3 Ways Looking Only at ROAS Can Lead You Astray

August 3, 2020
Jhana Ellard

It’s a common practice for advertisers to use ROAS as a way to highlight performance. I saw someone on LinkedIn last week point to his 300x ROAS as his greatest accomplishment as an advertiser.

Though ROAS can and does tell you valuable, useful, and interesting information on how your ad campaigns are performing, it does not and never will, give you the full story.

This post is designed for those who’ve hired an advertiser to better understand the information being presented to them. It’s also useful for junior advertisers to help them with their data analysis toolbelts.

If you’re hiring an advertiser, it’s important to know what the meaning of the information you’re being presented is.

“There are three kinds of lies: lies, damned lies, and statistics.”
-Sir Charles Dilke

But first, a note on ROAS vs ROI.

These two terms are often used interchangeably, but they certainly should not be. Let’s go through what they mean.

ROAS means the return on your ad spend.

In other words, it means the amount of revenue you generate as a result of what you spend on digital ads.

Say you spend $1,000 on Facebook Ads, and you receive $10,000 of the attributed purchase conversion value (ie. revenue) in return.

To determine ROAS, you take the conversion value and divide it by the cost of advertising. $10,000 / $1,000 = 10. With this result, you’d generally say you have a 10x Return on Ad Spend.

You made an average of $10,000 of revenue for every $1,000 you spent on advertising. Or, put more simply, for every $1 you spent on advertising, you make, on average, $10 in return.

This is your ROAS. This is not your ROI.

ROI refers to the return on your overall investment.

ROAS is looking at your digital ads in a vacuum. ROI acts as a way to capture the overall business picture.

What to “count” and “not count” in your calculation of ROI can vary based on the business, but generally, your ROI from the perspective of an advertiser will take into account your business profit — ie. revenue after you take into account product margins, agency management fees, and cost of goods sold.

To take our earlier example, we were only including direct ad costs into our calculation and then relating it to revenue. Whereas ROI requires you to take your digital ad spend ($1,000) + your cost to buy and ship the products wholesale ($3,500) + your ad agency management fee ($1,000).

When you redo the calculation with this in mind, you are taking your total revenue ($10,000) / your total expenses ($5,500) and getting a result of 1.81x.

That’s a massive difference. The same results, but ROAS = 10x, ROI = 1.81x.

Now you see how crucial it is to know the difference between these two numbers.

This leads us to the first reason why ROAS can give you an incomplete picture of how your advertising is performing.

1. Your ROAS is not taking into account your eCommerce product margins.

The most important thing to note here (which people often forget) is that revenue does not equal profit.

When you sell a product on your eComm store, you receive revenue. You then need to spend money on producing or buying the product at wholesale price + the cost of shipping that good to your customer.

When you do this calculation, you get your profit margin.

So, a sale of a good for $10 of revenue may actually only equal $4 of profit after you’ve paid your supplier and DHL to ship. And if you’re running ads, you’ll also need to take into account the cost of advertising. If you spend $5 on ads to acquire a sale, you’ve actually lost $1.

Let’s see the above in a real-life example.

John owns a store selling custom cotton socks. His socks sell for $10 a pair and have a 40% profit margin (meaning he incurs $6 of expenses in order to buy the sock at wholesale price + ship it to the customer).

John hires an advertiser to run ads for his business. The advertiser spends $2,000 on ads and comes back to John with great news.

“Hey John. Your ads have a 2.0x ROAS. For every $1 we’re spending on Facebook ads, we’re making $2 in return!”

This may seem like amazing news. Double your money! Right?

Not quite.

Let’s take another look.

The advertiser has spent $2,000 on ads and has achieved a 2.0 ROAS, meaning $4,000 of revenue.

With a 40% profit margin on his socks, that means that John has made $4,000 * 0.4 = $1,600 of profit.

So, now if you recalculate, John has spent $2,000 on Facebook Ads, but has only made $1,600 of profit in return.

This means that John’s return on investment is actually negative at 0.8x. For every $1 John’s advertiser spends on ads, John’s business makes $0.80 cents back.

