If you are running a business or are an advertiser, you probably hear the term ROI quite often. In online marketing, the terms CPC, CTR, and CPA have been pushed aside and ROI is almost the only thing that advertisers talk about. Optimization methods have evolved to center the focus on ROI. ROI optimization methods have been created and ROI quickly became the most significant metric to measure in ads reporting.
But the real question is, do we know how to measure our true return on investment?
Should we rely only on the metrics that advertising platforms provide us with our return on advertising investment as a performance indicator? Isn’t it a little dangerous or unwise to make decisions based on this metric only?
Ad platforms track your return on investment simply based on pixel tracking where they dynamically track your sales. Then they segment the sales that are associated with the ads and deduct the ad cost. The result is what they consider your return on investment.
Ad platforms have the interest to show you as high of a return on investment as possible as it will make you want to spend more on their platform. That makes complete sense, but there are other factors you need to consider. Here are some examples.
If you are selling a physical product, your return on investment would be the following:
Based on the number provided by ad platforms, with an ROI of 2X ($2 return for every $1 investment in ad spend), you would think that your profit is $1. If you calculate the product cost, your actual ROI would look something like this. For the sake of the example, let’s say your product cost is $5, your ad spend is $10 and your revenue is $20 (2X).
You might be thinking that your real ROI is 2X, but if you factor in your product cost, you will notice that you’re getting a 0.5X profit. You spent $10 in ads to generate a $5 profit.
Platforms like to exclude advertising spend from your ROI calculations to make the stats look better. So if you spend $10 on ads and get $10 in sales, they will consider it a 1X ROI. Other experts argue that that ROI is zero. If you didn’t make profits from it and only made sales to cover your ad spend (without including product cost), why should it be considered more than zero ROI?
Refunds and chargebacks
Like product cost, future refunds, and chargebacks that will be associated with the orders should also account for your true ROI. If your average refund per month is 15%, you would need to deduct it from your ROI calculation to get your true ROI.
Processing costs, customer service costs, merchant fees, fixed costs, and hidden costs are important numbers to factor into your ROI calculation. Most companies have average fixed costs which include their facilities, employees, and their base operating costs.
When you spend money on advertising to generate more profits, you should try to calculate a basic figure of approximately how much it will cost you to handle the extra sales. For example, if for every $1000 in sales it costs you roughly in $50 in associated fees, your actual ROI will be $50 less, as you generated an extra $1000 which requires an extra $50 in associated fees.
This is not an exact figure. Other dynamic metrics are involved depending on your business model. The example above is to show you that an increase in ROI reported off the advertising platforms doesn’t necessarily mean you will make more profits and you should consider all associated fees and expenses to evaluate your true ROI that results from the ad.
It’s not all bad news. I started with the factors that lower your ROI, but there is one thing that can dramatically increase your actual ROI, and that’s the lifetime value of your customers.
When we normally evaluate our ROI directly on ad platforms, they only provide us the ROI based on our selected dates. Meaning, if someone comes back two weeks or two months later to make another purchase, that data won’t show.
Say, for example, your average repeat customer rate is 25%. It means that for every four customers, one customer will come back to make another order.
Let’s take this scenario: You spent $100 on ads to generate $200 for purchases. For the sake of the matter, let’s exclude product costs and associated fees and go based on the calculation that ad platforms provide. For a $200 revenue and $100 ad spend, we get a 2X ROI. Let’s assume that our average order value is $50. Considering we will have a 25% repeat rate means that from four customers we will get five orders and our actual revenue from the $100 ad spend was $250 instead of just $200. This means that our new ROI will be 2.5X.
Also, what about if the same customer comes back and purchases a third time? Now we will get six orders instead of four and our actual revenue will be $300 for $100 ad spend, which is 3X.
This is just an example and there are more variables to factor in such as what if we invest ad spend in repeat customers as well, or what about other ad platforms that might also drive the user to purchase, etc. Imagine having a 30% repeat customer rate and how much online advertising can help you expand your customer base while driving in more purchases along the way.
The example above is only to demonstrate the importance of evaluating the entire lifespan of your users to help you make a more educated analysis of the performance of your ads.
Top-performing online businesses understand the importance of these metrics and as a result, they create sophisticated strategies to pretty much break even on the first order knowing that their lifetime value is high and that they will make profits along the user’s journey.
Creating a profitable marketing strategy to generate daily profits is amazing, but incorporating lifetime value into your model to achieve massive growth while expanding your customer base is beyond spectacular in my opinion.
If you are an advertiser or a business owner that advertises online, ROI is one of the most common terms you hear. While advertising platforms calculate your ROI based on your total sales divided by your total ad spend, to stay profitable, it’s important to know what your true ROI is.
Expenses like product costs, refunds and chargebacks, operational costs, and merchant costs should be formulated into your ROI to understand your true ROI, which is sales minus all global expenses divided by ad spend.
Lifetime user value is critical to understand your real ROI. If you have a strong repeat customer base, your ROI is greater than what you initially thought. Big companies create their marketing strategy using the customer lifetime value as one of the main fundamentals.