Jan 09 Why High Return on Ad Spend (ROAS) Isn’t Always a Good Sign
When evaluating the success of ad campaigns, ROAS, or Return on Ad Spend, is a metric that commonly steals the spotlight. Most marketers and brands are under the impression that a higher ROAS is synonymous with a successful campaign. However, contrary to popular belief, a high ROAS might not always be a positive sign. Let’s explore the reasons why and explains how maintaining a balanced approach towards ROAS can lead to more profitable outcomes for your ecommerce business.
Understanding ROAS
ROAS is a performance measure used to evaluate the efficacy of digital advertising campaigns. It’s calculated by simply dividing the revenue generated from an ad by its cost. This ratio signifies the return on every dollar spent on an ad campaign. While a high ROAS might suggest that you’re getting a good bang for your buck, it’s crucial to understand that not all high ROAS are created equal.
The Implications of a High ROAS
There are two key reasons why a high ROAS might not be as beneficial as it appears:
- Unexploited Opportunities: An exceptionally high ROAS might indicate under-investment in ad spend, thus leaving potential revenue untouched. For instance, a ROAS of 10:1 might suggest that you’re not capitalizing on the high demand and are missing out on potential profits. Similarly, if your ROAS is low, it could be a sign that you need to pull back on your budget. Essentially, ROAS serves as a guide, indicating where you should be adjusting your ad spend.
- Misleading Traffic Sources: A high ROAS could also be a result of not excluding existing traffic from your prospecting campaigns. This can lead to a situation where most of your ads are shown to existing customers, artificially leading to a high Facebook revenue but limiting the influx of new customers and subsequently, the growth of overall website revenue.
ROAS is Not the Only Metric That Matters
While ROAS is a valuable metric, it doesn’t provide a comprehensive view of your ad campaign’s success. For instance, it doesn’t account for the volume of customers acquired or the market segment targeted. A high ROAS when targeting cold traffic might sound impressive, but it could imply that the campaign isn’t scaling enough. A successful cold traffic campaign should be spending a substantial amount daily, and when you’re aggressively seeking new customers, you’re unlikely to see high ROAS figures.
Prioritizing Scale Over Profit Maximization
The ultimate goal of any ad campaign should be to convert as many customers as possible, even if it comes at a lower ROAS. Most businesses make the bulk of their profit on the backend (post the first purchase point), and by acquiring more customers, you expand your community, which you can monetize and profit from over time. Therefore, it becomes critical to consider the long game and focus on acquiring customers, rather than fixating solely on the profits made from initial sales. Your target ROAS is determined by factors such as your repeat purchase rate and customer lifetime value. Once you understand these numbers, you can set a realistic and profitable ROAS target.
Understanding the Limitations of High ROAS
If you’re aiming for a high ROAS, you might be limiting your company’s profit and growth potential. For instance, if you spend less on advertising to achieve a high ROAS, you’re likely not reaching the profit-maximizing amount of ad spend. This means that although your ROAS might look good on paper, you could be missing out on potential profit.
It’s essential to strike a balance between maintaining a decent ROAS and investing enough in your ad campaigns to maximize profit.
The Trade-Off Between ROAS and Profit
Consider a scenario where two businesses manufacture and sell women’s clothing. Both have the same costs, but one focuses solely on achieving a high ROAS, while the other prioritizes maximizing growth.
In this case, the company focusing on ROAS might sell fewer pieces but achieve a higher ROAS. For example, generating $100K in ad sales from a $10K in ad spend (ROAS of 10x). In contrast, the company prioritizing growth might spend more on advertising, achieve a lower ROAS, but sell more products and generate more revenue overall. For example, generating $5M in ad sales from a $1M in ad spend (ROAS of 5x).
While ROAS is a valuable metric for assessing the efficiency of your ad campaigns, it’s not the only factor you should consider. A high ROAS might look good on paper, but it could be hiding underlying issues such as under-investment in ad spend or a lack of new customer acquisition.
To maximize your profits and grow your business effectively, it’s crucial to strike a balance between maintaining a good ROAS and investing enough in your ad campaigns to reach as many potential customers as possible.
Agencies that promise high ROAS should be scrutinized, as they might be focusing too narrowly on ROAS and neglecting other important aspects of your business.
By understanding the full picture and not just fixating on a single metric, you can make more informed decisions about your ad spend and drive better results for your business.