If you advertise online to gain leads and increase sales, you definitely want to measure your revenue versus the dollars you spend to run ads.
The most important metric you should use to assess your advertising performance is called return on ad spend or in its short form - ROAS.
Read on to understand how ROAS works, how you can calculate and interpret the results. You will also learn how to distinguish it from the commonly confused ROI and how you can use ROAS to improve business performance.
What is ROAS?
ROAS, return on ad spend if you like the long-form version, is a popular and worthwhile marketing metric digital advertisers use to calculate business revenue generated from every cent you spend on promoting your products and services.
This metric weighs the revenue your ads generate for you against the amount you spent on them and basically tells you whether your advertising is efficient or not.
ROAS is one of the most important metrics for growth marketers, who are performance-oriented and make data-driven decisions to achieve their objectives.
Why and for who is ROAS calculation important?
As you can already guess, ROAS is an essential metric everyone who advertises online should monitor. It is not the only metric you should be monitoring, but it gives you a very good idea regarding your ad performance.
Measuring your ROAS has 3 main benefits:
1. Identifying scaling opportunities
ROAS allows businesses to evaluate the effectiveness of individual campaigns based on their performance.
Examining each campaign individually helps a business to find out the type of ads that are performing well so they can scale them to maximize results.
You can run multiple campaigns and as you assess each of them, you can capitalize on the campaigns with the highest ROAS to increase your revenues.
Campaigns and ad sets that drive high ROAS for you can be scaled in order to drive more profits.
Pro Tip: Know that your ROAS might decrease when you scale your ad budget. It’s completely normal and this is why you want to keep monitoring your ROAS and make sure you stay profitable (or don’t lose too much) while scaling.
2. “Trimming off the fat”
Once you measure the performance of each of your active ads, you can optimize your campaign budgets.
Spending much on ads does not always translate into higher revenues. However, spending wisely on your best-performing ads can drive more sales and grow your revenues significantly.
ROAS calculation results are valuable in assisting you to identify the ad sets and campaigns on which you are overspending. In these cases, you need to reduce your budget to protect your business from losses.
If you advertise on Facebook, for example, it is recommended that you set up Automated Rules on the Facebook Ads Manager or use Madgicx's Automation Tactics to reduce budgets or turn off ads and ad sets which drive low ROAS.
You can then allocate these budgets to the campaigns and ad sets that drive good ROAS and are ready for scaling.
3. Refining your marketing strategy
Successful marketing strategies are based on facts. That is a fact.
ROAS is your right hand in digital advertising. It will allow you to assess the effect of an individual campaign on your business.
This metric provides you with reliable information to make important decisions regarding your next marketing actions.
You can easily find out which campaigns outperform the others and you can align your marketing strategies along these lines to maximize your future profits.
How to calculate ROAS?
A novice would expect some level of complexity in the formulae for such an important business metric.
However, calculating ROAS is very simple. You only need the amount of money you are spending and the corresponding earnings at that moment to calculate it.
Return on ad spend formula
The formula for calculating ROAS is very simple, and can be described as follows:
All you need to do is to calculate the total revenue from customers who converted on your ads and divide it by the total amount you spent on ads.
An example of ROAS Calculation
Let’s say you have a whiteboard animation software company.
You spent $5,000 on Facebook ads to promote a new software release. Your company generated $50,000 from the conversions achieved by this ad campaign.
In this case, the calculation would be as follows:
Advertising cost: $5,000
Conversion revenue: $50,000
ROAS = $50,000/$5,000 = 10
What's your breakeven ROAS?
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ROAS vs. ROI
When you think of running campaigns to boost your business, you will definitely come across both terms - ROAS and ROI.
These terms can be confusing if you don’t have a glimpse of what they stand for and when to use each of them. You may already be familiar with ROI, but ROAS is less common unless you already have experience with paid advertising.
ROI (Return On Investment) and ROAS (Return On Ad Spend) are both useful metrics in marketing.
ROI is calculated by dividing your net profits by the overall capital investment you put into your business. It measures the profitability of each investment you make and can be calculated for each unique investment separately.
