Return on Ad Spend (ROAS) is a critical metric in digital marketing, yet even seasoned eCommerce merchants often get confused as to how it works.
Understanding ROAS is critical to improving the effectiveness of your advertising campaigns, but more importantly, it can help you navigate important business decisions such as monthly advertising spend and how to price your products in a competitive market.
This guide breaks down what ROAS is and how to leverage it for optimal ad performance.
What is ROAS?
Let’s start with dissecting exactly what this metric is. ROAS is calculated by dividing the revenue generated from advertisements by the cost of those ads.
ROAS is expressed as a ratio or a percentage, and it’s used to evaluate the financial return from specific advertising efforts. A higher ROAS indicates a more successful advertising campaign in most cases.
It’s important to note that in some cases, a wildly high ROAS may have very little to do with sustained or reliable ad performance. I will delve more into this subject below, but let’s say you have a product that is going for around $600. You run an ad for a week with a tiny budget of around $10 a day and no real strategy, yet by chance someone clicks on the ad and converts.
Well, at the end of the week, your ROAS will be somewhere around a 10.00 or 10x. You spent around $60 to gain a $600 profit. Not bad, right?
However, is this number sustainable? Is a 10x ROAS the norm for this product or industry, or was this just luck? The next week, you might spend twice as much and get only one sale again. That means you would have spent $120 to get a $600 order. Now you’re at around a 5x ROAS.
See how such a small change can dramatically affect how ROAS is interpreted? You doubled the budget and got the same exact number of sales, but your return was halved. This kind of bizarre result might be a cause for massive confusion if you don’t understand the digital advertising landscape.
Let’s dig a little deeper into exactly how ROAS works and what can affect it:
Factors Affecting ROAS
Average Order Value (AOV): This is the average amount of money spent each time a customer places an order. A higher AOV can positively impact ROAS, as it means more revenue is generated per transaction. Strategies to increase AOV include upselling, cross-selling, and bundling products. Key takeaways: the price of your products plays a big role in your achievable ROAS. If the average cost of an item in your store only costs around $10, and shoppers tend to only purchase one of these items at a time, then by definition, it may be difficult to achieve a high ROAS.
Customer Acquisition Cost (CAC): This measures the total cost of acquiring a new customer. If CAC is high, it can lower the ROAS, as more is being spent to attract each customer. In competitive industries where the average price of a click or view is high, a high ROAS will be that much harder to achieve. In some industries, a 1.5 ROAS might be the expected norm.
Ad Quality and Relevance: Ads that are well-designed and highly relevant to the target audience tend to perform better, leading to a higher ROAS. This includes factors like ad creative, messaging, and targeting precision.
Market Competition: In highly competitive markets, ad costs can be higher, which might reduce ROAS. Conversely, in less saturated markets, ad spend might yield higher returns.
Seasonality and Trends: Consumer behavior often changes with seasons and trends, affecting ROAS. For instance, retail businesses may see a higher ROAS during holiday seasons.
Website and Landing Page Experience: The user experience on a website or landing page can greatly influence conversion rates. A positive, seamless experience can lead to higher conversions and thus a better ROAS. It’s critical to understand the correlation between ROAS and conversion rate, and how the user experience of your site plays a role here. It doesn’t matter how high you price your products or how much traffic you drive, if your conversion rate is only around .2% or .5%, it will be difficult to drive a positive ROAS.
Strategies to Improve ROAS
As you can see from the above list, there are numerous factors that play a role in how ROAS is calculated. In many cases, it has little to do with ads at all, but more to do with the products, the average order value, and the conversion rate, which are influenced by things like the UX of the website, brand trustworthiness, and what the individual products cost relative to the competition.
There are some straightforward approaches to improving ROAS, however. Here are some:
Optimize Ad Targeting: By refining the targeting parameters to reach the most relevant audience, advertisers can improve the efficiency of their ad spend, potentially boosting ROAS. This is the bulk of the secret sauce that goes into a smart advertising campaign, whether it’s a Google PPC strategy, a Facebook ads campaign, or even a TikTok ad. Knowing how to target the right audience instead of just throwing ads at anyone with eyeballs is often the key difference between a successful ad campaign and just “running ads.”
