Back in the days when ad tracking was limited, most advertisers didn’t have the ability to evaluate their ads based on the return on ad spend (ROAS) metric. The lack of technology and late adaptation by different platforms made it hard to track direct return on investment from advertising, and advertisers had to rely on other metrics to evaluate their ad’s performance. Fast forward to a few years back: modern tracking evolved, pixels were placed on websites to track all activity, and many advertisers shifted their focus to understand their most important metric: return on investment. Return on investment in advertising is defined as the amount of revenue a company receives for every dollar spent on an advertising source.
Why is this so important? When you run a marketing campaign and you need to decide if the campaign is profitable or not, you need to first evaluate your return on investment. If your return on investment leaves you profitable, you can spend more on advertising. If it’s negative, you need to scale down or eventually stop advertising because you are losing money. Now that we’ve covered the fundamentals, we can talk about what really matters.
ROI IS NOT A UNIVERSAL METRIC.
Unless you are selling exactly the same products as your competitors, with the exact same product cost, the only metric that is relevant to your business is your own ROI. Other business’ return on ad spend is irrelevant to your business. I find it entertaining when businesses ask me what the average ROAS is for my other campaigns. Why do I find it funny? Return on investment is a metric created to allow advertisers to measure their ad cost vs. revenue for their business, not to make comparisons to anything else. It’s like asking who scored more points in today’s game, the basketball team or the soccer team.
Here is an example that shows how higher ROI doesn’t always mean higher profits:
In the example above, you can see that higher ROI might look good from an advertising standpoint, but doesn’t mean anything when you don’t factor in your product cost. ROI will always look better for products with a higher ticket price, but it doesn’t mean that they will be more profitable than lower ticket items. Ideally, items with the lowest product cost and highest ticket price ratio will have the most profits (as long as they are attractively priced compared to the market price). These products will have the most room for ad spend, and in some cases, even with low ROAS, can still be very profitable.
Advertisers Can Manipulate Their Own ROI
Most online business owners might not be aware of this factor, but sneaky advertisers love to use this trick. It’s important to understand that ROI is usually not measured on your website directly. It’s measured and shown mostly on the advertising platform under the results metrics, which can open up the door for questionable results. Let me explain.
The most common trick is reclaiming and taking credit for users who are already very likely to purchase from a different source, or retargeting to warm users who are coming from other traffic sources. For example, if you’re already receiving sales from a traffic source like Google, and you want to expedite the performance from a platform like Facebook, what’s the easiest way to do it? Simply target your returning visitors who are very likely to purchase, such as users who already added something to their cart or started checkout but didn’t complete it. In addition, If you have existing buyers or a large list of past buyers, the easiest way to get conversions fast is by targeting them when they are close to taking an action, and as long as they see or click on the ad, most platforms will take credit for that conversion.
So what’s the problem with this? It’s like preaching to the choir. If these users are already going to convert, you will just be paying an extra premium by showing them another ad before they purchase. Obviously this is not always the case – perhaps you targeted users who abandoned their carts and your ad is what made them come back and purchase, but understand that when you are running ads on two different platforms, conversions might be counted twice, and that can increase your overall ad spend without increasing actual profits.
Higher ROI Doesn’t Always Mean More Profits…
Most advertisers make the vital mistake of relying on sources other than their own reporting to evaluate how their marketing is performing. They see a positive return on investment reported on advertising platforms like Google Ads or Facebook Ads, and they don’t take the time to question if the results are accurate.
You see, every platform has a goal. Obviously, advertising platforms would like to show you that they are getting as many results as possible. Even if they didn’t technically drive that sell, they will do everything they can to take credit for it. That can lead to a decrease in your marketing performance and less profit.
Besides the points that I mentioned above about ROI manipulation, here’s another scenario to consider. When you are an established business with a brand that is widely known, and you have a strong repeat customer base, how can you measure the impact of running ads? How do you know the overlap size between pure prospecting traffic and existing customers or followers? What difference does it make if the advertising platform shows you it gets you double your ROI, four times your ROI or six times ROI if at the end of the day you have the same or less profit? The proper way to measure ROI if you are a known brand and have an existing large customer base is by measuring the uplift in overall sales that result from the specific advertising source.
If for example, without Facebook ads, you are averaging $100K in sales for the month of September, you will need to measure the actual uplift in sales when you add Facebook ads. Then, take the total sales you received from the uplift and divide by your advertising spend to get your true ROI. Compare those numbers to the previous year and factor out other external results to ensure the results are a direct effect of your ads. I know it sounds complex – I have other articles that go into much more detail, but it’s important that you are aware of this.
See an example below:
As you can see in the illustration above, the ROI is measured strictly by the uplift in sales that compares new sales to previous years’ sales. Of course this will only be the case, if no other factors are likely to cause this increase. Yes, there are tools that allow you to track different platforms at the same time, but it can be challenging to track effectively considering the attribution models that these platforms are using. So let’s assume for a second that theoretically, the example above would be for an online store that also has a product/inventory cost of 35% from total sales. This would mean that the actual profit for every dollar spent on ads based on the uplift will be 15%.
This means that by looking solely at the ad platform, we might think that we are getting four times every dollar spent. However, when we look at our data and measure only the ad spend in the uplift value and deduct our product cost, we can see that we are actually making 15 cents profit on every dollar spent on ads. Still very good, but different than what most advertisers anticipate when strictly analyzing ROI reported.
ROI, also known as ROAS in marketing, is widely known to be the MVP metric in advertising platforms. ROI is not a universal metric and should be used for evaluation of your marketing performance against the other costs associated with your business. ROAS can be manipulated by segmenting and targeting warm traffic or existing customers to get the ROAS reported by the advertising platform. Businesses with a strong customer base who use ROAS as a metric to evaluate their ad performance should only evaluate their ROAS based on the uplift of sales, which in most cases will always be a smaller number than what the advertising platform reports.