A Guide to the ROAS Formula and Improving Your Ad Campaigns

ROAS-formula

If you’re a business, you’re probably familiar with the term return on ad spend (ROAS). Better yet, you’re curious about the ROAS formula. And how it can and should work for you.

Whether you’re an online e-commerce business or if you have a physical store, you’ve probably dabbled in the world of advertising, particularly Facebook ads.

Depending on what you’re selling, you may have even ventured into Google Ads, PPC campaigns, or any other kind of advertising effort.

In this article, we’re going to talk about what the ROAS formula is, what good ROAS is, and how e-commerce businesses can improve their return on ad spend.

What is ROAS?

Return on ad spend (ROAS) is a metric used to determine the impact and return from your advertising efforts.

It tells business owners and marketing managers if they’re spending is reaping good results or if they should rethink their digital marketing strategy.

ROAS is different from return on investment (ROI). ROI is about the overall returns and costs incurred by your company or store. ROAS, on the other hand, focus on advertising only.

Check out the 46 E-commerce Vocabulary, Metrics and Biz Terms You Need to Know

If you’re spending money on software, ROI is the metric you use to calculate the return of that software on your employees and your bottom line.

You can think of ROAS as being a part of ROI. But not the other way round. You’d need to know if your return on ad spend formula is supporting your business or not. You’ll then want to use ROI to see how your advertising along with other expenses and efforts and translating into revenues and profits for you – or if they aren’t.

What is the ROAS Formula?

The return on ad spend formula is how you calculate your ad spend.

ROAS measures what you get for every dollar you spend on advertising.

This is what the ROAS formula looks like:

ROAS = revenue from ad campaign (divided by) cost of ad campaign = Ratio

The result of this equation is a ratio. You can also take the result of this equation and multiply it by 100 to get a percentage.

ROAS = revenue from ad campaign (divided by) cost of ad campaign x 100 = %

Let’s see the ROAS formula in action.

If you spend $10 on advertising and get $30 in revenue, then your ROAS is 3:1 or 30%.

That’s a simple example. Let’s take a more realistic one about some retailers’ ad spend.

furniture-store-example

Imagine a furniture store spending $50,000 a year in ads and generating $150,000 in revenue.

To calculate the ROAS for this furniture store, we’d need to divide the revenue from the ad campaign by the cost of the campaign.

That’s $150,000/$50,000 = 3:1 or x100 = 30%

The return on ad spend for this furniture business is 30%.

What is good ROAS?

Now that you know what the ROAS formula is, let’s dive deeper into a commonly asked question:

What is a good ROAS for my business?

To begin, there’s no one-answer-for-everyone for this question.

The reason is ROAS differs based on:

  • The size of the business
  • How long the business has been present in the market
  • The industry of the business
  • The cost per lead
  • The ad campaign itself
  • Overall health of your business

Among other things. But these are the main culprits.

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If you want to know how your ad campaign is performing, that is if it has a good ROAS, then you’ll need to “examine your specific scenario, research competitor ROI, and compare your results to the industry standard,” according to Lemonads.

To know whether you’re generating good ROAS, you need to see if your ad campaigns are generating $1 or more for every dollar spent.

Suffice to say, if you’re spending $1,000 on advertising and generating $500, you’re losing money. If you’re generating $1,000, then you’re not making money but you’re not losing it either. Which is still not a win.

If you’re paying $1,000 on ads and generating anything for $1,100 and more, then you’re making a profit – at least in terms of your ads.

What is generally accepted as good ROAS is 3:1 or 4:1, that’s $3 and $4, respectively, earned for every $1 spent.

Other factors that affect your return on ad spend is your business’s life cycle.

“If you’re a cash-strapped startup, you probably want the most bang for your buck. If you’re an established, healthy business, you may be willing to settle for a lower ROAS in exchange for increased brand awareness,” explains Segment.

Improve your ROAS

You know the ROAS formula and have a general idea about what good return on ad spend means.

Now, it’s time to work on your advertising efforts and get a better bang for your buck.

 1. Know your customers

You’ve probably heard this before – or more times than you can count. But understanding who your customers are plays a major role in how you create your ads.

If you don’t know who you’re targeting and selling to, chances are you’re going to waste lots of dollars.

One way to focus on your target audience is by using your product’s buyer personas and working your way from there.

2. Segment your customers

You know your customers and buyers, now you want to ensure that your ads reaching them well.

To that and get the most from your ad campaigns, you’ll want to segment your customers. Narrow the segments instead of keeping them broad.

