There are so many KPIs out there that it is often hard for most marketers (and founders!) to understand which metrics matter, and which don’t. We know metrics are important, so we tend to track too many of them.
Is there one metric that can be an unequivocal signal of the present and future health of my business?
No, but we can get close.
ROAS is a great performance indicator for 99% of eCommerce brands, and although it is broadly utilized, it is also broadly misunderstood.
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The basics: what is ROAS?
ROAS stands for Return on Advertising Spend, and it is commonly expressed as a multiple (2x, 4x, 6x). It is calculated by dividing advertising revenue by advertising spend.
You can do that calculation across the board (blended ROAS) or you can do it for individual marketing channels.
Although most eCommerce brands will define ROAS as [Sales from Paid ads] divided by [Ads cost] ROAS can technically be calculated from any marketing action that results in a business outcome.
Does that mean everything should have a ROAS?
No. ROAS makes most sense when calculated on direct response, demand generating marketing campaigns.
As part of your marketing you will have to do a ton of campaigns that do not necessarily have a ROAS attached to it, but that positively affect your business.
That blog post you just wrote? No ROAS, but will grow your organic traffic.
That product video your team is putting together? No ROAS, but it will increase your conversion rate.
That awareness campaign you are running on Facebook? Probably has a ROAS of below one, but it introduces new customers to your brand and feeds your high-ROAS audiences.
Although from a cost analysis perspective it is attractive to think everything must have a ROAS, it’s simply not practical and usually leads to slower growth.
Why ROAS should be your main marketing metric
Most brands will use CAC (Customer acquisition cost) as their main KPI, although we know not all customers are created equal. Different marketing channels/audiences/campaigns return variable customer qualities (based on their likelihood and eagerness to spend) and that should be accounted for.
This is particularly true for brands that see high Variance in their AOV, and those who count on LTV to make a profit.
CAC simply doesn’t tell you enough about your customer.
What is a good ROAS?
A ROAS of 1x simply means that you are making enough money to cover your marketing efforts. That, however, doesn’t mean you are breaking even.
After ROAS, you need to input:
- Cost of goods sold (COGS)
- Shipping costs
- Operational costs
- Affiliate commission (if it applies)
The variability in these costs from brand to brand essentially means that the answer to the ‘what ROAS should I aim for?’ depends solely on your cost structure (and your expectations for profit).
Some companies can grow and turn a profit at 2x ROAS, some need 4x or more. This is one of those cases where it does not make a lot of sense to look at industry ‘benchmarks’.
Truth is, a good ROAS is the one that allows your business to grow at your desired pace while matching your profitability goals and expectations.
Additionally, a higher ROAS is not always a positive sign for a business, here’s why.
With ROAS, higher = better?
The only verticals where you should optimize for maximum ROAS are those that are highly commoditized and where growth is almost impossible to come by. In those, it makes sense to try to minimize acquisition costs, since we have already maximized penetration.
That’s less than 1% of eCommerce verticals.
A 10x ROAS may sound great, but it may be stifling your growth.
Think about it this way.
The core of your advertising are your top converting audiences, those give you a great ROAS, since they are so targeted and narrow. Narrow is great for quality, not so much for volume.
And for growth, you need volume. So you will expand your audiences into lower quality segments and lookalikes. The net result is a less targeted audience that results in higher acquisition costs, lower ROAS and lower margins.
For every marginal customer you get, your marketing costs increase, thus squeezing your margins.
In essence, you trade off margins for growth.
So what does all this mean?
That 10x ROAS business is actually growing much slower than they could. By aiming for a higher ROAS, they underinvested in marketing and grew much slower than their potential.
They would have been better served setting a target ROAS maintained over time (let’s say, 4x or 5x) and aimed to maintain that ROAS as they scaled.
Too often we see eCommerce companies underinvest in their marketing in the name of maximizing their profit per unit, when they would be much better served acquiring more customers (albeit at a marginally higher cost) in the name of maximizing their EBITDA.
To wrap up, despite what marketers may tell you, a good target ROAS is that which allows you to maximize your growth while matching your profitability targets. If you have high net margins per unit, you may be better served giving some of that up, in order to grow faster.
As with most things, it pays to have a good handle on your brand’s financials and customer acquisition structure, but a first target to aim for is maintaining your ROAS as you 2x your revenue.
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Thanks to our friends at Wayflyer for writing this post.