Return on Ad Spend (ROAS): The first (but not only) step in analyzing e-commerce results
E-commerce executives have long debated the magic metric, digging deep into the alphabet soup acronyms that might hold the answer to all their business growth questions: ROI, CAC, ROAS, AOV, COGS… to name just a few.
One of the most popular metrics used by e-commerce professionals, especially those involved in digital marketing, is ROAS (Return on Ad Spend). ROAS is easy to measure and is commonly used to evaluate the effectiveness of a marketing or advertising campaign. To calculate ROAS, simple divide Revenue from Ad Campaign by Advertising Dollars Spent:
Let’s take an example. In a month that a clothing manufacturer spent $10,000 on advertising, it sells $50,000 of clothing. In this case, the ROAS is five, which means for every dollar spent, the retailer made $5.00.
What is a good ROAS? According to Insight Matters, a good rule of thumb for ROAS is between 5 and 10 percent. A very high ROAS means you may be leaving money on the table by not investing more in your advertising efforts, and if it’s too low, your profit margin for products sold needs to be high enough to compensate for a lower than ideal ROAS.
Many retailers think the best way to boost revenue quickly is simply to increase their advertising spend. However, spending 2x on advertising to drive 2x on revenue won’t make your ROAS any better or your company more profitable unless your gross margins are very high. Instead, increasing conversions to sales from existing traffic, paid or organic, is a more sustainable and profitable way to drive sales. In the quest to increase conversion rates, many companies run A/B tests with different Call-to-Action (CTA) placement, colors, headlines and design elements. However, the most effective way in 2022 to increase conversions is through immersive shopping experiences, such as AR/VR, Virtual Try-On, and more. Note that Shopify reports a 2x, or 200%, increase in conversions when AR is used for product visualization.
While every business would love to focus on one magic-bullet metric, such as ROAS, the truth is that every business is different, and applying one metric or industry benchmark for all products and companies doesn’t really work. Savvy business executives must consider other, less objective factors such as competitive threats, resources, the company’s experience with a specific channel, and the nature of the buyers responding to the campaign. Will the buyers driven to your online store be the kind of buyers that buy a lot, driving Average Order Value (AOV) up? Or are you attracting low-end buyers who are price-shopping and don’t deliver long-term value for your brand? If they are long-term, repeat customers, do they also buy premium products with high gross margins?
In the great debate about e-commerce metrics that matter, one article by Common Thread goes so far as to call ROAS a “terrible metric.” The article suggests that by relying on a “shallow” metric that is easy to measure, business leaders could ignore more important business information that usually requires more work to acquire.
From our standpoint, ROAS is a great metric to measure, but keep in mind that it only provides a surface view of your e-commerce website’s value. The most successful e-commerce players focus on the foundations of a solid business plan by selling products with good gross margins, making sure they are optimizing conversion rates on their e-commerce website and product pages, and delivering highly engaging and immersive customer experiences that keep customers coming back for more.