Top-level executives are usually interested in the return on investment so they can make quick decisions based on the profitability of different ventures.
ROI requires that you work with numbers before you give any constructive feedback to your employees or put more money into your venture.
The formula for calculating ROI
The formula for ROI calculation can be described as follows:
Pro Tip: Some marketers multiply the result by 100 to get their ROI in percentage from their investment.
Your net profit is calculated by gathering your total revenue gained from your investment and reducing the investment itself and the taxes from this amount.
ROI takes into account both online and offline costs and all operating costs as well.
ROAS, on the other hand, helps you calculate the revenue your business generates for each dollar you spend on online advertising.
It is all about “buying” purchases. Meaning, you’re getting buyers to spend on your products and services by paying for leads and clicks to drive online sales.
ROAS calculation covers only your ad spending cost. You will have to do extra calculations to get the net profit from your total investment, as this calculation does not cover operating costs that keep your business running behind the scenes.
ROI vs. ROAS calculation
Since ROI and ROAS are both about numbers, consider the following example: Imagine you’re running a business with digital campaigns and would like to find the difference between your ROI and ROAS.
Let's calculate your ROI vs. ROAS in two different examples.
Assume your business generated $20,000 in revenue in the first quarter of 2020. From this revenue, you spent $10,000 on digital advertising and $5,000 on operational costs.
Using the formulae for ROAS and for ROI calculation will give you:
ROAS = $20,000 / $10,000 = 2
This ROAS indicates that your advertising efforts are driving revenue for your company.
ROI = ($20,000 - $15,000) / $20,000) = 0.25
Or in percentage from the investment: 25%.
Such an ROI can be an indicator of successful business activity.
Assume your business generated the same amount of $20,000 in revenue in the second quarter of 2020.
From this amount, you spent $10,000 on digital advertising again, but in this quarter, your operational costs rose to $12,000.
Using the same formulae ROAS and for ROI:
ROAS = $20,000 / $10,000 = 2
Your advertising remained as effective as in the first example.
ROI = ($20,000 - $22,000) / $20,000) = - 0.1
Or in percentage from the investment: -10%.
This ROI can be an indicator of an unsuccessful business venture. This time, your ROAS isn’t high enough to cover your business expenses.
The conclusion from the above examples
In the first example above, the ROI was positive, which means the ROAS was high enough to make your business profitable.
However, in the second example, your ROAS had the same value, which means your advertising was just as efficient, but the ROI was negative. This means that your ROAS was not high enough to make your business profitable.
ROAS will help you measure the effectiveness of your ads in generating revenue. Nonetheless, this metric will not suffice to determine the overall profitability of your business activity because there are other factors involved.
This leads us to the following question.
What is a good ROAS?
Well, you might be surprised, but there’s no definite answer to this question.The answer would depend on your business objective. Let’s look at 2 different objectives:
1. Driving profits
If your main business objective is driving profits, a good ROAS will be such that keeps your business profitable.
Your breakeven ROAS will be the value that covers all your expenses. This means that your ROI is 0.
If your objective is driving profits, a good ROAS will be every value above your breakeven ROAS.
In the first example above, your total business expenses were $15,000. This means that in order to break even, you need equal advertising revenue.
Let’s calculate your breakeven ROAS in this case:
Breakeven ROAS = $15,000 / $10,000 = 1.5
This means that a good ROAS for you would be anything above 1.5.
In the second example, your breakeven ROAS would be 2.2, and anything more than that will be positive for your business.
2. Increasing market share
If you have enough reserves and you decided that your objective is gaining more market share, you can sacrifice your profitability to a certain extent.
This means that you can decide, for example, that you want to advertise as long as you don’t suffer greater losses than 10% each month.
Let’s test the above examples based on this business objective.
In the first example, a 10% loss for an investment of $15,000 will be $1,500. This means that the ROAS that gives you this result is:
10% loss ROAS = $13,500 / $10,000 = 1.35
Any ROAS above this value would be good for achieving your objective in this case.
In the second example, any ROAS above 2 would do the work.
