As an eCommerce store owner who runs PPC ads, you’re probably familiar with terms such as Cost Per Click (CPC) and Cost Per Acquisition (CPA). But do you know how to calculate your Return On Ad Spend (ROAS), and figure out the ROAS target that will maximise your profits?
If you want to learn more about ROAS, you’re in the right place. In this blog article, I’ll walk you through:
What ROAS is
How to calculate your break-even ROAS
How to calculate your profit-maximising target ROAS
The difference between ROI and ROAS, and
Tracking your ROAS on Google Ads
Your end goal is to optimise your ad campaigns using this metric, and to increase the effectiveness of your ads. Alright, let’s get to it!
What is ROAS?
ROAS is basically a measurement of how much money you generate for every dollar you spend on advertising; you can use this metric to measure the overall effectiveness of your digital marketing efforts, or drill down into measuring the effectiveness of a specific campaign or ad group.
To calculate your ROAS, simply identify the revenue you’ve generated from your campaigns, divide this by your ad spend, then multiply it by 100 to express it as a percentage.
For instance, say you’ve made $20,000 worth of revenue from all your campaigns in February, and your total ad spend for that month was $10,000. Here’s how you’d calculate your ROAS:
ROAS = $20,000 / $10,000 x 100 = 200%
While some people calculate ROAS as a percentage, others might prefer to express it as a multiple, a ratio, or a dollar amount. So with this example, you can either say that your ROAS is 200%, 2x, 2:1, or 2; these all mean the same thing.
How to calculate your break-even ROAS
Many eCommerce store owners do work backwards to calculate their break-even ROAS; this gives them a reference figure to keep in mind while they’re running ads.
Here’s the formula to calculate your break-even ROAS:
Break-even ROAS = 1 / Average Profit Margin %
Pretty straightforward, right? If your average profit margin is 50%, then your break-even ROAS is simply 1 / 50% = 200%. This means that you break even at 200% ROAS, and if your ROAS is below this number, you’re losing money on your online ads.
Now, some eCommerce store owners might think of their profit margin in absolute numbers, but they might not be 100% sure about their profit margin, expressed as a percentage. If that’s you, don’t sweat it - you can easily do some calculations to convert your profit margin into percentage form. Here are the formulas you’d use:
(1) $ Average Profit Margin = $ Average Order Value - $ Average Order Costs
(2) Average Profit Margin % = Average Profit Margin / AOV x 100
For best results, don’t half-ass it and estimate your profit margin. Instead, take some time to actually work out your average profit margin (using the first formula), and then plug that into the second formula to derive your profit margin in percentage form.
How to calculate your profit-maximising ROAS target
So your break even ROAS is basically the minimum ROAS that you should achieve… but how do you know what ROAS you should aim for?
Unfortunately, there’s no one formula that you can use to figure out the ROAS that will maximise your profits.
Some online guides will tell you that you should strive to hit a 400% ROAS; that said, this doesn’t make much sense, because each company’s ideal ROAS differs based on their industry, the products they’re selling, and even their competitors. Bearing this in mind, you’ll have to do some testing in order to arrive at a ROAS that maximises your profits.
Now, here’s a misconception that I’d like to clear up: while most eCommerce store owners think that the higher your ROAS, the better, this isn’t necessarily the case. Keep in mind that ROAS has a trade-off with volume, and it’s impossible to score an exceptionally high ROAS, and achieve high conversions or sales volume at the same time.
Let’s unpack this a little. The key to having a high ROAS lies in keeping your costs (relative to the revenue that you generate) low. There are several things that you can do to push down your costs, but the most straightforward way of going about this is to keep your CPC bids low.
Keeping your bids low, however, brings about another problem. When you reduce your bids, Google will start showing your ads less often, and you’ll see your competitors’ ads appearing more often and in higher positions that your ads. This translates to missed opportunities in terms of impressions, clicks, and conversions, all of which ultimately lead to fewer sales and less sales revenue.
On the flip side, if you’re trying to maximise the impressions, conversions and sales that you drive from your Google Ads, then you’ll have to bid high, and be willing to spend more on each click. But of course, when you bid high, your ad spend goes up and your ROAS goes down.
Between high costs and more sales, and low costs and fewer sales, which should you go for? Well, you’ll have to figure out which option maximises your profit. To do this, simply experiment, and switch up your targets from month to month.
An Example ROAS Experiment
Here’s an example. Say your break-even ROAS is 200%, and you’re currently aiming to hit 400% ROAS for a start. After running your campaigns for a couple of months, you hit this target comfortably. Here, calculate the actual profitability of your campaign (Revenue - Ad Spend - Cost of Goods Sold), then strive to hit a different ROAS. You can either aim for a higher ROAS (500%) or a lower ROAS (300%). Whether you decide to aim higher or lower depends on a few things, namely your Impression Share and break-even ROAS.
