The Power of Return on Ad Spend (ROAS)

Return on Ad Spend helps businesses understand their profit margin regarding advertising efforts and specific campaigns.

Explore this article:

1. Why knowing ROAS is more important now
2. Target Return on Ad Spend
3. Examples by Business Type 
   
4. Interpreting ROAS Results
5. Target ROAS Conclusion

Why knowing ROAS is more important now:

The landscape of online advertising is undergoing a remarkable transformation. The days of simply purchasing keywords and selecting specific ad placements are long gone. Thanks to artificial intelligence, big data, and predictive analysis, we now have access to strategies surpassing human experts' capabilities. Industry giants such as Google, Microsoft, and Apple are swiftly introducing comprehensive and seamlessly integrated brand-placement experiences throughout the consumer journey. The algorithms are complex and unpublished. 

While you may feel a loss of control over your advertising decisions, the silver lining is that the new advertising platforms consistently outperform the outdated manually driven pay-per-click models of the past—IF we provide the right inputs. 

The technological transition from paper Rand McNally maps to Garmin GPS provides a useful analogy to the shift happening in online advertising: a paper map is an aid to the traveler who still solely carries his beginning and end points and thinks through each turn to devise a route. A Garmin thinks for the traveler throughout the journey but can only do its job when crucial inputs are delivered, namely, a start point and an end point! Similarly, the emerging generation of advertising products requires ad buyers to provide conversion metrics to optimize the system. 

The best new bid strategy is to understand your own performance goals and conversion metrics so that you can provide them to a smarter breed of ad products. 

One key metric to consider is the target Return on Ad Spend (tROAS). 

What does Return on Ad Spend mean?

Return on Ad Spend (ROAS) is a performance metric that evaluates the revenue generated from advertising in relation to the amount invested in advertising. It helps gauge the effectiveness and profitability of advertising campaigns.

Calculation Methods: ROAS can be calculated in different ways, depending on the specific goals and requirements of the business. Here are two commonly used methods:

1. Basic ROAS Calculation: The basic formula for calculating ROAS is: ROAS = Revenue Generated from Ad Campaign / Ad Campaign Cost.
2. Advanced ROAS Calculation: The advanced method involves considering additional factors such as overhead costs, average order value, and customer lifetime value. This method provides a more comprehensive understanding of the true return on investment. The formula for advanced ROAS calculation is: ROAS = (Revenue - Cost of Goods Sold - Overhead Costs) / Ad Campaign Cost.

Let us explore a couple of examples to illustrate the concept of ROAS.

Example 1: E-commerce Business 

Imagine an e-commerce business that invests $10,000 in an advertising campaign and generates $50,000 in revenue. Using the basic ROAS calculation, 

ROAS = $50,000 / $10,000 = 5

This means that the business earns $5 in revenue for every dollar spent on advertising. A ROAS of 5 indicates a profitable campaign. Sometimes ROAS is written as "5X."

Example 2: Subscription Service 

Consider a subscription-based service that spends $8,000 on advertising, resulting in 200 new subscriptions. Each subscription is priced at $50 per month, and the average customer stays for 6 months. Taking into account the advanced ROAS calculation: 

ROAS = ($50 x 200 x 6 - Cost of Goods Sold - Overhead Costs) / $8,000

Now include a 6-month Cost of Goods at $70 per subscription and a per-subscription overhead attribution of $50:

ROAS= ($50 x 200 x 6 - $14,000 - $10,000) / $8,000 = 4.5

The lifetime value of the customer (LTV) becomes a big factor in determining the profitability of the campaign. Calculating the ROAS in this example using only the first one-month purchase would lead to a negative ROAS: -1.75.

Learn more about setting a ROAS target for your business here.

Interpreting ROAS Results:

The interpretation of ROAS results depends on the specific industry, business model, and campaign objectives. Here are a few scenarios:

ROAS > 1-- A ROAS greater than 1 indicates that the campaign is generating more revenue than the cost of advertising. This signifies a profitable campaign. 

ROAS = 1-- A ROAS equal to 1 means that the revenue generated is exactly equal to the cost of advertising. While the business breaks even, it may need to evaluate strategies for increasing profitability. If the goal is to grow market share, a ROAS equal to 1, may be acceptable.

ROAS < 1-- A ROAS less than 1 suggests that the campaign is not generating enough revenue to cover the advertising costs. In such cases, adjustments and optimizations are necessary to improve the campaign's performance.

Target ROAS:

Target ROAS (Return on Ad Spend) is a bidding strategy used in online advertising campaigns, particularly in platforms like Google Ads. It allows advertisers to set a specific ROAS goal or target they want to achieve for their campaigns. The target ROAS is the desired return on the amount invested in advertising.

By implementing target ROAS, advertisers can optimize their bidding strategies to maximize their return on ad spend and achieve their specific business goals. 

Here's how target ROAS works:

1. Set the Target ROAS: Advertisers define their desired ROAS as a percentage or ratio. For example, if a business aims for a target ROAS of 400%, it means they want to generate $4 in revenue for every $1 spent on advertising.
2. Algorithmic Bidding: Platforms like Google Ads running Smart Shopping, especially Performance Max campaigns utilize machine learning algorithms to adjust bids in real-time based on the likelihood of achieving the target ROAS. The platform's algorithm takes into account thousands of signals such as historical performance data, conversion rates, and the value of different clicks or conversions.
3. Bid Adjustments: The algorithm adjusts bids for individual keywords, ad groups, or campaigns to increase or decrease the likelihood of achieving the target ROAS. Bids may be increased for keywords or placements that have historically shown a higher likelihood of generating conversions with the desired ROAS. Conversely, bids may be decreased for keywords or placements that have not performed well in terms of meeting the target ROAS.
4. Dynamic Bidding: Target ROAS bidding strategies allow for dynamic bidding, which means bids can be adjusted in real-time based on various signals such as device type, location, time of day, and audience demographics. This helps optimize bids for different segments to maximize the chances of reaching the target ROAS.

Target ROAS provides advertisers with a way to align their advertising goals with their desired return on investment. By providing your goals to the platform, you allow the proper utilization and customization of machine learning algorithms and real-time bidding adjustments. Businesses can optimize their advertising spend by letting the platforms focus efforts on campaigns that have a higher likelihood of achieving the desired ROAS.

Return on Ad Spend (ROAS) is a vital metric input for preparing advertising campaigns. By understanding and leveraging ROAS, businesses can communicate to ad platforms their typical marketing funnel conversion metrics so that the platform can in turn make informed decisions, optimize campaigns, and maximize revenue. Remember, ROAS is not a one-time measurement but a continuous process of evaluation and refinement. Stay vigilant, analyze results, and unlock the power of ROAS to propel your advertising efforts to new heights of success.