What is ROAS?
From the PPC perspective, return on ad spend (ROAS) is how much you spend on advertising costs divided by how much revenue you see for each advertising conversion. It’s what we call an efficiency metric, a measure of how effectively your ad campaigns turn spend into sales dollars. Generally, efficiency metrics tend to work in opposition to conversion volume; the more you spend, the more conversion volume you’ll get, but the lower your efficiency metric will be. Think of a seesaw (or teeter totter, depending on where you live) with ROAS on one side and volume on the other. As one goes up, the other goes down.
Finding the Right ROAS
So, what is the right ROAS for you? Of course, it depends. ROAS is a PPC metric, but it goes back to your business data. ROAS, really, is a derivative of product costs and profit margin. (If you don’t have that data generated for your business, we strongly suggest you determine that information first).
To answer that question, we’ll have to go all the way back to quadratics. That’s right, you’ve been hoodwinked into a high school math class. My ninth-grade math teacher loved using widgets as his unit of sale. I’m still not sure what a widget is, but that’s what we’re selling now.
Break-Even ROAS
Let’s start easy. We’ll find our break-even lower ROAS limit. We’re looking to define the number at which you spend exactly 100% of your profit on ad budget, neither making a profit on advertising nor losing it (this is not your ideal ROAS; we’re just defining a range here!).
For the sake of math, we’ll say a widget sells for $100, and you have a profit margin of 20%. So, $20 of every sale goes into profit. If you’re spending $20 on an ad budget for each $100 sale, you’ve made no profit. We can plug those values into the ROAS formula:
(Conversion value [100] / Cost [20]) = a ROAS of 5
So, if your PPC campaign’s ROAS is below a 5, you’re likely losing money and want to either raise your ROAS or stop advertising.
You can determine your break-even ROAS without ever spending a dime on advertising, so it’s usually a good idea to determine your ROAS “floor” beforehand. Use this handy calculator to help figure those out!
ROAS Calculator
Output
Maximum ROAS
Next, we need to determine the maximum ROAS limit. (Math nerds may see where this is going. We’re filling in a parabolic equation). Here, we’re determining at what ROAS your sales volume becomes zero or lower.
This gets a little more complex because it is determined by the market, not by your own internal business data. I’m going to give a basic example, but from here on out, you’ll have to run ads and test to find your own data.
We’ll set a ROAS goal of 20. So, for every $100 widget you sell, you want to spend $5 on advertising costs. But your competitors are willing to spend $10 on advertising costs. Your fancy new site’s ability to convert may be a little better, and you may have a better quality widget, but they’re willing to pay to get above you on the search results page. Before you know it, you’ve played yourself out of the market before you get a chance to bring your competitive advantages to bear.
The good news is the maximum ROAS is still fairly cheap to test, as you won’t be spending much because your competitors will get the vast majority of clicks available in the market. The bad news is you’ve made minimal sales.
Ideal ROAS
You now have a minimum ROAS of 5 and a theoretical maximum ROAS of 20. Your ideal ROAS is somewhere within those two extremes. So, how do you determine what is best? Testing.
Pick a ROAS target between your minimum and maximum, and run the campaign for at least two weeks. Next, record the total conversion value generated during that time, multiply by your profit margin, and then subtract your advertising cost. This will produce the total profit generated by ads. Then, run the experiment again at another ROAS target, which will likely produce significant changes in total conversion value. Eventually, you’ll have enough data to plot a parabolic graph. Your aim is to get that result as high as possible, the peak of that parabolic arch.
Now, that’s all theoretical. You don’t have unlimited time and budget for testing, and there are a million market factors that will interfere with the quality of that data. Most businesses looking to explore the paid search sphere will be best suited by first determining their profit margins, then determining their minimum ROAS limit, and from there, pick a ROAS fairly close to that minimum and go live with campaigns. Over time, that ROAS number can be increased to the ideal ROAS through target ROAS smart bidding.
