Math Behind Your ROAS (And How To Improve It)
Updated: Sep 8, 2023
The most common question I get when talking to businesses about their ads is “What ROAS (return on ad spend) can you get us?” And “What’s the best ROAS you have ever got?” I guess some businesses think that ROAS is a metric that can be magically predicted or changed. This article is not written to explain what ROAS is nor why it’s not a universal metric as I have written previously on these topics:
HOW TO CALCULATE AND INFLUENCE YOUR ROAS
The purpose of this post is to break down the math of what makes ROAS and what steps you can take to improve it. ROAS is a metric that measures the amount of revenue you make against the amount of ad spend you invest. Most advertising platforms measure and report ROAS in the following way:
If you invested $100 in advertising spend and generated $200 in revenue, your return on ad spend will be 2X since you generated $2 for every $1 invested in ads. You can argue that your true return on investment is $1 and not $2 since $1 goes directly to cover ad spend, which is why your return on investment should be 1X or 100%.
In this post, we are going to specifically focus on platforms that use the “pay for impression” model. If you are running conversion campaigns (campaigns with the objective of generating conversions such as purchases or sign-ups), you are being billed based on 1000 impressions of ad delivery regardless of the results you may get. This means that you are billed for every 1000 impressions of your ads being served.
Some platforms like Google or Facebook allow you to bid based on other pricing models like “cost per click” or “cost per page like”, however, the “cost per click” or “page like” cost will be determined based on the market price of 1000 impressions. Market price means how many other advertisers are competing for the same impressions.
Almost all advertising platforms have shifted to performance-based models which essentially means that, instead of telling them how much you want to pay for a specific action like a click or an impression, just tell them how much you want to pay for a result or a goal and they will optimize your ads to meet that target in the most effective way. Let’s look at how ROAS (return on investment) is broken down.
Your return on investment is made out of 4 different metrics.
Cost per 1000 impressions.
Click-through rate.
Website conversion rate (buy to detail rate).
Revenue generated
Have a look at this illustration:
What I find interesting about the illustration is how much impact click-through rate, conversion rate and revenue generated have on your actual ROAS. If you’ve been running ads online before, you know that ROI is a simple calculation of revenue generated divided by ad spend and you may feel like this is a beginner’s guide to advertising. However, I guarantee that after reading this post, you will give the above metrics more focus than you previously did.
In an effort to improve your ROAS, it’s important to differentiate controllable and uncontrollable factors.
UNCONTROLLABLE FACTORS: MANIPULATING THE COST PER IMPRESSION
The first thing that comes to mind when you look at the illustration above is that simply lowering the bid on the cost per impression will lower your cost per purchase and improve your return on investment. Of course, we all want to pay the lowest amount possible on the cost per impression but that’s the one factor that you can’t manipulate, and here is why.
Cost per 1000 impressions relates directly to the quality and relevancy of your audience. The more relevant your audience is, the more competitive it will be to reach them which means a higher cost per impression.
If, for example, you target a third world country, the cost per impression will be much lower than the US, but the value is also lower. The reason that the cost per impression is high for specific audiences and lower for others is directly related to competition. The more advertisers are willing to pay to target specific audiences, the higher the cost. Higher cost per impression is not always a bad thing because when your ads become more relevant to your target audience, your click-through usually improves at the same rate or higher.
Look at this:
There is a common misconception that the best way to lower impression costs is to use cost controls/bid caps, which is where you tell the advertising platform what your target cost per result is and, as a result of lowering that target, your ads will reach cheaper audiences with a lower cost per impression.
What will actually happen is the advertising platforms will only target the cheapest group within the audience you are wanting to reach in the effort of trying to meet your target result. This will lead to low delivery and you will eventually be forced to gradually increase your bids to get conversions.
Note that regardless of your bid caps, advertising platforms like Facebook first look for the cheapest conversion opportunities within your audience and work their way up to more higher-priced opportunities.
One last thing to consider when examining your cost per impression is that, unless you are using direct search when you bid on specific search terms or keywords, your bidding is based on an audience (people) rather than words. This means that you are not just competing with your direct competitors, but also with many different advertisers who want to reach the same users and want that advertising space as well.
For some advertisers who sell more expensive products or have a high conversion rate different audiences can be worth different amounts and that directly impacts the overall cost per impression on the platform. To summarize, if you are advertising to generate conversions, your cost per impression is automated based on the market and you can’t directly impact it.
CONTROLLABLE FACTORS: CTR, CVR AND ORDER VALUE
The good news is that you have way more control over your ROAS than you might think. It’s not just about running ads and hoping that your ROAS will magically skyrocket. If you’ve read my other posts, you know that my approach on targeting and structure is 100% algorithmic, which means that I highly recommend using completely broad targeting and the most simple structure to give the advertising platforms’ machine learning as much freedom as possible to fine-tune and automate targeting.
If you do some research online, you will notice that all the official recommendations from Facebook are to give 100% freedom to its algorithm and not restrict it with targeting or feature like lookalikes. Google works in a similar way. The modern approach of digital paid advertising is to use as much machine learning as possible and as little human interference as possible.