Your customer segmentation strategy will help you group customers based on geography, behavior, demographics, and psychographics.

This will help you understand your customers better, create better-targeted ads, and accordingly sell more because you’re offering customers what they want.

3. Use good ad copy

There’s no doubt that ad copy plays a role in how your customers react to your posts and ads. It can get them to engage with you, buy from you, or leave you.

good-ad-is-important-for-your-roas

The best ways to get customers to take action is to have a call-to-action along with one or more of these:

  • Social proof (’25 other customers also bought this product’ or ‘4.9/5 stars, rated by 1,000 happy customers’)
  • Create a sense of urgency (‘offer ends in 3 days’ or ’10 hours left for the 20% discount’)
  • Short, choppy copy that’s to the point and doesn’t bore the customer

A note though: If you use the ‘sense of urgency’ too often, customers will lose faith in your pricing and store. Use with caution.

4. Ensure your website is mobile friendly and loads quickly

Did you know that nearly 49% of e-commerce sales in 2020 were done by customers using mobile phones? (Statista)

It’s true. Data by Statista also shows that by 2021 (this year!), 53.9% of e-commerce sales will be through mobile. And it’s likely the rate will keep growing in the years to come.  

This means that if you ads are sending customers to landing page on your website, your site needs to be both mobile friendly and quick to load.

Customers using their phones will quickly leave a site that they can’t view properly or that takes too long to load.

Read Discover How and When to Use Dynamic and Static Ads

5. Avoid ad fatigue

Ad fatigue is when your customer sees your ad way too many times that they are no longer affected by the ad, the message, or the call-to-action.

You can avoid ad fatigue by changing the images and ad copy for you ads every now and then.

6. Create retargeting campaigns

Retargeting campaigns are for customers who have clicked your ads, engaged with you, or purchased from you before.

To create retargeting ads, you need to ensure that you have the Facebook Pixel installed on your website.

Did you know that Convertedin can help you with segmenting your customers, creating lookalike audiences on Facebook, and with retargeting campaigns?

It’s your turn

Knowing and using the ROAS formula is just the first step in measuring the effectiveness of your ad campaigns.

Knowing your customers and their buying habits is one of the most important aspects of creating a successful ad strategy.

You can also use e-commerce automation to speed-up the process of creating your ads, reaching your customers, and retargeting them.

E-commerce automation is where Convertedin comes in. You can upload your audiences to Convertedin and the platform will automatically create customer segments and lookalike audiences.

Start your free trial now!

What You Need to Know about the Difference between ROI and ROAS

difference-between-roi-and-roas

When you’re running an e-commerce business, there are many metrics to consider to keep your business running, making revenues, and profits.

Among these metrics are two often mixed up terms. They are: return on investment (ROI) and return on ad spend (ROAS).

Let’s focus on the difference between ROI and ROAS and how e-commerce businesses can use each of them and when they should.

What is ROI?

Return on investment (ROI) is metric that measures the performance of an investment.

Investopedia explains ROI as a metric used to “evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments.”

Businesses who use ROI try to see whether the investment they made was a good one or not.

ROI is calculated by dividing the investment’s net profit (or loss) by the initial cost. The result is a percentage.

This is what the equation looks like:

ROI formula

It also looks like this:

ROI = profits-costs / costs x 100 = %

Here’s an example of ROI:

Kelly invested $1,000 in a business venture and sold it for $1,300 a year later. To calculate the ROI, we’d have to divide the net profit (the $1,300 – $1,000 = $300) by the investment ($1,000). This would result in an ROI of $300/$1,000, or 30%.

ROI can be used for a variety of things, although most businesses use it as a profitability measure. ROI was an investment measure before everything turned digital. Online businesses use it too.

However, there are some downsides to ROI. “While ROI is a simple and straightforward measure, it does not take into account the holding period or passage of time, and so it can miss opportunity costs of investing elsewhere,” notes Investopedia.

What is ROAS?

Return on ad spend (ROAS) is a metric that measures the impact of your marketing and advertising. Every dollar you spend on ads needs to translate into a return, a result.

ROAS is the metric that measures that result.

Whether you’re trying to track clicks or conversions, ROAS is what tells you if the dollars you’re spending are resulting in high value or not.

ROAS is how your business benefits from every dollar you spend on advertising messages and ads. The higher your revenue from dollars spent on ads, the better your ROAS.

The important thing about calculating ROAS is to know how much you are spending on ads and how much are you earning in return.

How to calculate ROAS

To calculate return on ad spend, you’ll need to divide your conversion value by the total amount of your advertising (or your advertising costs).

