We get this question a lot from online merchants. Before we can answer, we need to get one thing straight: ROI is a term from finance that a lot of marketers use to mean something a little different. Read our blog post on How Digital Marketers Misunderstand ROI for more on that. I usually try to use other terms that are more precise. In advertising, when most people say “ROI”, they actually mean “Return on Ad Spend”, which is the total revenue divided by the total ad spend.
With metrics like that, any level of returns can be targeted and generally achieved. If you want a 10:1, that’s possible. 8:1, sure. 20:1, no problem. 4:1, fine. With some time and some scale, there's enough data to determine what parts of an ad account are doing better or worse than a given goal, and you can be more cautious in some areas and more aggressive in others to keep returns at any desired level… plus or minus some variation. That may not happen in the first few months on a new account since there’s usually not enough data to target more precisely, and quality scores are low. But as data builds, targeting a ratio like that is possible.
Given the nature of the ad auctions, growing accounts requires increasing bids to outbid competitors who are currently buying those clicks. And that means when trying to grow, there’s increased costs for each additional click, and thus decreasing marginal profit as you ramp up. If you want a really high ROAS ratio, that will limit how much total revenue you can bring in while still achieving your target ratio. Growing past that point requires sacrificing some additional margins in order to get more profit at lower margins. Truly optimizing to drive the most possible profit across all transactions is a different game than trying to drive a consistent average margin on the average transaction.
Here’s an example. Let’s say a business has 30% gross margins and is willing to spend 10% of sales on advertising. In other words, they might say they want a 10:1 ROAS goal… and that can be done. They might find that, at that level, they’re able to spend $10K monthly and generate around $100K in sales, ending with around $20K in gross profits after ad cost. They might want to spend more, but there just aren’t more clicks to buy at those bid levels. Maybe if they increase their budget to $15K, cost per click goes up on the extra ad spend, so they only get an additional $30K in sales, for $130K total revenue. Their ROAS dropped from 10:1 to 8.7:1. That means their margins are thinner on average, but they still have more total profit because they made $9K in additional gross profit on the additional $30K in sales, and presumably their business overhead didn’t change, so those gross margins are what drove profit to the bottom line. Even after covering the increase of $5K in ad spend, they’re left with another $4K in profit they didn’t have before.
Take that same example. They might want to have higher margins and change to a 20:1 ROAS goal. By cutting back on the account, they might find that they can achieve that, but only on a smaller pool of available clicks that they can get much more cheaply. So that might limit how much they can spend to $2K per month, even though they still want to spend their $10K budget. And that $2K only gets them $40K in sales, with $12K in margins, and only $10K toward the bottom line after paying for the ad spend. ROAS targets that are too tight can restrict sales and decrease the total profit that’s achievable.
ROAS often goes down while profit goes up, and ROAS can go up while profits go down. This is why ROAS is not a useful goal when you actually want to maximize business profit. For more on this see Why ROAS Bidding Kills Ecommerce Profit.
Because of these sorts of dynamics, most of our clients don’t use only a ROAS target. Maybe they have an idea of one as a general ballpark. But we often take things a bit further after achieving that and have some more nuanced conversations on what we can do to drive more business growth profitably, if it makes sense to do so, or where we can trim costs. Most businesses have different margins on different products or product lines, so blanket ROAS goals across the entire business can also hurt total profits by misallocating ad spend on low margin products.
For some clients, we aim to deliver a given ROAS if that’s actually a useful goal in their scenario. With others, we’re trying to maximize total profits, understanding that margins on some sales are thin and on other sales they’re healthy, but even some sales with thin margins are adding additional profit to the bottom line. And with some aggressive clients, we’re actually working on maximizing long-term shareholder value. With that, we’re modeling the customer lifetime value and often spending more money than the profits achieved on an initial sale, knowing that the real profit comes in future orders, but still balancing the costs and the net present value of projected future returns in a way that’s designed to maximize total streams of profit over time.
To sum this up… the ROI you can achieve is a more complicated conversation, and that depends a lot on business goals, gross margins, and the competitive landscape. Until we dig into those details, we can’t possibly know how much volume you can drive at various budget levels and what sorts of returns are attainable. There’s no substitute for having real data and a real understanding of what drives profit for a particular business.
Psyberware specializes in managing online advertising for ecommerce businesses, and nothing else. If you want to build a great relationship with a group of dedicated people who really understand ecommerce, get in touch with us.