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What the ROAS? A practical guide to improving return on ad spend
Contributor Jacob Baadsgaard shows how ROAS, or return on advertising spend, can be used to show the effectiveness of advertising campaigns and whether they are worth the money spent on them.
Do you want to improve your paid search campaigns? There are a lot of paid search metrics, but one of the most useful and most underused is return on ad spend (ROAS).
One of the main points behind online advertising is to drive sales for your business. This is particularly true when it comes to paid search. Most paid search campaigns are targeting potential customers who are fairly low in the funnel. A paid search click usually costs more than a display or paid social click, but it’s worth having if that click turns into a paying customer.
However, just because you are targeting bottom-of-the-funnel traffic, that doesn’t mean that every element of your paid search campaigns is a good investment.
This is where ROAS comes into play. One of the best things about paid search advertising is the ability to connect what you spend on a campaign, ad or keyword to how much new revenue is generated. With a little extra effort, you can connect all the dots and use ROAS to identify which aspect of your paid search advertising deserves more of your budget and which needs work.
Figuring out your ROAS
The key to using ROAS to improve the performance of your paid search campaigns is great conversion and sales tracking. After all, if you don’t know which campaigns, ad groups, ads and keywords are producing which conversions and sales, you can’t exactly calculate and use your ROAS.
Fortunately, most paid search platforms make it pretty easy to track conversions and sales. For example, if you’re running an e-commerce company, you can easily assign a conversion value to transactions and directly view the value a particular campaign element produces in AdWords:
However, ROAS isn’t just a metric for e-commerce businesses. For example, most conversion types can be directly tracked in AdWords, and with the right tracking set up (UTM parameters work great for this), you can follow data in a CRM like Salesforce.
As those conversions turn into sales, you can use this AdWords-Salesforce integration to pass your sales and revenue data back into AdWords for easy tracking and analysis.
Using your ROAS data
Sadly, most marketing decisions are not made using ROAS data. At my company, we’ve audited thousands of paid search accounts and found that only 29 percent of advertisers are tracking conversions effectively — let alone ROAS!
Using metrics like click or conversion data to guide your marketing isn’t a bad thing, but without ROAS data, you can end up making decisions that improve your metrics and hurt profitability.
The problem with clicks
Here’s an example of not using ROAS data in decision-making.
Let’s imagine that you sell hot tubs. Your average hot tub sells for $3,500 and has a 50 percent profit margin. In an effort to boost sales, you’ve been running five paid search campaigns that have yielded the following results:
If you had to pick a campaign to keep investing in, which would it be? The obvious choice here is campaign #3: it has the highest click-through rate and the cheapest cost per click.
However, while campaign #3 drives the most clicks at the lowest cost, we really don’t know much about the quality of those clicks. For example, if campaign #3 is driving a lot of traffic because you are bidding on the broad match keyword “hot tub,” you could be getting all sorts of irrelevant clicks.
The problem with conversions
To address our traffic quality issue, let’s take a look at how those clicks are converting:
As you can see, campaign #3 has a relatively poor conversion rate (CR). However, campaign #3 also drives so many cheap clicks that it still has the lowest cost per lead (CPL) of the group by a considerable margin.
Using this data, it still looks like campaign #3 is worth the investment. Sure, it could probably use a little optimization, but it clearly outperforms the rest of your campaigns.
Or does it?
Leads are nice, but a lead is not a sale. Conversion data only tells us how good a campaign is at getting people into our funnel; it doesn’t tell us anything about how well a campaign produces new revenue.
A ROAS reality check
To really answer the “is this campaign profitable?” question, we need to take a look at ROAS:
Now which campaign would you invest in?
Although Campaign 3 had the best click and conversion stats, it has a terrible sales rate (SR) and cost per sale (CPS). In fact, with your 50 percent profit margin, every sale from Campaign 3 actually costs you money. In contrast, Campaign 4 is incredibly profitable. Sure, it had lousy click and conversion stats, but when it comes to profit, it’s the obvious choice.
Obviously, this is a bit of a manufactured scenario, but it makes an important point. Click and conversion data can help you identify problem areas in your marketing, ad or keyword campaigns. But if a campaign is not producing a good ROAS, something needs to change.
Using your ROAS
By now, I hope I’ve convinced you to use ROAS to evaluate and optimize your paid search campaigns. The question now is, how? To answer that, let’s work through another example.