Improve Ad Creatives: Testing different ad formats, visuals, and copy can help in identifying what resonates best with the target audience. You know that if you are targeting the same audience with two creative variants, and if one is performing better than the other, that the creatives are likely playing a role. Regularly analyzing campaign data and conducting these kinds of A/B tests can help in identifying what works and what doesn’t, allowing for continuous optimization and improved ROAS over time.
Enhance User Experience: Optimizing the landing page or website for better usability and faster load times can increase conversion rates. Usability includes things like clear and attractive product images, easy checkout, helpful product descriptions, trust factors like reviews, and readable fonts.
Focus on Customer Retention: Acquiring new customers is often more expensive than retaining existing ones. Implementing strategies to increase customer loyalty and lifetime value can positively impact ROAS.
Adjust Pricing Strategies: Consider testing different pricing models or strategies to increase the average order value, thereby potentially boosting ROAS.
Expand to New Channels: Diversifying advertising channels can help in reaching new audiences and can also reduce the reliance on any single channel, which might be seeing diminishing returns. Each advertising channel technically has its own user cap in terms of how many people can potentially be reached in a given month or year. When a certain audience becomes exhausted, adding on another channel can be one way to mitigate the potential fall off in users and revenue.
Utilize Seasonal Campaigns: Capitalizing on seasonal trends and creating timely marketing campaigns can help in achieving a higher ROAS during peak times. It’s important to note that the ROAS that can often be achieved during promotions should not be taken as a baseline for average day to day performance.
Educate and Engage Your Audience: Content marketing and engagement strategies can build brand loyalty and trust, leading to higher conversion rates and repeat purchases.
ROAS in the Learning Phase
It’s worth noting in any conversation regarding ROAS, how it can vary substantially depending on what phase of the campaign you are on. In the beginning months of an advertising campaign, especially on Google, ROAS can be incredibly low, because the ad platform is serving ads to everyone that potentially falls in the audience bucket. As the ad learns, it gets served to an increasingly optimized audience. This will naturally improve the ROAS.
On the other hand, there are times when an ad campaign is first launched where the ROAS can seem strangely high. This is because the full budget over the course of the month has not yet been utilized, however a few high average order value orders might still be placed, thus driving up the ROAS. Once the ad runs for a few more months and evens out, the ROAS may go down.
The Relationship Between ROAS and Ad Spend
The last point worth noting here is how ad spend is correlated to ROAS.
Let’s say you are currently getting a 4x ROAS, and this return works for your business given your margins. You love the return and decide to increase the spend. The logical inference is that if you are getting a 4x return on a set amount of spend, that if you spend more, you will get more money, because the 4x will sustain itself.
This is not at all the case in many cases.
Remember, the return you get is directly correlated to the ad spend you are putting into the ads. So if you are spending $10,000 a month and getting $40,000, upping the spend to $20,000 could result only in around a $50,000 or $60,000 return, or a 2-3x ROAS.
The reason for this involves a combination of users in the available audience, the price of the products, and the actual amount of money being spent, among other things. Always weigh these factors when proposing an ad spend increase.
Building an Effective Advertising Strategy
ROAS is a vital metric in evaluating the effectiveness of digital advertising campaigns, but it’s clear that there is a lot to learn when it comes to really getting a handle on it and how to positively influence it. One of the best reasons to engage with a qualified eCommerce PPC agency, because experts understand the nuances involved with ad spend returns and can often make the necessary adjustments in order to improve it.
Regardless of your approach, it’s important to take ROAS into account at every step of your PPC approach, no matter what platform you decide to advertise on.
Matthew Lovett is the Director of Content and Social Media at 1Digital. Specializing in thoughtful marketing solutions and content that is goal-oriented and value-driven, he is passionate about helping businesses scale through organic growth. He is endlessly interested in the latest trends in social media, AI, crypto, and gaming.