How to calculate ROAS – Image via Segment

But what is a conversion value?

The conversion value measures the revenue your business can generate from a single conversion.

This means that the ROAS formula can also look like this:

ROAS = revenue from ad campaign (divided by) cost of ad campaign = Ratio x100 = %

Let’s explain this better with an example:

If John spends $20 on advertising to sell a $100 product, then his ROAS is 5:1 or $5. That’s $5 in ROAS for every dollar spent to sell John’s product.

If your ROAS is less than one, it means you’re not making money; you’re losing money.

If your ROAS is $1, that is $1 earned for every $1 spent, it means you’re breaking even, which again isn’t a good indicator. But you’re not losing money.

But if your ROAS is above $3 for example, then for every $1 you spend, you’re getting $3 back and you’re making a profit. (That’s a 200% return on ad spend).

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If your e-commerce strategy is to achieve profit, then your goal would be to achieve the highest ROAS possible for your business. You’ll need to know what the average ROAS is for your industry so you can see how you average accordingly.

However, the target ROAS benchmarks are usually between 3.0 and 4.0. Again, these can differ based on the industry and the stage where the business is at. Larger businesses can enjoy good profits at a ROAS of 3.0, while smaller businesses might need to achieve a ROAS of 5.0 or more.

The difference between ROI and ROAS

You now have a brief idea of the difference between ROI and ROAS.

Do they sound similar?

Yes.

Are they similar?

Yes. And No.

The main difference between ROI and ROAS is that ROI measures the value of an entire investment. Yes, that investment can be ads as well. But it can also be an investment in a new business, a factory expansion, a new department, and so on.

ROI is profitability measure. It takes into account other types of spending, like new software for your business.

ROAS, on the other hand, is specifically about your ad spend and its performance. It won’t tell you if your ad spend translated into profit for your business.

Here’s another example that shows the difference between ROI and ROAS on application.

XYZ company spends $25,000 in ads and generates $100,000 in revenue from its ad campaign. However, it has other expenses such as software and personnel amounting to $90,000.

To calculate the ROAS: Revenue of ad campaign – cost = ratio x 100 = %

($100,000/$25,000) x100 = 400%

To calculate the ROI: profits-costs / costs x 100 = %

Profits (loss) = $100,000 – $25,000 – $90,000 = -$15,000

Costs = $25,000 + $90,000 = $115,000

-$15,000 – $115,000 x 100 = – 13%

As you can see, the ROAS is showing stellar performance. But once it’s included alongside other expenses to calculate the ROI, we see negative performance or negative ROI.

By calculating ROI, we can see that XYZ Company is making a loss.

Another major difference between ROI and ROAS is that ROI is about the money you make after deducting all your expenses, whereas ROAS compares between how much you’re spending and how much you’re making on ads only.

The sole purpose of ROI is to determine whether the campaign is worth the investment or not. By taking the margin into account, you can quickly determine your overall profits and determine what your actual ROI is.

The bigger picture of ROAS and ROI

ROAS focuses on advertising and its results. It helps businesses determine if their advertising efforts are paying off or not.

By focusing on ROAS, e-commerce businesses can make better future decisions, see where they need to invest their dollars, and how to better invest them.

That said, relying on ROAS only can be misleading for a business. Why? Because ROAS is about advertising results only. Your ad campaigns may be resulting in a high conversion rate, but the cost of each conversion is quite high resulting in an overall loss for the company.

An example of this is a business selling a product for $30 but generating leads at $50 per lead. Each translates into a $20 loss for the company.

The loss doesn’t necessarily have to be in the cost of the lead in the ad campaign. The loss may come from additional aspects such as production and shipping.

This is where ROI comes in. It factors in the other expenses that aren’t just related to the ad spend.

“When you consider ROI vs. ROAS, it’s important to remember that it isn’t an either/or situation. Whereas ROI can help you understand long-term profitability, ROAS may be more suited to optimizing short-term strategy,” notes GoCardless.

Next steps

There are many differences between ROI and ROAS. As a business you can’t rely on just one metric.

We recommend using both. Using ROAS to see how your ad campaigns are performing and then using ROI to see how your overall marketing budget and other expenses fit in the equation.

This means that an effective digital marketing campaign would rely on both ROI and ROAS.

Another metric you should include in your digital marketing efforts is customer lifetime value (CLV). CLV combined with ROI can offer great results for your business.

Want to know more about the metrics and means to help your e-commerce business? Tell us what you’re struggling with in the comments and we’ll share our tips with you.

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