Mommy, where does ROAS come from?

By Jeff Campbell, VP, Search Account Director

It’s always been a sort of mystery to me where Online ROI or ROAS (Return on Ad Spend) goals come from for Paid Search, Display or Email campaigns. As we gain new clients, we inherit old goals from previous campaign managers. But who set these goals? Are they right?

As I see it, once you hit the breakeven point of profitability, it should be off to the races on driving volume – right? I’ve discussed the relationship between efficiency and volume before and you can have both… but efficiency must be found first.

So how do you determine true efficiency? First, you must have a true picture of ROI/ROAS by actually calculating the goal based on your business margins and operating costs. I have a hunch that (too) many online marketers/retailers look at historical PPC reports and just tack on a ~10% improvement to set the goal. Unfortunately, this is not a measure of true profitability and therefore makes it pretty tough to justify major increases in budgets.

Whether you enjoy Gross Profit or Gross Margin Percentage, you need to first calculate your Cost of Goods Sold. I won’t pretend to be your accountant, use the links or ask him or her. Armed with this important data, you can get to your true ROI breakeven point.

Math Problem:

Q: If you sold $10,000 in widgets online and it cost you $5,000 in media costs, were you truly profitable at that $2 ROI? Widgets.com has a 40% Gross Margin (it’s a good business to be in).

A: As 40% of $10,000 is $4,000, it looks like spending $1k more than you earned is a short lived business model. Now, if you had sold $12,500 in widgets for that $5k in media, you would have broken even ($2.50 ROI). A dollar over $12.5k and you’d be making online profit. Widgets.com would then need to determine the profit level it wanted to make (say 15%), back into that ROI goal and task the agency with hitting that goal ($2.88). Once the campaign managers hit that true ROI goal, they should keep the efficiency dials steady and put the foot on the volume pedal – no need to be any more efficient or it will come at the expense of absolute revenue & orders. Don’t forget to factor in any additional COGS such as tracking or agency fees.

It’s decently simple, so I hope all marketers are going through this process before tasking their agencies with true ROI goals. Further, I hope agencies realize the power of pushing revenue volume versus just improving efficiency. Next step, if you sell offline (i.e. brick & mortar) determining the online to offline impact is the next hurdle in looking at the true profitability of your online media investments. Maybe next month I’ll tackle that one ;)