Not such good news anymore. Not to mention that we haven't even taken into account the fee that John has spent to pay his advertiser to run the ads.

So, be wary when an advertiser is trying to report the results of their ads to you without taking into account your actual business.

The problem is not the fact that there is a negative ROI, (as even achieving break-even ROI with ads is incredibly difficult to achieve), the problem is that crucial information is missing when you choose to fixate on only ROAS.

Make sure you’re having these conversations with your advertiser. If you’re not, it’s something you should certainly be asking them about.

Let’s look at the next way that ROAS can be misleading.

2. Your ROAS is not taking into account the amount of money you spend.

The first point had to do with tying your overall business goals to your advertising efforts. These next two are going to dive into advertising specifics a little more deeply.

What’s important to note here is that no singular metric carries significance in isolation. Stats always exist in relation to other stats.

An extremely vital relationship to consider here is the relationship of your ROAS to your Ad Spend. Only talking about one half of this relationship misses incredibly vital information.

Remember, ROAS = return on ad spend. So understanding the amount you’ve actually spent is crucial.

This will be a difficult (and perhaps counterintuitive) point to get across — but is seriously important. A higher or lower ROAS can only be judged as “good” or “bad” if you take into account how much money you spend. You need to grade your ROAS on a curve based on the ad spend.

Perhaps it’s best to illustrate with a (simplified) example.

Campaign A: Spends $1,000 — Achieves a 15x ROAS

Campaign B: Spends $1,000 — Achieves a 9x ROAS

Campaign C: Spends $5,500 — Achieves a 5.8x ROAS

Let’s, for the sake of example, assume that all other variables are the same (creative, copy, time of the campaign, audience, etc). The only variables that are different are spend and ROAS.

First, let’s evaluate Campaign A vs Campaign B. This should be a generally easy example to conclude that Campaign A performed better. They both spent $1,000, and one made more revenue in return. Easy.

But, if you were to ask me which of these three campaigns was the best performer, I’d point to Campaign C. This campaign had less robust returns than A & B, but it’s still better?! That doesn’t seem right.

If you were to evaluate campaigns solely on the basis of ROAS, you’d make the incorrect conclusion that A is best — as it has a 15x ROAS. But what you would’ve missed is that oh-so-important principle of diminishing returns.

This, broadly, means that your dollars will go “less far” for every additional dollar you spend. In other words, as you increase spend, you can generally expect your returns on that spend to diminish as spend increases.

This is actually not a bad thing, it’s just something to be aware of at all times.

Believe it or not, sometimes your ROAS needs to decrease to achieve your ultimate business goal: profit.

Let’s actually take a look at the profit of these campaigns. Let’s assume a 60% profit margin.

Campaign A: Spend — $1,000. Revenue — $15,000. Profit — $9,000

Campaign B: Spend — $1,000. Revenue — $9,000. Profit — $5,400

Campaign C: Spend — $5,500. Revenue — $31,900. Profit — $19,140

As you can see, though the ROAS is higher on campaign A, the profit is 115% higher on Campaign C.

Kind of a no brainer when you evaluate based on profit. This is something you will miss if you’re fixated on ROAS.

The real test of campaign A vs C will be when you scale campaign A to have a similar spend as C, what will the ROAS & profit be?

This is why it’s vital to not look at ROAS in a vacuum.

The TLDR: Grade the ROAS on a curve based on your ad spend.

3. Your ROAS is not taking into account the audience you're targeting.

This point follows the same principle as #2. Don’t look at ROAS alone without also taking into account the audience of people you’re targeting.

This is important because you will have vastly different results based on where the people you’re targeting with ads are in the marketing funnel.

Let’s go back to our individual at the beginning of this article who touted his 300x ROAS in isolation as evidence of his success as an advertiser. I would ask this person the following.

  1. What was your ad spend?
  2. Who were you targeting?

I used to work for a company that advertised for live events. This is a great place for an advertiser because there’s a lot of existing cache for a live event + the average order value is very high (generally over $300).

If you wanted me to try and “maximize ROAS,” it would be the easiest thing in the world.

