What is ROAS?
ROAS stands for “Return on Ad Spend,” a very popular financial metric in the world of digital marketing in particular, and a similar alternative metric to ROI, or “Return on Investment.” ROAS is commonly used in eCommerce businesses to evaluate the effectiveness of a marketing campaign.
It should be noted that having a high return on ad spend does not necessarily mean a company is profitable, as there are many other expenses that have to be deducted before determining a company’s net profit margin. This metric does, however, show the existing correlation between advertising efforts and revenues.
In addition to gauging how generally effective a company’s advertising is in terms of generating sales, ROAS can also be used to compare the cost-effectiveness of one marketing campaign against another. For example, advertising campaign “A” may generate twice as large an increase in sales volume as advertising campaign “B” does, but if campaign “B” costs only one-fifth the price of campaign “A”, then “B” is a more cost-efficient advertising expenditure.
Some advertising efforts can boost total sales without measurably improving profitability, while other efforts may show a significant rise in net profit margin even though sales only rise slightly. This might be due to the fact that campaign “B” primarily helped to increase sales of products with very high profit margins.
What is the ROAS Formula?
Below is the Return on Advertising Spend formula:
Return on Advertising Spend = Revenue Dollars / Advertising Spend Dollars
See an example in Excel here.
An eCommerce company spends $100,000 on a Google AdWords campaign and generates $250,000 of product sales on its website, directly from those ads.
Revenue = $250,000
Advertising = $100,000
= $250,000 / $100,000
ROAS = 2.5
If ROAS > 1, then you are at least covering your marketing expenses with revenue, but are likely losing money after deducting expenses. In broad, general terms, a ROAS of 3 or more – which means every one dollar spent on advertising generates three dollars in revenue – is considered “good.” What constitutes a desirable ROAS varies significantly according to industry, type of business, size of the business, etc.
As with most financial metrics, examining a company’s ROAS is most meaningful when compared with other very similar companies, and with the company’s own financial history. A company that gradually raises its number from 4 to 7 during its first five years in business is apparently getting better and better at producing cost-effective marketing campaigns.
Challenges with ROAS
Revenue from ads is not necessarily a good indication of economic benefit because Return on Ad Spend may be considered a vanity metric. A vanity metric is a figure that managers/owners favor mostly due to ego, and that doesn’t necessarily contribute to long-term business viability.
A better metric to use may be something such as Contribution Margin, which is equal to revenue minus variable costs, e.g., cost of goods sold (COGS) and shipping. For many eCommerce businesses, cost of goods sold and shipping are major expenses, and may not leave much of a net return.
To learn more about ROAS and contribution margin, check out our online course on eCommerce Financial Modeling. This course will show you, step by step, how to model the economics of a marketing campaign for an eCommerce business.
Thank you for reading this guide to Return on Ad Spend. To learn more about other ways of measuring return on investment for corporations, check out the following CFI resources:
- LTV/CAC ratio
- Hurdle Rates
- Return on Assets
- Return on Equity
- What is Financial Modeling
- Financial Modeling for Dummies
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