You can learn more about the benefits of using machine learning in these two posts:
IMPROVING CTR (CLICK-THROUGH RATE OF ADS)
Because I just advised against using targeting or complex setups, your click-through rate is the most important factor that you can directly impact. The key to improving your click-through is your creatives.
It’s not uncommon to see cases where a single video or image can dramatically improve the click-through rate and create a lift in performance anywhere from 20%-200% depending on how bad the original creative was or how great the new one is. There are no recipes for which creatives are more effective but there is a lot of common sense involved.
Consider the platform that you are advertising on, your ads need to look as native as possible so they fit the flow of the platform. If your ads look like ads then it means you should be improving them. If you are able to create an improvement of 50% on your click-through rate, that means that you will pay the same amount per impression, but you are going to get 50% more clicks which will result in many more conversions. The best recommendation for improving your click-through rate is testing your creatives and then testing them some more.
Use Facebook’s ads library to examine what your competitors are doing and set a goal of testing new creatives every week or month as an on-going process. Many advertisers think that once they find one creative that works, they consider the job done. Creatives do burn out and become less effective after a specific amount of reach and time. Remember that there should be a correlation between the amount you spend on ads and the number of new creatives you produce.
IMPROVING YOUR CVR (WEBSITE CONVERSION RATE/BUY TO DETAIL RATE).
CVR works in a similar way as CTR to improve your ROAS. If you are able to double your numbers and get a 2% conversion rate instead of 1%, you will get twice the amount of conversions for the same cost. Think of how you can compete with other websites that have a 3-4% conversion rate.
If you have a 1% conversion rate and get a conversion out of every 100 visitors and your competitor converts 4% of his visitors then he or she just needs 25 visitors to get their first sale while you need 100! That’s not fair. When you have a low conversion rate, think of how many people you lose from impression to conversion (i.e. purchase/sign up). From those 1000 impressions, you will have a 1-2% click-through rate, and from that small number, you will have a 1-2% conversion rate. Really low numbers that call for on-going improvements.
If you are selling a product, the biggest impact that you can make is your creative images/videos on the product page, and the price. Yes, the price is super important. You are putting your ad in front of people, not machines. If they don’t think the price is attractive they won’t purchase. If you are selling a service, then copy and offer also play a huge role.
Work on minimizing steps from a visit to purchase and utilize a/b tools that allow you to simultaneously test 2 versions to measure statistical significance in your experiment. Then, you can create small changes with the copy, the creative, the layout, the funnel, and, of course, the pricing to find a winning match and gradually improve your conversion rate which will directly improve your return on every dollar spent to drive traffic.
INCREASE THE REVENUE GENERATED.
Another way to increase ROAS is by getting more revenue for each order. If we are getting $20 revenue for every $10 invested in advertising, our ROAS is 2X. If we are able to increase the average order value to $30, we will get a 3X ROAS. To increase the return on investment we can optimize our campaigns with the objective of increasing ROAS which means that instead of just optimizing for regular conversions, we can set our target to reaching the users who are more likely to spend higher amounts thus increasing the average order value.
It works in a way where platforms like Facebook and Google optimize towards maximizing the return on investment even if it means that the cost per result will be higher. For example: When we just optimize for conversions, advertising platforms treat each conversion the same, regardless of the amount they cost to obtain. The platforms will look for the most cost-effective conversion opportunities and will try to get them for the lowest amount possible.
On the other hand, when we choose to optimize based on ROAS, they will look for the conversions that are most likely to deliver the highest ROAS. What’s the difference? With the first scenario of focusing on purchases, each conversion can cost $10 and generate on average $20 in sales, giving you a ROAS of 2X. In the second scenario of optimizing based on ROAS, each conversion can cost you $12 and can generate $30 in revenue which will be a ROAS of 2.5X.
Aside from setting your ROAS targets at a platform level, there are things that you can optimize on your website to increase the average order value such as:
Offer FREE shipping over a specific amount to encourage purchasers to spend a little more.
Better sorting of your products and have product recommendations.
Make sure that complementing products are appearing at the right place and at the right time so visitors notice them.
Bundle offers or have “buy one get one free” offers.
Showcase products at checkout or have post-purchase upsells.
There is no one method that works for all, however, if you continue to improve and test different ideas you will find ways to improve the average order value.
IN SUMMARY
When spending on advertising you want to get the best bang for your buck which means optimizing for the best conversions for each dollar spent. ROAS is simply a measure of how much revenue you get in return for each dollar you spend on ads.
There are several metrics that you can look at to see if you are getting the most effective return on your ad spend: cost per impression, click-through rate, cost per conversion, and revenue generated by visitors to your website. An increase in ROAS can be achieved by manipulating the latter three of these metrics via your creatives and having attractive offers that will draw visitors to your website and transform them into buyers. Also, changing out your creatives when they get tired will add a new lease of life to your campaigns. Do these and you will see an amazing turn around in your ROAS numbers.