I would spend $1 on ads targeting an audience of past purchasers the day before the event went on sale. Then, on the day of the on-sale, likely one or two of these people who saw my ad would buy a ticket.

I spend $1. The company makes $3–600 in revenue. Voila! My ROAS is between 300–600x.

The issue here is, again, reporting on ROAS in isolation.

Let’s run through another example. Let’s say it’s a 2021 music festival.

Campaign A: Spend — $100. ROAS — 50x. Audience — Past Purchaser Retargeting

Campaign B: Spend — $100. ROAS — 2.3x. Audience — Cold Prospecting

You’ll see we have the same issue. Many would conclude that the campaign with the higher ROAS is the better performer.

“50x is better than 2.3x. Obviously we should allocate our budget to campaign A.”

This again makes the fundamental mistake of looking at ROAS in a vacuum. Think about it, the past purchaser list of users is far more likely to buy regardless of whether they see an ad or not than completely cold traffic.

It’s so much less impressive to get high ROAS numbers when you’re targeting people at the bottom of the funnel. In fact, in this example, it is a far, far greater feat to get 2.3x ROAS on targeting an audience of completely cold traffic.

This example I’ve outlined may seem obvious, but I’m painting an obvious example to highlight something that people are doing in far less obvious cases.

I’ve heard the deduction so many times that “our retargeting is doing so well, especially compared to our prospecting campaigns, let’s shift our budget to retargeting.”

Though this may make intuitive sense for someone outside of the ads industry, it’s important to note that the audience stacks the deck one way or another. Again, you need to grade on a curve.

You will always get better ROAS from targeting Cart Abandoners than a Look-A-Like on Facebook. This should come as a surprise to nobody.

Do not be trapped by this tunnel vision if you’re an advertiser making strategic marketing decisions. And do not be misled if you are a business owner glancing at some of your own ad results.

A good advertiser grades on a curve. A good advertiser is also looking at the performance of ads within the same funnel position across time and not comparing apples to oranges by looking at different campaign types with different goals.

In Conclusion: Even in Digital Ads, never lean on raw numbers alone.

This is perhaps the biggest takeaway.

There are an infinite number of metrics, numbers, stats, and data points that you can use to convey what you‘re motivated to convey. What’s actually important when talking to clients is to tell a coherent and logically consistient story that is supported by numbers.

I’ve sat in on phone calls where agencies or freelancers will get on the phone with their client and simply say “your CTR is X, your CPC is Y, and your ROAS is Z.”

People will do this without providing any context to these numbers — such as:

“How have these numbers changed over time?"

"Have we moved closer to our monthly targets?"

"What do you think the cause is for the spike of X?"

"How does this translate to business profit?”

The reason is that it’s incredibly difficult to do. Looking at and leaning on numbers alone is actually not that difficult. Framing and contextualizing different data points and coming up with actionable strategies for you and your clients is what’s tough. It takes a lot of practice and experience.

Additionally, it’s genuinely understandable that agencies and freelancers would be hesitant to report on these more crucial business metrics. Think of our example of the advertiser whos ads went from profitable from a ROAS standpoint to a net-loss from an ROI standpoint with the same data.

If agencies decided to bake in their client’s eComm costs + shipping + their management fee, it may look like the bulk of agencies are a net loss for businesses. What a difficult thing to present to the business paying you.

But it’s important to face and address this openly and honestly with your client. Then, it means you can address it and work together to improve.

Remember ads are incredibly difficult and in most cases to even achieve break-even ROI is a massively impressive feat. You’ve acquired a customer for the business at a breakeven cost, hats off to you, you’re ahead of most businesses.

If you’re working in ads, or if you’ve hired someone to do your ads for you, try looking beyond things like ROAS. Try relating different numbers together, mapping them out over time, try taking into account your fee and presenting it to your client. The honesty and openness may have the opposite effect of what you fear.

If you’ve made it to the end of this incredibly long and technical post, I applaud you. You’re on the road to making far more informed business decisions and taking the path towards profitability.

I hope this helps you get there.