A former teacher, Matt now specializes in R&D for ecommerce business owners and helps guide merchants in understanding the importance of this digital-first world.
In this post we'll cover:
- What Return on Ad Spend (ROAS) is
- How to calculate ROAS
- What a "good" ROAS is
- Pitfalls to watch out for
As the owner/manager of an ecommerce business, you’ve probably heard the phrase “you gotta spend money to make money” more times than you can count.
Now, we’re not going to get into a huge debate over whether or not that’s true; that’s another topic for another time.
What we will say, though, is that your goal should always be to make as much money as you possibly can off of every single dollar you invest in your business.
Okay, okay...this isn’t exactly news to you. You didn’t start a business with the hope of breaking even, or simply making ends meet. You dove headfirst into the world of ecommerce with the intention of absolutely dominating your industry - and making a killing in the process.
(And, uh, providing big-time value to your customers too, of course.)
At any rate, our point is that, no matter what part of your business you’re investing in, you want to be sure that the investment will pay off in dividends.
While there are, of course, a number of different areas of your ecommerce business that require some sort of monetary investment on your part, today we’re going to focus specifically on advertising.
Let’s dive in.
Return on advertising spend, more commonly referred to as ROAS, is basically what it sounds like:
The amount of revenue a specific ad or ad campaign generates, as compared to the amount of money spent on said ad or campaign.
Essentially, ROAS allows you to assess the effectiveness of a given ad campaign, in turn allowing you to determine whether or not to continue investing in the campaign (or in future ads through the same channel).
You can also use ROAS to determine the effectiveness of a specific keyword, as well.
ROAS is calculated using the following equation:
Revenue Generated by Ad / Money Invested in Ad
ROAS can be expressed in a few different ways:
- A multiple of the invested amount
- A ratio
- A percentage
- A comparative dollar amount
To illustrate, let’s look at a simple example:
An ecommerce company invests $1,000 into a Google Shopping ad in a specific month. Throughout the next month, the ad ends up generating $5,000 in revenues. Using the formula from above, the ROAS of the ad is calculated to be 5x, 5:1, 500%, or $5 for every $1 spent.
Needless to say, this hypothetical ad campaign was quite successful - but we’ll get more into what is considered a “good” ROAS in a bit.
ROAS vs. ROI
Now, you might be thinking “ROAS sounds a whole lot like return on investment.”
It’s not uncommon for even experienced entrepreneurs to fall into this trap, so it’s worth spending some time explaining the difference between the two.
While ROI is often (mistakenly) calculated using the formula we used above for ROAS, the true formula for ROI is:
(Revenue - Cost of Ad) / Cost of Ad
Using our previous example, in which the hypothetical ad’s ROAS was 500%, the ROI would be calculated as follows:
($5,000 - $1,000) / $1,000
So, the ROI of that same ad campaign is actually 400%.
A good way to think about the difference between ad-related ROI and ROAS is that ROI is a wide-lens metric that assesses how a specific ad affected the company’s overall profits, while ROAS zooms in on the the effectiveness of the ad itself - regardless of the overarching impact it had on your business.
To put it a bit more simply:
- ROI is a business-centered metric
- ROAS is an ad-centered metric
In other words, it’s sort of an “apples and oranges” situation. While both metrics certainly relate to one another, they definitely aren’t synonymous. We’ll circle back to this in a bit when we discuss some of the pitfalls to avoid when analyzing and assessing ROAS.
According to a 2015 study by Nielsen, the average ROAS across most industries hovers around 287% (or $2.87 for every $1 spent).
Note, though, that this is the average return on ad spend for the average company across all industries. Some industries (such as infant-related products) skew much higher, while others (like OTC products) fall a bit below this number.
And, of course, the “average” ROAS is just that: not bad - but not good, either.
So, what is a “good” ROAS, then?