ROAS across different stages of the funnel
A full-funnel marketing strategy is crucial for your success in digital advertising.
You have to understand the structure of your marketing funnel in order to plan an effective strategy according to the journey your potential customers go through.
The ROAS in each stage of the funnel may and should be different. Ideally, you’d want to set up different ROAS targets for different funnel stages. In the Acquisition stage, your ROAS will usually be the lowest, especially when it comes to Prospecting. That is because it’s always harder to acquire new customers.
In the Retargeting stage, your ROAS may be higher, and in the Retention stage, they’ll probably be the highest, as it’s usually easier to convince existing customers to buy more.
Based on your business model, you’ll have different definitions for a “good” ROAS in each stage.
For example, if you know that your conversion rate is much higher in the Retargeting stage than in Acquisition and the value of each conversion is relatively high, you can allow a lower ROAS in Acquisition.
In this case, you would probably test other metrics such as Add to Cart and View Content in order to make sure your Acquisition campaigns provide you with an audience that is prone to convert in Retargeting, though.
How to increase your ROAS?
Now that you understand how important ROAS is and how crucial it is to improve this metric, you probably want to know how to increase it.
Here are 3 tips that can help you:
1. Target high-intent audiences
It’s okay to start with broad and interest targeting, but as you gather more data on your Meta Pixel, you can improve your Retargeting campaigns.
If you target high-intent website visitors, there’s a much higher chance these people will convert, as they have already shown interest in your brand.
Gathering more data in your ad account will also allow you to deploy Acquisition Re-Engagement ad campaigns.
These campaigns target people who showed interest in your product but didn’t visit your website yet. People who watched 75% or 95% of your video ad are a good example of such an audience.
In addition, in your Acquisition Prospecting campaigns, you can target people who showed interest in your competitors, instead of targeting general interests in your field.
These are people who don’t only need your product, but they have also shown interest in buying such a product before.
2. Test various lookalike audiences
Lookalike audiences are no doubt one of the strongest weapons for Acquisition Prospecting campaigns.
These are audiences Facebook creates for you based on the source audience, target location, and desired audience size you define.
When creating a lookalike audience, Facebook locates people who share the same characteristics as those in your source audience.
This means that you can target people who share the same characteristics with your customers or people who showed interest in your brand. Consequently, these people have a good chance to convert.
You should test different lookalike audiences and monitor the ROAS they drive until you find the best ones, which you can then upscale.
3. Freshen up your creatives
Even experienced marketers and creative producers can’t tell for sure which creative will work best. This is why you have to keep testing creatives until you find something that works well.
You can also try different kinds of ads. It is highly recommended to include video and poll ads in your campaigns to drive more engagement. It’s very important not to “fall in love” with your own creatives. Not everything that you like will be popular among your target audience.
Moreover, the hard work you put into a certain creative does not mean you should insist on using it even if it doesn’t drive good ROAS for you.
Once you find a creative that drives a high ROAS, you can scale it up and push it to a broader audience.
However, that being said, even great creatives suffer ad fatigue at some point. That’s why you need to keep freshening up your ads regularly.
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You can improve your digital advertising performance a lot by monitoring your ROAS.
This essential metric is easy to calculate and can give you a very good idea of your success with digital advertising.
Monitoring it will allow you to increase your profits by upscaling profitable campaigns and avoid overspending on non-profitable ones. It will also help you refine your marketing strategy.
You need to know what is a good ROAS for your business based on your business model and analyze it according to the different funnel stages.
Increasing your ROAS can be achieved by optimizing your targeting strategy using high-intent audiences and testing various lookalikes. You should also freshen up your creatives regularly to avoid ad fatigue.
In conclusion, if you’re running online ads, check your ROAS, do your best to improve it, and learn from your results.
*Contributed to this article: Caleb M.
You can spend months running ads and still get subpar results. Or you can use Madgicx to keep your Facebook ad accounts optimized 24/7 and reach your target ROAS (and beyond) infinitely faster.
Yuval is the head of Content Marketing at Madgicx. He is in charge of the Madgicx blog, the company's SEO strategy, and all its written marketing materials.