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Profitability vs ROAS – How do you know if your ads are profitable? 

February 8, 2024
Byron Marr
written by Byron Marr
ROAS feature image

An accurate measure of profitability is about more than just ROAS.

Marketing and business goals

Return on ad spend (ROAS) has long been a measure of PPC and paid social campaign efficiency.

While it’s certainly an indication, given that the higher your ratio of ad revenue to cost, the more you’re returning per £1 spent, it’s not truly a measure of actual ‘profitability’.

This is where things can become quite complex, as there’s an interplay between ROAS and ad profitability. However, in isolation, it’s not a measurement of success.

Many SME owners/directors faced with this challenge will turn to benchmarks as a guideline for whether campaigns should be on or off, increased in funding or kept as they are.

Many blogs and articles online cite that a 4:1 ROAS is deemed ‘good’ (returning £4 for every £1 spent on advertising).

The challenge here is that every business will have very different average order values and, most importantly, margins on the product itself. So, while it’s always good to have a starting point, benchmarks don’t consider the nuance your business needs.

Let’s take a look at a simple example:

Business 1 – 4:1 ROAS

Spend – £1000

Revenue – £4000

Margin – 60%

Margin value – £2400

Gross profit – £1400 (Margin value – ad spend)

Business 2 – 4:1 ROAS

Spend – £1000

Revenue – £4000

Margin – 35%

Margin value – £1400

Gross profit – £400 (Margin value – ad spend)

In both instances, we can see there is at least ‘profit’ being returned, with varying product or service margins, with the same ROAS, and very different commercial outputs.

Of course, there are numerous other additional factors to consider: tax, shipping, management fees, un-measured conversions, impact on other marketing channels, etc. 

What’s important is to get at least to a point where you can see if your ads are returning profitably on ad spend and product cost. This will ensure that your activity isn’t wasting spend and costing you money.

Optimising for growth over profitability

I’ve focused on scenarios where current performance isn’t profitable because it’s the most common issue people have. 

There’s also a use for understanding ad profitability for your business on the flip side, where a brand wants to focus on growth while maintaining a minimum viable return.

Most frequently, this is where there’s a recursive revenue element, high CLTV outside of recursive or perhaps VC funding and, therefore, a focus on acquisition for a period over direct return.

Knowing where you are and where your minimum viable return is still helps here. If you’re currently targeting and achieving a ROAS above that point, then you’re potentially restricting your customer acquisition volume and can relax targets.

Impact on campaigns

On a more tactical day-to-day side, campaigns in key ad channels, Google Ads and Meta in particular, need the correct target to be input to work towards giving you the desired output.

You’ll be asked for your target ROAS when you run any campaign that is optimising for conversion value (revenue).

Smart Bidding in Google Ads is very good at optimising for what it’s been asked to do. Over the years, I’ve seen in countless accounts a wrong target being input and the campaign then heading in that direction. While it might not be a desirable outcome for the business, it’s not technically incorrect.

If the target ROAS is too low, the campaign will grab clicks in an attempt to optimise for the maximum volume of sales below your profitable level return. 

Too high of a target ROAS and the campaign will stop entering into auctions, drying up sales and clicks, due to the goal being so unlikely. 

It’s not as simple as just inputting the correct target and then getting results. 

You have to consider what your baseline performance is and then find out where you need to get to (also understanding what’s involved in improving performance along the way to achieve it – no pressure).

In short, if you don’t know what ‘good’ looks like, then you can’t aim for and achieve it. 

How do we calculate what our ROAS should be?

If you’re starting to feel like I’m giving you a headache, then you’re not alone!

As a specialist who’s been working with e-commerce SMEs for the past ten years, this is the number one conversation that comes up and for good reason. 

As we’ve seen, marketing channels and specialists optimise and measure based on ROAS, which they should because they have to. Finance directors and owners want actual business-level profit, which is also correct.

I used to spend hours in spreadsheets for every client. Modelling this out and ensuring that campaigns are commercially underpinned means that you can then focus on hitting the goal and then scaling up spend in a sustainable way.

Thankfully, having locked myself away in a room for a number of days in Q4 2023, I’ve created a free calculator tool that makes this much much simpler.

Our ad profitability calculator asks for five basic pieces of information regarding your ad performance. From that, we can tell you if your current performance is profitable.

We also go further and show you what your break-even point would be in terms of ROAS and where a minimum suggested target should be.

So, in two simple steps and in under two minutes, you’ll see where you are, where the cash burn stops and then where the profit is for your business – cool, huh?

The results are also emailed to you in a PDF so that you can share them with your finance director, marketing team or whoever else for further discussion.

Summary

My hope from this is that we can simplify the complexity and reduce the disconnect currently between marketing metrics and business goals. 

For SMEs, ad spend is usually one of (if not) the highest monthly outgoings, and Google Ads is usually the highest revenue-generating channel. Any efficiency that can be made here should add material value to the business.

How do you get your performance from where you are to where you want to be? Well, that’s a much bigger question for another blog post.

Try our calculator tool for yourself here.

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