While we said earlier that ROAS itself doesn’t necessarily explain the impact a given campaign has on your business, determining a “good” ROAS for your campaigns does require you to consider a number of business-related factors.
For one thing, think about your overall goals related to growth, and your timeframe for attaining these goals. Of course, as we said in the introduction, your goal isn’t just to do “good enough,” though - so an above-average ROAS might still not be sufficient in your eyes. If growth and timeframe were your only concerns, the sky would be the limit for what’s considered a “good” ROAS.
Thinking more realistically, you’ll want to consider your profit margin in conjunction with your advertising budget. For example, if you run a dropshipping business with little to no overhead outside of advertising costs, a 3x ROAS will be much more palpable than it would be for an inventory-based ecommerce business.
But, at the same time, since advertising is likely the main expense for the dropshipping company, a 300% return on ad spend isn’t all that great (i.e., if the company is focused mainly on creating revenue-driving ads, a mere 3x ROAS shows major room for improvement).
The previous example brings up another good point: while ROAS is a self-contained ratio, what it “means” to a business is completely subjective.
Say one ecommerce company spends $1,000/month on ads, and makes $3,000 in that month. Another company spends $200/month on ads, and makes $600 in that same month. In both cases, the companies both have an ROAS of 3x - even though the first is likely in much better shape than than the second.
But, again, let’s not confuse the issue here. ROAS does not necessarily mean business is booming; it simply means the company’s ads are performing well.
All this being said, defining a “good” ROAS depends on whether you mean “good for an ad campaign” or “good for a specific company or industry.” An objectively “good” ROAS is at least 400-500%; the latter, of course, depends entirely on the context within which the ad exists.
By now, you’ve probably come to the understanding that, as helpful as focusing on improving your ROAS can be, approaching it in the wrong way can be incredibly detrimental to your overall business.
So, before we explain exactly how to set up and track ROAS using Google Adwords, we need to hammer out a few things so as not to unintentionally lead you astray.
ROAS Isn’t a Business Metric
We touched on this in the previous sections, but now it’s time to tackle it head-on.
Recall that ROAS is often mistakenly thought of as “advertising ROI.” The problem with this is that ROI refers to overall profits, while ROAS refers to campaign-specific revenues.
Let’s say your company creates a marketing campaign for $10,000, which generates $50,000 in its first month of implementation. Using our ROAS formula, we find the return on ad spend for this campaign to be 500%, or 5x. As we talked about in the above section, this is a pretty darn good ROAS.
The problem, here, is that it’s incredibly easy to lose sight of all the other costs associated with running the business in question - especially when you nail a solid monthly ROAS.
While celebrating the success of your latest campaign, you forgot all about the fact that:
- Your cost of goods sold for the month was $25,000
- You paid your staff $10,000
- Shipping and returns cost you $5,000
While your latest marketing campaign absolutely was incredibly successful, at the end of the day your profits for the month were a mere $10,000 - essentially meaning you simply broke even for the month. Needless to say, this isn’t sustainable for growth - and can lead to major losses if your main focus is on your ROAS.
A good rule of thumb, then, is to not put too much emphasis on ROAS until you’ve maintained a steady budget, and have seen a consistent increase in your profit margins on a monthly basis. While you’ll still want to take these metrics into consideration as you begin to focus on ROAS, you’ll have a little more leeway when it comes to looking at ROAS as a standalone metric.
ROAS Can’t Be Applied to All Marketing Efforts
For the sake of providing simple examples throughout this article, we’ve worked under the assumption that the ROAS of all marketing efforts can be easily defined.
Unfortunately, this isn’t the case.
For a marketing campaign to be assessed using ROAS, the true cost of said campaign must be absolutely concrete.
For example, as PPC ads have a concretely-defined budget, determining the ROAS of a given PPC campaign is as simple as dividing the revenue generated by said campaign by the cost of the campaign.
On the other hand, the true ad cost of many types of marketing campaigns simply cannot be determined on a per-instance basis.
