What is considered a “good” return on ad spend?

by Josh Biggs in Finance on 6th June 2019

Many web business owners want to know how much they should spend on advertising, and what a good ROAS is considered to be. If you aren’t familiar with modern digital marketing, you may also be wondering the differences between ROI and ROAS.

In this article, we’re going to briefly summarize the difference between ROAS and ROI, help you figure out what a good ROAS for your company is, and show you several examples along the way.

How ROAS differs from ROI

With ROAS, your gross revenue is measured against everything spent on advertising. This allows you to gauge how effective your online ad campaigns are. To make it really simple, ROI only looks at how much you spent, and how much you profited. You look at (net profit / net spend) * 100, for example, so if you spend $5,000 and earn $10,000, you have a 100% ROI.

ROAS, on the other hand, goes (ad revenue / ad spending) * 100. So if you make $10,000 and spend $5,000, you have an ROAS of 2x (200%). ROAS only considers the direct spend on advertisements, whereas ROI considers all associated costs.

With ROAS as a metric, you’re able to fine-tune your advertising campaigns, because you’re able to figure out if your ad campaigns are actually effective, including number of impressions, ad clicks, and overall ad revenue. It focuses entirely on the ad campaign, nothing more – thus, ROAS won’t help you figure out if your advertising department is worth it or not. You need ROI for that. ROI and ROAS each have an individual purpose.

Example of effective ROAS

To show you an example of an effective ROAS-based marketing campaign, we’ll turn to a story from Inflow. They helped a trendy design apparel company achieve a 360% ROAS within a month, in their Google Shopping Campaign.

How they achieved this return on ad spend was simple. They looked at Skreened’s top-selling products, which were t-shirts with meme slogans (“come at me, bro”). As their case study shows, they achieved this using a three-tier campaign strategy. You can read the entire case study in the link, but to summarize, they figured out the best keywords for the products being sold.

However, because Google doesn’t allow for targeted keywords in PLA campaigns, they needed to create filters to tell Google which search queries to not include them in. Thus leaving only the most ideal search queries remaining.

Here’s a graphic chart of the three-tiered campaign approach that was most effective for them:

What is a good ROAS?

And now to finally answer the main question, but be prepared to be disappointed with the answer. Because what is considered a “good” ROAS is that it depends. If your margins are sky-high, a return of 2x is ‘acceptable’. To follow along, you should use an ROAS calculator.

However, if your margins are a bit tighter, you might need something more along the 5x line. So for example, if you’re spending over $50,000, a 3x is considered a good starting point. If you spend $50,000 and earn $150,000, that’s a 3x return, which gives you room to be profitable.

A lot of CEOs and marketing managers get a little too hung up on getting the highest returns possible. A 10x ROAS is not always possible, especially if you’re spending a lot of money. Sometimes you might see a 10x ROAS when you’re actually spending very little, or you’re just focusing on retargeting.

Say that your average order value is $50, and your average cost of goods sold is $12. Now input your ad spend, maybe around $50,000 per month, and place the return at 2X. The profit comes out to $26,000 which isn’t bad, but it likely won’t cover your overhead by itself. Now if we had a 3X instead, that’d be $64,000, which is marginally better.

Now if we play with this a bit, let’s pretend your ad spend is $100,000 monthly, and you get a 2.5X ROAS. Even though your return drops a bit, we’ve actually made more profit at $90,000. This shows us that you shouldn’t get hung up on having the highest ROAS possible. You can spend a ton of money on ads, have a lower ROI, but still make huge profits. There is no one-size-fits-all for ROAS, but a 3X is generally accepted as a good range.

Others might say a 4X ROAS is more ideal. True, higher is better, but realistically, it’s all highly dependent on your operating margins. Let’s say you run a web store on very thin operating margins. If your gross margins are only 20%, and you have a 4X ROAS, that means you’re spending 25% of your revenue on advertising.

Effectively, you’re losing 5% of revenue on each sale, wasting all of your gross margin. Now, if you had a high margin item such as a recurring subscription, your operating margins might be around 70% or more. A 4X ROAS would be pretty amazing.

Return on ad spend isn’t the only metric you should be tracking. If you’re a marketing startup, your cash burn rate and runway are vital to keep an eye on. Check out this guide if you’re looking for extra reading and build up a bank of KPI’s to monitor.

Categories: Finance