Return on advertising spend (ROAS) is a critical metric for measuring the effectiveness of your marketing dollars. In fact, in my opinion, it is the single most valuable metric for marketing teams. It gives every channel manager, and the team as a whole, a common metric to measure, compare and optimize results. Without such a singular metric, it is easy for channels to get out of sync by focusing on disparate data that skews your marketing insights.
Sounds great, right? Well, the catch is that there are a few ways to calculate ROAS and it is important to understand the nuances so you can determine what works best for your marketing team.
The most common expression of ROAS is as a percentage on the return, using the formula spend/revenue times 100. So if you spent $10K and received $100K in revenues, your ROAS would be 1,000%. I don’t know about you, but I hate looking at large percentage numbers (unless I am looking at my stock portfolio). Trying to make sense of ROAS by channel with percentages ranging from 833% to 1,055% doesn’t look right to me and it is hard to know what that really means. It can be especially confusing since a lower percentage is a better ROAS in this calculation.
An alternative ROAS calculation is as a dollar amount. The calculation is revenue minus spend divided by spend, so with my above example, the 1,000% ROAS would be $9 ($100K-$10K/$10K=$9). This means for every $1 we spend, we generate $9 in revenues. I like this number more than the traditional calculation because I know exactly what it means for my bottom line. Plus, in this calculation bigger is better so my brain likes it more too.
However, my new favorite way to express ROAS is as an expression of cost of revenues. This calculation is simpler too (ad spend divided by revenues). So again, using the data above, the ROAS would be $10K/$100K=10%. Looking at this data across channels, I am able to see the percentage of my revenue that is going towards advertising. Using this calculation ties things more directly to profitability and revenues. It allows marketers to take into consideration margin (or cost of goods) and manage campaigns to be below a specific percentage of revenues.
Which is right for you? They all work, but the important thing is for the whole team to use the same calculation. This gives you apples to apples comparisons and helps you understand which channels are the most profitable. Once you get to this point, you can start adding in your key performance indicators (KPIs) and marketing goals to better understand how each marketing channel is driving specific results. For example, being able to see where new customers are coming from or which channels drive higher order values and/or higher margin product sales is key to truly optimizing your marketing dollars. Math lesson over, now get back to work (or number crunching)!