The vicious cycle of ROAS targets is killing your business
While many companies focus on return on ad spend (ROAS) as their primary KPI for search, columnist Andreas Reiffen believes that ROAS targets can often inhibit growth and new customer acquisition.
Your marketing team is hard at work tweaking ads and landing pages to drive efficiency and hit the targets set for them by the C-suite. And those targets are more than likely ROAS-related.
But, for two reasons, these ROAS targets are actually causing a lot of damage:
- ROAS usually doesn’t take incrementality into account, which incentivizes marketers to turn on retargeting or brand campaigns to meet their targets while hardly generating any tangible results.
- It sets incentives to sell more low-margin products to mainly existing customers because this type of second-class revenue is cheaper to get.
If, like most companies, you’re focused on growth and new customer acquisition, you need to ditch ROAS-based KPIs, come up with a new metric and include incrementality before it’s too late.
This is what you get if you ignore incrementality
When we talk about “incremental sales” as a digital marketing KPI, we’re talking about how much a specific marketing campaign or channel contributed to increasing sales revenue. So, if a search or shopping ad led to a sale that wouldn’t have happened otherwise, that’s an incremental sale.
Return on ad spend (ROAS) takes into account purchases from users after clicking on an ad. At first glance, that sounds reasonable. It seems like that measure would tell you how good an ad is at driving revenue.
But what ROAS usually doesn’t tell you is whether or to what extent those sales would have happened anyway (without showing ads). In other words, ROAS doesn’t account for incrementality.
Imagine you’re shopping for high-priced luxury products; you put them in the shopping basket, but then decide to wait another few days to think about whether it’s worth spending the money. Then you see your favorite products following you all over the web, and at some point, you’re intrigued to click through. Finally, the day after, you buy. This happens hundreds of thousands of times every day.
Our industry now understands — much better than a couple of years ago, at least — that a significant number of these people would have bought the items anyway, even if they hadn’t seen the ad.
You’re probably thinking, “OK, sure, but how big a deal is incrementality, really?” It turns out it’s quite a big deal. Based on our internal client testing here at crealytics, we’ve found the following:
- If you’re a multibrand retailer (e.g., Kohl’s or Staples), brand searches will usually drive no more than 1 percent incremental sales.
- Display retargeting often hovers around 5 percent incremental sales when tested properly.
- Search retargeting rarely gets higher than 20 percent incremental sales.
Channels that drive the highest number of incremental sales are also generally more expensive. So, if you set ROAS targets without taking incrementality into account, marketers will have to look for cheaper sources of revenue. Usually, they will see themselves in a situation where “Search Brand” is already split out and treated separately because of the obvious lack of incrementality. So, where do marketers find the revenues they need?
The revenues which are least incremental are usually the cheapest, and therefore, marketers often try to increase the volume of display or Facebook retargeting first. Search retargeting is also a great way to hit targets without really having a substantial impact on the business. And the best part about search retargeting is that it’s hidden in the overall search numbers — you have to really zoom into AdWords to see what percentage of the revenue is coming from people who might have bought without spending ad money.
The vicious circle of ROAS targets
Let’s assume you’ve tested the incrementality of your most important marketing channels, and you’re factoring in the findings when measuring the success of your campaigns. Instead of setting traditional ROAS targets, you now refer to incremental ROAS.
In this case, ROAS should no longer be an issue, right?
Sadly, no. In reality, it’s still a big issue which silently destroys performance even at some of the savviest retailers.
How performance marketing targets are set
In most retail companies, marketing budgets are set by finance looking at the historical performance of past advertising campaigns. They know ROAS is a bad indicator for bottom-line profitability, so they go ultra-granular, take the numbers from some internal tracking system — usually based on last-click attribution — and analyze the profitability of every single order, taking into account contribution margins after COGS, shipping, packaging, payment costs and so on.
If bottom-line profitability differs from the internal financial planning, ROAS targets and budgets are adjusted accordingly. Marketing is then incentivized to hit the new targets while not exceeding the budget constraints.
What marketers will do to hit their targets
In order to hit these ROAS targets (including incremental ones), performance marketers will tend to sell more low-margin products to mainly existing customers because these sales deliver the best ROAS.
One simple way to sell to existing customers is by using Customer Match to target known customers. If revenue is the criterion and not margin, bidding systems will automatically allocate the budget where revenue can be found at the cheapest price. Areas of the assortment which have low margins will look better because there is usually less competition.
So, what happens in the next budgeting cycle? Finance will again zoom down to the most granular level, take all the orders and analyze profitability. They will notice that for some strange reason, profitability and new customer rate are down again. As a result, they will tighten the ROAS target.
If you see ROAS targets in your company, it’s very likely that you could easily do much better. If, in addition, you hear that ROAS is not reflecting incrementality, you’re really missing out on a huge opportunity.
Setting better targets and testing incrementality
In order to set performance marketing targets that are beneficial to the bottom line, you first need to find the exact incrementality levels for each of your marketing channels.
Very quickly, incrementality tests are implemented by defining a test and a control group. The test group sees ads, the control group doesn’t. You then analyze the revenues generated by the two groups over time. Incrementality presumes that the test group that sees the ads will generate more revenue than the control group. How much more defines your incrementality.
Once incrementality levels have been established, marketing and finance can work together to align on which metrics they want to use to measure progress. I always recommend customer lifetime value (CLV) or margin.
By using a profit-driven metric, you remove the ability to hit targets by selling low-margin products; and by taking incrementality into account, you make sure that hitting those targets gets you incremental gains.
The only way to enable marketers to really drive what matters is to give them access to order profitability and margins in such a way that they can use them in their bidding tool. This will undoubtedly require some technical integration, but it will deliver an unparalleled return.
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