If you’re not sure what your impression share is, this is basically the number of impressions you've received divided by the estimated number of impressions you were eligible to receive. It’s your share of voice, essentially. If your impression share is very low, then you might want to try higher CPC bids. In order to allow your CPC bids to go up, you will need to allow your ROAS to come down. Hence, if your impression share is low, then you may want to experiment with a lower ROAS target.
Impression share aside, another factor that will impact your decision (to try for a higher or lower ROAS) is your current ROAS versus your break-even ROAS.
For instance, if your current ROAS is only 50% above your break-even ROAS, then it isn’t feasible to push down your ROAS goal by 100%. On the other end of the spectrum, if your current ROAS is 10x your break-even ROAS, then this gives you a lot more wiggle room. All other things being equal, you’ll be able to play around with a lower target ROAS, without worrying about not turning a profit.
The difference between ROI and ROAS
What’s the difference between Return on Investment (ROI) and ROAS? In a nutshell, ROAS factors in your other costs, while ROAS doesn’t. The formulas say it all:
ROAS = Revenue / Ad Spend
ROI = Revenue / (Ad Spend + All Other Costs)
At the end of the day, ROAS is a self-contained metric, so if you want to look at the big picture and identify the profitability of your campaigns, you’ll need to keep an eye on your ROI as well. Because ROI factors in other costs, it’s a true measure of the profitability of your marketing efforts.
For instance, say you’re currently running a PPC campaign promoting your bestsellers, and you’ve generated $100,000 worth of revenue using $20,000 of ad spend in the past month. That works out to a 500% ROAS, which seems more than decent.
Now, here’s the important part: while your ROAS indicates that your marketing campaign is effective in driving sales, this doesn’t mean that you’re making a profit on this campaign. Let’s say your Cost Of Goods Sold was $40,000, and you spent an additional $14,000 on payroll and $26,000 on processing returns. Add that all up, and you’ll realize that you’ve just broken even for the month.
That said, relying on ROI does come with its own set of challenges; the primary disadvantage that ROI brings to the table is that it’s much more difficult, and time-consuming, to calculate.
More specifically, most business owners’ Cost of Goods Sold (COGS) include variable costs, which can be hard to pinpoint. Also, most eCommerce store owners generally don’t have accurate COGS data in Google Ads, Google Analytics, or whatever system they’re using to benchmark the performance of their marketing campaigns.
What we recommend doing, which is how we work with all our clients, is to use ROAS as the primary metric for measuring your campaigns. This gives you something that’s quick and easy to calculate that can be shown in near-real-time in your reports and analytics. Periodically, say once a quarter or once a month, calculate your true ROI. Compare it to your ROAS… at the ROAS you were achieving, how good was your actual ROI? Good enough? Great! Probably no need to switch up your ROAS targets. Not good enough? Hmmm OK, then you might need to aim for a different ROAS target.
Tracking your ROAS on Google Ads
Want to start monitoring your ROAS more closely? Don’t worry, you don’t have to keep an Excel spreadsheet handy, and do the calculations manually. Instead, you can either use imported conversions from Google Analytics to track your ROAS information, or use the Google Ads website conversion tracking tag to do the same.
At Big Flare, we typically rely on the Google Ads website conversion code for tracking ROAS. With this method, the key thing is to make sure that the conversion code on your site is properly customised to send revenue data back to Google Ads. This guide from Google will walk you through the entire process.
Alternatively, if you’d prefer to import your conversions from Google Analytics into your Google Ads account, that’s possible as well. Firstly, ensure that you’ve added eCommerce tracking to your website. Here, you’ll add a tracking code to your site, and then enable eCommerce for the Reporting View in which you want to see the data.
From here, link your Google Analytics account to Google Ads, then add the “Conv value / cost” column to your Google Ads dashboard. Moving forward, you’ll simply have to glance at this column to determine your ROAS; if you see that Ad Group A has a value of “3.5” under this column, this means that the ROAS of that particular ad group is 350%.
For those of you who are using Shopify to host your site, Shopify has its own guidelines that you can follow to ensure that your revenue is reported to Google Ads correctly. To learn more about this, check out Step 4 (Make the conversion value dynamic) of this Shopify guide.
If you’re running ad campaigns for your eCommerce store, but you don’t take the effort to calculate your ROAS and assess the effectiveness of your ads, then that’s a recipe for disaster. Just like how you’d keep track of your cart abandonment rate and actively try and optimise your site to increase your conversion rate, you should also keep an eye on your ROAS, and strive to hit the “ideal” ROAS that will bring you maximum profits.
So, go ahead and set up your Google Ads dashboard so that you can track your ROAS, and start figuring out what ROAS will bring you the best results. Happy experimenting!
Do you use ROAS to benchmark your Google Ads campaigns? What other key metrics do you keep track of? Let us know in the comments below!