ROAS (Return on Ad Spend) is the industry standard for assessing and reporting the performance of paid digital campaigns, but it really sucks as a KPI.
To be totally fair, ROAS has a few strengths. It is easy to calculate (even easier than ROI): Revenue / Ad Spend. It is a relatively clear measure of efficiency. It is a metric that can be used across channels and media. But that’s about it, and when you start digging in, ROAS has a lot of limitations, including one huge killer that makes it, well, dangerous:
You can go out of business optimizing to ROAS.
And that is where ROAS really comes into its own as a sucky KPI. Frankly, I want KPIs that align with the financial health of my business and I certainly want that alignment in KPIs used for assessing campaigns we run for clients. ROAS doesn’t do that. ROAS is an efficiency metric. It has very little to do with how much money you make. This is because (like ROI) it is only a good metric when comparing exactly the same media spend. The problem is, nobody does that.
When you look at marketing reports across the industry, you will almost always see ROAS as a standard KPI, even when marketing spend changes. And this is where the danger part comes in. ROAS works as a comparison of efficiency, and not magnitude. An ROAS of 6 is more efficient than an ROAS of 5, but that doesn’t mean you made more money (or any money, but I will get to that). An ROAS of 6 on $10 did not make you more money than an ROAS of 5 on $10,000,000. That is a fairly obvious example, but marketers often treat ROAS as a KPI in isolation, which means you can easily reduce the magnitude of returns in the search for higher efficiency. Google even allows campaigns to use ROAS as a target for bid optimization, regardless of the effects on magnitude. Ponder that for a moment. And while it seems crazy, we have seen marketers make the decision to optimize for ROAS, opting for efficient returns even when the magnitude wasn’t enough to make payroll and keep the lights on.
Which brings us to the second danger with ROAS which is that it is based on top-line revenue, and not profit. This is why you can have positive (>1) ROAS and still lose money. This can happen when the efficiency of the return isn’t enough to cover costs. Unfortunately, many marketers aren’t given deep enough financial information to know whether campaigns are profitable or not. They just have this one metric which will only ever tell them if campaigns are so grossly inefficient that they aren’t even covering revenue. Again, I want metrics that alert us when we are even slightly less profitable, and not just when the bus is so far off the road that it is lying at the bottom of the canyon.
So what’s a good metric? Total post-marketing profit (aka Contribution Margin), which I will cover in an upcoming post.