Are you tracking the success of your ad campaigns?
Are you measuring your return on investment or your return on ad spend?
If you need ideas on how you can measure your campaign success, keep reading.
Although these 2 metrics are somehow related, they are quite different.
- ROAS looks at revenue, and not on profit.
- ROAS just considers the direct spend and not other costs associated with the product
- ROAS gives you an understanding whether to continue investing in an ad or not and can be used to determine the effectiveness of it.
- It’s better suited for looking at short term strategic growth
How do you calculate ROAS?
ROAS = Revenue Generated by the Ad / Money Invested in the Ad
Most marketers are pretty familiar with the formula and its usage is a common practice within the industry. If you divide the return by the cost, you’ll know if the revenue covers your ad cost.
On the other side, ROI measures the Return On Investment. If you are a business owner, you are probably pretty familiar with ROI
- It’s about being profitable
- It takes the costs associated with the good into account
Simplified, if the return is higher than the investment, you are profitable, otherwise, you are not.
- ROI is usually used for looking at long-term profitability
The formula for your advertising ROI is:
(All Revenue generated as a result of marketing activity – Direct Cost of Sale) / Advertising costs
Or in other words:
- Net Profit / Advertising Costs
So, which one do you use?
Most marketers use ROAS, probably due to a few reasons:
- The simplicity of the formula – it’s a formula you can calculate in your head fairly easy
- the data is available and can easily be extracted from your campaign information
In contrast, calculating ROI can be a bit harder, as the calculation relies on a number of factors like the costs associated with the product. This can include manufacturing costs, personnel costs, advertising costs, etc…
For a company to be profitable it has to include a margin on the goods it sells. Let’s have a look at this from the perspective of selling blue jeans.
Let’s say you are selling blue jeans for $200 and your margin is 40%, making you $80 ($200 x 40%) in profit and having a cost against it of $120 ($200 x 60%), the cost reflects the costs associated with the product. Let’s say the advertising cost was $50.
Now, if we wanted to calculate the ROI from this, we would calculate:
ROI = (Revenue – Total Cost) / Cost of Advertising
ROI = (200 – 120) / 50
ROI = 1.6
For every $1 we spend we make 60 Cents on the dollar. This is pretty powerful to know.
Now, let’s have a look at ROAS and let me show you why it can be misleading if you just focus on ROAS without considering ROI.
If we continue with the same example from above, we can calculate:
ROAS = Revenue / Advertising Costs
ROAS = 200 / 50
ROAS = $4
As you can see, ROAS looks pretty good and you could argue that your campaigns grow your business. And in this case this is certainly true, as our ROI is positive.
But what would happen if our first example (when calculating a ROI of $1.6) was a bit different.
Let’s say our advertising cost would be $90 instead of $50, then we get the following outcome:
ROI = (200 – 120) / 90
ROI = 0.89
ROAS = 200 / 90 = 2.22
Although our ROAS is telling us that we are returning $2.22 on the advertising dollar spend, ROI tells us that we are not even hitting break even. We are losing money.
So, what to do now? Should you just look at ROI from now on?
Although, as marketers it would be nice to have this visibility on a business it’s often not realistic due to different reasons.
- The owner may not know what the costs associated with a product are
- The company may not want to share this information
- The true costs associated with a product are not that easy to calculate, and the list goes on…
Personally, what I sometimes do (if margins are not available from the client-side) is take a margin that kind of reflects a worst-case scenario, e.g. 10%, and then feed in the numbers from my campaigns and see if we are above or below the breakeven point.
Most clients that “just” define a ROAS target usually define it at a level that is most likely ensuring profitability also.
Performing ROI calculations may not be a daily or weekly thing, but it’s still good to look at them from time to time to ensure everything is tracking alright.