure and track both ROAS and ROI as they bring different data points to the table. Together, they can give you a better understanding of your ad campaign performance and how those efforts fit into your greater marketing strategy.

Why is ROAS so important?

As with most data in digital marketing, measuring and tracking ROAS helps businesses evaluate which advertising strategies are working and which can be optimized to improve future returns. ROAS shows how well digital advertising is either contributing to or hurting the bottom line of your marketing budget and net income as a business.

What makes ROAS so invaluable is its difference in nature when compared to other common marketing metrics. While traffic and conversion data can be useful in assessing several key performance trends, they don’t speak directly to the profitability of your business. This is because most visits and conversions are worth more or less than others depending on the specific action taken.

ROAS gets right to the point. It can be looked at to determine everything from an entire account’s performance to how well a certain ad is resonating with a specific audience. If you can compare revenue against cost, you can calculate ROAS.

What is a good ROAS?

To use ROAS to help make decisions, you first have to establish what an acceptable ROAS is. Is 3:1 good enough? Is an ROAS of 2:1 too low? Should you be shooting for the stars at 10:1 or higher? The target benchmark your business strives for will depend largely on your own budget and profit margins – which should both be clearly defined before outlining your advertising strategy.

For the sake of industry standards, a ROAS of 4:1 is a fairly common target. However, most eCommerce sellers may need a higher ratio to stay profitable given their already-low profit margins, while others in higher-margin industries can get by with a lower ROAS.

Take into account your margins and budget prior to advertising and use them to help determine what your target ROAS should be.

Breakeven ROAS and your profit margin

When talking about ROAS, it's important to mention another specific term commonly known as "Breakeven ROAS".

Breakeven ROAS is a ROAS target that you hit when you break even during customer acquisition. The metric tells you how much you need to make to cover the costs of advertising and can be calculated by dividing your average order value by your average order value multiplied by your margin.

Breakeven ROAS = Average order value/(Average order value x Margin)

At first, this might seem a little backward— don't you want to make money off of your customers, not just break even? But for businesses (especially e-commerce) in the process of growing and acquiring new customers, it's a strategy that advertisers can implement to start determining what truly accounts for a successful ad.

This is also a strategy newer companies use to quickly acquire customers and start competing in the market. It usually results in a profit loss up front, but that loss is recovered as those customers become loyal to the brand.

The strategy behind breakeven ROAS

For new businesses, if they can break even on a first purchase, every other purchase after will generate a positive contribution on a customer level, meaning they'll attain customer loyalty after securing that first purchase.

But break-even ROAS isn't just for new businesses. It can work for any business with return purchases that contribute to a higher LTV (lifetime value), which isn't accounted for in the first purchase and thus isn't reflected in ROAS.

For example, if the cost-per-conversion from ads is $50 and the first purchase is $50, then it looks like you are breaking even. However, if the average LTV is $500, this quickly makes up for that break-even ROAS.

Additionally, some businesses may even go negative on ROAS based on their higher LTVs. Of course, this only makes sense if you have repeat customers or you are focused on a customer acquisition strategy that provides value beyond the immediate return.

It's important to note that this strategy won't make sense for every business. The success of break-even ROAS as a marketing strategy is highly dependent on the product or service you're selling and won't make sense to utilize for all businesses.

How to improve your ROAS

Now that we understand how ROAS is calculated and its importance in optimizing your advertising strategy, here are a few ways to improve your ratio.

1. Launch a branded campaign – Branded campaigns target your business’ name and typically have high conversion rates because users searching for your name are likely already interested in contacting you or making a purchase.
2. Use negative keywords – Negative keywords prevent your ads from appearing in searches for keywords that may be related to your target keywords but not to your business’s offerings or campaign goals.
3. Use geo-targeting – Especially valuable for brick-and-mortar businesses and for those with a limited shipping area, narrowing your targeting based on geographic location ensures you’re not wasting spend on users who aren’t able to receive your products or services.
4. Ensure your site is mobile-friendly – An increasing percentage of web traffic comes from mobile devices, and if users click on your ad and land on your site only to experience friction and poor usability, they’re going to leave.
5. Adjust bids based on time and location – If you know your ads aren’t going to perform as well on the weekends or in the middle of the night, you’ll want to reduce bids during those times to save on ad spend. Similarly, if you’re targeting an almost entirely urban audience, you should reduce bids in rural areas.
6. Optimize your landing pages – Landing pages are where users are sent when they click on your ads, and they must be optimized to ensure they load quickly, are easy to use, and they direct users down a clear conversion path.
7. Test, test, test – As with all marketing strategies, ad and campaign performance can always be improved. Experimenting with different images, copy, timing, locations, CTAs, offers, and more – and then analyzing the test results – will help to continually improve your ads’ efficacy and ROAS.

Maximize your ROAS with Perrill's paid media experts

The Perrill team is comprised of collaborative experts in the latest and most proven trends in digital advertising, SEO, content marketing, and much more. In more than 25 years as the original Minneapolis digital agency, we have helped countless local and national businesses establish themselves as online industry leaders.

Contact us today to learn more about how to craft and execute a strategy designed to get the most out of your ad spend.