The current economic reality of increased advertising costs and a post-pandemic afflux of e-businesses competing for the same eyeballs and wallets place eCommerce in a very competitive landscape. In their quest to increase sales, companies of any size will try complementing pricing, product-market fit, competition, and product features with a winning marketing strategy.
To succeed in this new e-commerce reality, marketers must grasp the true value of their marketing efforts and reassess the performance numbers they base their decisions on. Now, more than ever, optimizing advertising spend for profits and profit margins is required for tracking general ad performance based on revenue.
What is ROAS?
Return on advertising spend or ROAS quantifies the revenue generated for each ad dollar spent. After subtracting the ad costs, a campaign will generate sales and revenue.
How is ROAS calculated?
ROAS is calculated by dividing the revenue by total ad spend. Expressed as a formula,
ROAS = revenue / ad spend
For example, we could have $3000 revenue after spending $1000 on ads. This means the ratio will be 3:1. It’s often either expressed as a percentage or a multiplier:
ROAS = 3,000 / 1,000 = 300% or 3.0x
Various platforms will indicate the ROAS of running campaigns, such as Google Ads, which will show the ROAS as Conversion Value/Cost, and in Meta, ROAS will be visible as Purchase ROAS.
Pitfalls of using ROAS as a north star metric for e-commerce
For an extensive period, advertisers have regarded ROAS as a north star and assessed their marketing efforts based on it. Often, the ROAS has been a blended metric expressed as a combined result of all marketing campaigns via various channels and advertised products. While a good ROAS is desirable, it should not become the only metric analyzed.
Guiding results based on ROAS is a desired reality for companies focused on revenue growth or those trying to capitalize on new markets and conquer market share. For most companies, though, maximizing profits is more important than just bringing in revenue, especially for the industries in which margins are thin.
Below we list several pitfalls of reporting the ROAS as the ultimate performance metric.
ROAS ≠ ROI
A downside when looking ROAS only is that profits are not visible. Having only ROAS in sight, marketers will not have an understanding of their real return on investment and will only optimize for revenue, losing track of profit margins or return on investment. This can especially become a problem with campaigns advertising highly discounted products where ROAS might look good, but profits are actually negative.
ROI is calculated with the following formula
ROI = net profit / costs
Thus, looking at ROI, one can grasp earnings after costs and make financially wise decisions.
Marketers can analyze ROAS and understand the sales generated by their ad campaigns. Still, they will lack visibility on the costs associated with the sold goods and operational expenses such as shipping costs.
ROAS does not properly reflect sales of high-margin products
Also, an ad strategy that looks only at average ROAS as a performance indicator will sometimes cut ads for profitable products and prioritize goods that perform well in an ads campaign only. This brings the risks of having high margins products undermarketed or using discount campaigns too often only to increase advertising numbers.
While ROAS measures how much revenue was generated as a result of an ad campaign, POAS, or Profit on Ad Spend, measures the gross profit gained from every ad dollar spend. To calculate POAS, marketers need to consider other costs and profit margins.
To do so, advertisers must understand the actual performance and raw outcomes after excluding the COGS (costs of goods sold) altogether with other operational expenses such as variable shipping costs, which are different for various regions or countries.
To calculate POAS we first need to define what profit is. In commerce, there’s a metric called contribution margin 1, 2 and 3 (CM1, CM2 and CM3).
The different contribution margin metrics are calculated as follows:
CM1 = Net revenue - COGS
CM2 = Net revenue - COGS - shipping and transaction cost
CM3 = Net revenue - COSS - shipping and transaction costs - ad spend
The contribution margin metrics are often also expressed as percentage, relative to the generated revenue.
The formula for POAS is:
POAS = CM2 / ad spend
POAS = (Net revenue - COGS - shipping cost - transaction cost) / ad spend
Similar to ROAS, POAS is displayed as a multiplier. An example: A POAS of 2.3x tells that for each ad dollar spent, the business generates 2,3 dollars in net profits.
By dividing the gross profit attributable to the online marketing efforts by the ad spend, one can get a clear picture of how profitable the campaigns are. Thus, POAS becomes a great metric to measure marketing campaigns' effectiveness and helps determine advertising investments' profitability.
Benefits of reporting on POAS instead of ROAS
When reported correctly, basing decisions on profit on ads spend (POAS) can be a powerful strategy for boosting profitable sales. POAS is the process of assigning a certain amount of the marketing budget to profit-generating activities, such as selling more profitable products or services, rather than just spending to acquire more customers.
This approach allows marketers to focus resources on campaigns that are more likely to result in a return on investment. It also helps measure and track marketing efforts more accurately. And finally, it maximizes the impact of the marketing budgets.
In a nutshell, POAS indicates which products or services to spend ad dollars to generate profits.
Like always, POAS is not a silver bullet and there are use-cases, for instance, when your goal is to acquire new customers or drive subscriptions, where you want to look at other metrics, like subscriptions, new customer ROAS or new customer rates.
Use Admetrics to report profits instead of vanity metrics
The Admetrics Data Studio enables DTC brands to optimize profits by reporting on metrics like COGS, shipping costs, CM1, CM2, CM3, or POAS. These metrics are available on campaign, ad set, ad level, and of course, across all channels.
By providing deep insights into the health of an e-commerce business, they help make better decisions when selecting and scaling the most profitable marketing strategies.
If you want to understand the real value of your marketing efforts and stop reporting on vanity metrics in favour of actual profits, start your free trial here.For a limited time only, we offer assisted onboarding and a free data audit to base your business decisions on accurate data. Reach out to us at [email protected].