Are you ROI-Lingual?
Updated: Sep 8, 2023
What a way to start an article and get your attention. In this article, I want to focus on ROI, which is the most sacred metric in advertising. No matter what area of marketing you evaluate it always comes down to the bottom line which is: what’s your return on every dollar spent? Interestingly enough, when discussing and evaluating ROI many people confuse the term ROI for ROAS, which are two different metrics.
ROI vs ROAS
Let me explain to you what the difference is between these two.
ROI measures PROFITS. It’s defined as profit generated by ads after deducting the cost of the ads.
In a simple calculation, ROI = (net profit / net spend) x 100.
If for example, you generated $50 in profit for every $100 you spent on ads, your ROI will be $50 or 0.5X. This means that for every dollar that you invest in ads, you get 0.50 cents in profit.
To get your true ROI you would need to deduct all your expenses from revenue and then add the actual net profit to the calculation above.
ROAS measures revenue generated from ads, not PROFITS. It stands for “Return On Advertising Spend.”
In a simple calculation, ROAS = revenue made from ads / advertising spend x 100
If you made $200 in revenue after spending $100 on advertising, your ROAS will be 2X or 200%. In this example the equation is: (200/100) x 100.
Generally, when advertisers discuss ROI, they are referring to ROAS. To measure true ROI, you must have access to important data such as product cost, associated operational costs, software etc… Most advertisers don’t have access to all the information. Also, they rely heavily on what advertising platforms track and report. Advertising platforms like Facebook and Google track return on advertising spend.
Measuring ROAS is the preferred method for both marketing platforms and marketers because they get judged by the amount of revenue they generate, not by the number of profits. The difference between the revenue and profits generated can be extreme. In many cases, you can generate revenue and lose money if you’re not accurately measuring your cost of goods and other costs.
As a marketer, the question that I get asked the most is what is the average ROAS that I get for my campaigns or what is the ROAS that I think I can produce. I wrote a specific article called “What’s Your Real ROI” that explains that ROAS is not a universal metric.
Asking someone what is the average ROAS is like asking how many points someone scores in a single game in different sports. You can’t compare the number of points someone scores in football, soccer, or basketball, right? The same applies to ROAS.
Even if all sports used the same system for keeping score, would that be enough? No! The number of points you scored doesn’t mean that you won the game, does it? You could score fewer points than other teams in the season and still win the championship.
Using the sports analogy, revenue generated from ads would be the number of points you score in a game and net profit would be the number of wins you have in a season. It doesn’t matter if you make $100 per day in sales or $10,000 it matters how much profit you make.
SO WHAT FACTORS CAN IMPACT YOUR ROAS?
Now that we have defined ROI and ROAS and their differences, let’s look at what factors can impact your return on ad spend.
1. PRODUCT
Product price and the type of product can have a great impact on your return on ad spend.
Take, for example, a $1000 watch and a $200 pair of shoes. Branded watches tend to have lower markups which means that your product cost can be 50% or higher than the price you are selling it for. Let’s assume that you are buying it for $500 and selling it for $1000 and that the cost to advertise it to generate 1 purchase is $250.
The ROAS for this product would be ($250/$1000) x 100 = 4X or 400%.
Your actual profits will be $250.
Total price $1000
Cost of product $500
Cost of ads $250
Net profit: $250
This means that every dollar spent on ads generates one dollar in profits.
Now let’s look at the pair of shoes for $200.
Shoes tend to have higher markups, so let’s assume that the product cost is $40.
Products with a lower price tag tend to have a lower cost to advertise to generate a purchase so let’s assume the cost of ads to sell one pair is $50.
The ROAS for this product would be ($50/$200) x 100 = 4X or 400%.
Your actual profits for this product would be $100.
Total price $200
Cost of product $50
Cost of ads $50
Net profit: $100
This means that every dollar spent on ads generates two dollars in profits.
So, although both products have the same return on advertising spend, the shoes are more profitable to advertise. The fact that the watch is being sold for a higher price tag makes their performance look equally effective. Yes, when factoring the product price and the actual cost of the product, profitability can be very different.
2. AVERAGE ORDER VALUE
Similar to how product price impacts ROAS, average order value has a strong impact on your ROAS.
The explanation is simple: If two stores are selling the same apparel they both have a similar cost per acquisition (the cost to the advertiser to generate a single purchase) and they advertise on the same platforms.
Let’s assume that they both have a cost per acquisition of $10. Advertiser A is exceptionally good at offering attractive deals that encourage his customers to buy at least 2 items on average per order. Advertiser B puts little effort on increasing his average order value and he settles for an average of 1 item purchase per order. They both sell apparel with an average cost of $20.
By increasing your average order value, you decrease the cost to advertise to generate a purchase from the total revenue generated, thus getting a better Return On Advertising Spend.
3. CONVERSION RATE AND CLICK-THROUGH RATE
If you’re an active reader of my blog, you know how much I emphasize the importance of click-through rate and conversion rate. Click-through rate and conversion also impact your ROAS as they dictate your cost per acquisition (CPA) and your ad spend to revenue ratio.
The higher the click-through rate and the higher conversion rate, the fewer ad impressions and clicks you will need to generate a single purchase. If you’re able to create an efficient campaign that requires fewer ad impressions or clicks to generate a single purchase you can be more competitive both with your direct and indirect competitors.
You will be able to compete with your direct competitors on platforms like Google Ads, or other direct search platforms, as you will be able to pay more per impression or click since you will be able to convert more users with a high click-through rate and a high conversion rate.
If you can produce better results from the same traffic, you will be able to outbid your direct competition and spend more on ads. You will also be able to compete with indirect competitors on social platforms like Facebook, Instagram, or Tiktok as you are targeting users that might have an interest in your product who are in “discovery mode”.
To learn more about how the click-through rate and conversion rate impact your ads, read this post.
IN SUMMARY
When it comes to advertising, the two main metrics to consider are ROI and ROAS. However, unless you have access to all the costs involved in generating a conversion ROI is a difficult metric to accurately calculate. Therefore, marketers and advertising platforms use ROAS as the default metric to measure the success of a campaign.
ROAS can be influenced by many factors such as product, average order value, click-through rate and conversion rate. By focusing on streamlining these factors will allow you to tackle your competitors more effectively as well as running campaigns that provide higher returns on each ad dollar spent.