For example, say you create a retargeting campaign focused on getting cart abandoners back on your site. How, exactly, are you supposed to nail down a finite cost of ad spend here? It’s virtually impossible; you’d have to consider the monetary cost of:
- Creating the email copy
- Implementing the automation sequence
- The deal you may offer within the email
- The cost of sending each individual abandonment email (which is usually miniscule)
I mean, I guess you could figure all of this out - but it probably won’t tell you all that much in the long run, anyway. In fact, the ROAS of such a campaign will inherently skew over time - and eventually become meaningless.
Think about it like this: if you determine the cost of creating a cart abandonment campaign to be $1,000 - and you generate $3,000 in sales from cart abandonment emails within the first month of the campaign - the ROAS of the campaign is clearly 3x. The next month, you again generate $3,000 via cart abandonment emails - but you haven’t spent any money on the initiative (since it’s been bought and paid for). Obviously, this is a good thing for your business; but the ROAS of the campaign in this second month is literally undefinable.
(Of course, you can use a variety of other metrics to measure the effectiveness of such campaigns; ROAS just isn’t one of them.)
Not All Ad Campaigns Contribute Directly to Sales
Whereas the above section focused on the denominator of the ROAS equation (i.e., the money invested in a campaign), we’re now going to focus on the numerator of the formula.
As you’re probably aware, not all marketing efforts lead directly to a conversion; many initiatives aren’t meant to do so. Some initiatives - such as blog posts and newsletters - are meant to gain the attention of a target audience and get them to engage further with the brand in question, while others - like customer reviews and testimonials - are meant to seal the deal.
Simply put: it would make no sense to assess the ROAS of a top-of-the-funnel marketing initiative. While such initiatives certainly play a role in a customer’s decision to make a purchase (or not to do so), since the goal of said initiative isn’t to directly make a sale, there’s absolutely no reason to even mention ROAS when assessing the effectiveness of the campaign.
The Problem With Attribution
Going along with the last point, even when you can determine that a customer made a purchase after engaging with a specific ad, you still can’t say with 100% certainty that that ad is what caused them to convert.
Referring again to the sales funnel, a given customer’s journey to conversion features a wide variety of touchpoints along the way. Sure, at one point they clicked on your Google Shopping ad - but can you say for sure that this ad is what made them decide to make a purchase? Chances are, they browsed around your site a bit, checked out product reviews, compared your prices to your competitors’...the list goes on.
(We touched on this recently in a guest post on Wishpond, where we found that nearly two-thirds of customers who click on a given advertisement end up purchasing a completely different item.)
Typically, ROAS is attributed to either First Touch or Last Touch (i.e., the first or last ad or initiative customer engaged with along their path to conversion). While this can certainly provide evidence as to the effectiveness of a given initiative, you’ll need to dig deeper in order to get the “full story.”
Setting Up and Tracking ROAS In Google
To accurately calculate your ROAS in Google Shopping, you must first make sure you have correctly installed Google conversion tracking in the back-end of your e-commerce store.
There are two different ways to do this:
- Google AdWords (Website) Based Conversion Tracking
- Google Analytics Based Conversion Tracking
Before we dive into how to set each up individually, it’s important to keep in mind that you should only have 1 type of conversion tracking active in your Google AdWords account at a given time.
If you attach both, you run the risk of double tracking sales, and ultimately skewing the numbers you are seeing.
Google AdWords (Website) Based Conversion Tracking
Note: These directions are for the new interface
To get started, navigate to the top right of the screen and click on the wrench icon.
This will present a drop down of different settings. Find the “Measurement” column and click on “Conversions.”
This will bring you to the Conversion Actions page where you’ll be able to set up your tracking.
Next, click on the large blue + icon.
Choose the website option as the kind of conversion you want to track.
This will bring you to the set-up wizard where you’ll adjust the settings. First, you’ll name your conversion action as you please.