In this scenario, let’s say you run a whale-watching business. It is a side business, and your boat is kind of small, so you can only take one person out at a time. But you charge $150 for each one-hour expedition and make around 20 trips a month at a 50 percent profit margin, so it’s not a bad gig.
However, after hearing countless passengers say you should do this full time, you decide to finally bite the bullet. You rent an office, hire a part-time assistant and discover your expenses are running $2,000 a month, which is more expensive than you initially thought.
All of sudden, you are losing $500 a month. You need to sell more tickets, fast!
To bring in more business, you start running paid search campaigns. But how do you know whether a campaign, ad group, ad or keyword is working? Let’s see how we can use ROAS to answer that question.
1x return on ad spend
Let’s say you charge $150 a ticket. If it costs $150 to bring in a new sale, you should at least be breaking even, right? Unfortunately, that’s not how it works. When every trip costs you $75 in gas plus wear and tear, a 1x ROAS leaves you deeper in the hole with every purchase.
Plus, you still have that $500 monthly expense hole to dig yourself out of, so any campaign element producing a 1x ROAS needs some work or to be eliminated entirely.
2x return on ad spend
If a 1x ROAS doesn’t cut it, what about a 2x ROAS? You make $75 on every sale, so if you spend $75 on marketing, you’ll be okay, right? Sadly, still not the case. If all you do is break even on every trip, you will never make any money. In fact, you’ll never even be able to pay off that $500 deficit.
Since the whole point of marketing your business is to overcome deficits and make money, any campaign element with a 2x ROAS could probably use some work. I’d put more of a priority on 1x elements, but once those are working better, your 2x elements could use some attention.
3x return on ad spend
At a 3x ROAS, things start to make a lot more sense. If you can drive over 20 extra sales with your marketing at a 3x ROAS, you’ll actually be making money!
You won’t be rolling in cash at a 3x ROAS, but at least you’re in the black. In general, I recommend that you shoot for a minimum of a 3x ROAS in your marketing campaigns.
4x return on ad spend
Once you hit a 4x ROAS, things usually start to add up. At this level of return, you only need 14 sales to cover all of your fixed and variable expenses and start making money.
Getting and keeping every element of your paid search marketing campaigns at this level is a worthy goal, although it’s probably a bit impractical. But if your campaign is on the whole at a 4x ROAS, you’re probably doing okay.
5x+ return on ad spend
At a 5x or higher ROAS, your paid search campaigns are running well enough that you can probably start growing your business.
After about 12 sales, you are turning a decent profit, which should enable you to get a bigger boat and book larger groups. Both of these things will increase your profitability.
If we lived in a perfect world, every element of your campaigns would perform at this level, but if your campaign as a whole is a 5x or better ROAS, you’re probably okay.
Obviously, this is another highly specific scenario, but it illustrates a fairly consistent rule of thumb: Shoot for a 4x ROAS with most paid search campaigns and campaign elements.
Any campaign element with a ROAS of less than 3x probably needs work. How important it is to work on any given element will depend on how much it’s costing you, but in most situations, you need at least a 3x ROAS to break even.
Of course, this rule doesn’t cleanly apply to “branding”-type campaigns, but most paid search campaigns don’t fall into this category. Paid search marketing is usually expensive, low-funnel marketing, so if your overall ROAS isn’t at least 4x, your marketing is probably on life support.
When it comes to specific elements of your campaigns, ROAS is also a handy triage tool. As you can probably imagine, you’ll want to look at a big enough data set to fairly evaluate a given campaign (at least 100 clicks, at a bare minimum), but with sufficient data, you can use this rule of thumb to quickly identify campaign elements that need to be improved, eliminated or grown.
ROAS is often seen as an e-commerce metric, but in reality, it’s one of the most valuable and yet least-used paid search metrics out there. Yes, it does take a little extra work to get tracking set up, but the information is worth it.
Once you have ROAS tracking set up, you actually have to use it to improve your campaigns. The trick here is knowing what ROAS data tells you about the end performance of your campaign elements and how to use that information to identify elements that need to be improved. Fortunately, after reading through this article, you should have a good sense of how to interpret and use your ROAS data.
Your specific goals may vary, but by using ROAS to guide your campaign decisions, you’ll be making decisions that affect what matters most — making money!
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