Goodbye ROAS (and Good Riddance) – It’s Time For a Better Metric
January 06, 2021
It wasn’t too long ago that if you declared something like “ROAS is dead,” online marketers would look at you like you’re crazy. After all, for a very long time, Return on Ad Spend (ROAS) was really the only way that you could measure how effective your ad campaigns were.
And, to be honest, it still is a very good way to measure just that – how many sales your online ads generate, how your digital conversions directly contribute to incremental, top-line revenue. And, for brands that are primarily seeking new customers, ROAS is still considered a valuable metric.
But there’s a danger in using it as your sole focus, your primary KPI, because it doesn’t give a full financial picture of the effectiveness of that ad and how that conversion truly impacts the bottom line of your business.
So why would businesses consider sales, not profit, as the most important way to measure success? There’s a historical reason why ROAS has dominated for so long.
How we got here…
Traditionally, retail sales teams accrue approximately 15-20% of every dollar sold, and that would go into a “trade budget,” which would then be used for promotions and advertising costs to be spent against the retailer. With ecommerce retailers like Amazon, there are co-op fees (cost of doing business) that range from 15-25% before any promotion/advertising fees.
That said, trade budgets are almost completely spent before leveraging available demand drivers that are necessary to grow the business. In the first couple of years, levers like sponsored products advertising can cost startups (new to economy brands) an incremental 10-20% to drive awareness and new customer acquisition while costing more established brands ~5-7%.
So when Amazon introduced self-service advertising, sales teams looked to the marketing team to cover the incremental digital marketing costs. Paid search and sponsored products on marketplaces like Amazon and Walmart are a whole different animal, and when marketing teams took these on, they needed justification for this spend.
ROAS (revenue divided by ad spend/cost) emerged as the metric to use, as ad-attributed sales and advertising spend are readily available, easy to calculate and easy to understand. Benchmark ROAS was also relatively easy to determine, both for verticals (e.g., CPG) and by media type, with averages across all industries at $2.87 and within ecommerce, closer to $4.
So if for every dollar you spend on advertising for your ecommerce product, you get four in return, what’s the problem?
ROAS creates (false) limitations
When your primary KPI is ROAS and you are using algorithm trading (as all online marketers are) the machines learn to optimize by that – and that metric only. When this occurs, and ROAS is the only outcome that you are bidding toward, it creates a ceiling on your ad spend, limiting potential, instead of acting as a floor from which you can generate growth.
For example, you might engage in dayparting with a fixed budget, and once you achieve your ROAS goals for the day through morning bids and impressions, you stop spending. But this misses out on potential capture of late-day or evening shoppers who might have different shopping behaviors. Read more about what a flexible budget does for you in our case study.
ROAS creates a (false) impression of daily success
Another common issue with ROAS is its narrow focus on one marketplace. For instance, say you are spending money against Amazon, meeting your ROAS goals. But the dollars you are spending in Walmart or Target’s marketplace, while they look to be performing lower, are more successful in the long term because they are on SKUs that carry a higher margin.
While some technologies might be able to compare apples to apples in one marketplace and notify you of this, proprietary platforms and agencies would not be able to do so. Moreover, many of those reports you get from the agency come in at the end of the week or even month, so your learnings can’t be implemented in real-time.
ROAS (falsely) says you are making money
When, in fact, you are not! And in many cases, it’s not even about making a profit, it’s about not losing money…
It’s difficult enough to protect your margins online. Why? Because brick and mortar is where the profits are – brands can leverage economies of scale, distributing their product in giant cases and efficient shipments to retailers, who then sell those individual items in person, at a much higher margin than would ever be possible online.
Now what happens when brick and mortar more or less shuts down, as it did this year? And online is your only option? Instead of working directly with warehouses and giant retail buyers who write purchase orders, everything is automated. POs are generated automatically, and with single orders and fulfillment you lose massive amounts of efficiencies – and with that, money.
For example, it’s quite possible to generate four or five entirely different net profits from a single SKU, depending on which platform you’re selling on. Many have hefty referral, storage, and fulfillment costs – but again, it all depends on the product.
You might have one product that shows ROAS of $4-6 per one dollar of ad spend, which looks great on your P&L, right? But there might be one marketplace out of those four where you’re losing $0.40 with each unit due to excessive bagging, set creation fees or cash terms. If that platform is where you’re spending the most and driving the greatest volume, it counteracts the positive ROI of your other channels, leaving you in the red overall on that product.
To see how one beauty brand overcame this negative influence and made AI-driven, smarter choices in their ad spend in non-branded/category search, focusing instead on net profit margin instead of ROAS, see our full case study.
In the end, it all depends on what you care about. In football, you could cheer when your team has the highest number of completions, or your favorite player beats a rush record. But what most people care the most about is the final score. If you focus instead on the short-term metrics that show you success in just one part of the game, you risk losing sight of what really matters: the final score. And in business, that’s your bottom line, your profits.