Second, you select the category for your conversion action, which in this case will be Purchase/Sale.
This next step is where it get’s a little tricky. Obviously, you’ll want to track the value of each individual purchase to most accurately depict your campaign performance.
So, for the purposes of getting started, you’ll select “Use different values for each conversion” and leave the default value at 1.
For AdWords to accurately collect the financial data, you’ll have to make a slight adjustment to the tracking code, which we’ll go over shortly.
Moving down the list, for count choose “every.” This will count each purchase a click brings you. So, if someone clicks on an ad and buys 3 items, each of these items will be counted as a separate sale.
For the bottom chunk of settings, you can leave those as they are. Click the blue “Create and Continue” button to move to the next steps.
Now that you’ve configured the settings for your new conversion action, it’s time to get the code and implement it to you site.
In the “Set up the tag” portion of the process, you’ll be given two options. We suggest the “Install the tag yourself” option so that you can make the necessary adjustment for accurate financial tracking as mentioned earlier.
Next, you’ll have to add your global site tag and event snippet to your sites header.
There are 3 options for the global site tag:
- I haven’t installed the global site tag on my website
- I installed the global site tag on my website from another Google product (example: Google Analytics) or from another AdWords account
- I already installed the global site tag on my website when I created another conversion action in this AdWords account
Choose the applicable option and remember to adjust the code to track accurate conversion value. Directions can be found here: https://support.google.com/adwords/answer/6095947?hl=en.
For the event snippet, the “Page Load” option, and add the snippet to your confirmation page.
Once you’ve installed these snippets click the blue “Next” button at the bottom of the page to complete the process.
Google Analytics Based Conversion Tracking
To track conversions via Analytics, you’ll have to first set up a conversion goal.
To do this, navigate to the Admin tab on the left side column and click.
Next, find the “Goals” option in the Views column in your admin panel to the far right hand side of the page.
Once in the Goals menu, click on the red “+New Goal” button on the top left of the screen to begin building your conversion goal.
Now it’s time to build. In the first section titled “Goal Setup,” select the Place an order option then click continue.
The next step is “Goal description.” Here, name your goal as you please (by default it’s named Place an order).
Leave the goal slot ID section as is.
Under type, you’ll want to select “Destination,” so that a goal completion is attributed when someone reaches your post purchase landing page.
Now that you’ve determined your goal type, you’ll have to set the destination where shoppers will land for Google to count the transaction.
This is typically your order confirmation page or thank you page. For example, if your landing page is www.myecommercestore.com/thank_you.html, you’d set your destination as equals to /thank_you.html.
Keep the value and funnel options set to off. Analytics will count value as long as you have E-commerce enabled in your ecommerce settings.
Click save to finish setting up your goal in Analytics.
But wait, you’re not done quite yet!
Head back over to Google AdWords to import this goal and its values into your Google Shopping campaigns.
Head to the conversion actions settings menu as directed in the last section, but this time select the Import option rather than website.
This will prompt you to select where you’ll be importing your conversions from. Select Google Analytics.
Once you hit the continue button, AdWords will import any and all goals you have set up in Google Analytics.
Select the goal you just created, click import and continue. This will automatically set up your new conversion action in AdWords for you.
Keeping track of ROAS for specific ads, campaigns, and keywords is essential in order to ensure you’re getting the maximum possible value out of each of your paid marketing efforts - and to ensure you’re not wasting money on ineffective ads and campaigns.
As you begin to analyze your ROAS for various campaigns, remember to do so in the context of your overall marketing gameplan. In doing so, you’ll move past simply looking at “what works” and “what doesn’t,” and begin to gain a better understanding of why certain ads are resonating with your audience (and why others are falling flat).
As you know, successful marketing ultimately boils down to getting the right message in front of the right people, at the right time. Using ROAS, you’ll have a much better idea of whether or not you’re making this happen - and will be able to make much more informed improvements to your campaigns moving forward.