What? Is ROAS not the best metric for my e-commerce business? How come Google and my agency are using it as the primary KPI for performance then?
Well, the answer is relatively straightforward. In theory, ROAS or Return On Ad Spend is a great metric. If the Return is greater than the ad spend, you’ve made money on the campaign. However, the Return (profit) is not readily available in e-commerce analytics, thereby unavailable to Google, Facebook, and other marketing channels (that’s why we’ve made ProfitMetrics). So, along the way, they decided to switch Return for the readily available, but untransparent Revenue. So most often, ROAS is short for Revenue on Ad Spend, which is an entirely different thing than Return On Ad Spend.
Revenue tells you nothing about margins, fixed costs, payment fees, and shipping costs, which are some of the most critical factors in running a profitable e-commerce business.
Let’s make one thing clear before we move on: ROAS has been considered best practice for a long time simply because it was the best metric available to most e-commerce businesses.However, as you will see below, ROAS based on Revenue comes with pitfalls that may be blocking your profitability and success.
Pitfalls of ROAS as your KPI
First off, if you are using any tactic based on revenue, including ROAS based on Revenue, you are also allowing that:
Your marketing spend is allocated to your highest-priced products – not necessarily the ones with the highest profits.
You lose money. Either by loss of order volume or on individual lower-than-average margin order combinations.To minimize the negatives caused by ROAS based on Revenue, you can apply one of three tactics: Let’s have a look at the first one…
Tactic 1: Average ROAS target
The first tactic is to work with an average of your product margins or an average profit ratio based on order history – typically one year of order history. Essentially, this is a “win some, lose some” approach, in which you accept that not all orders will be profitable, as long as the overall result is positive.
The pitfalls of this tactic are:
Unavoidable loss of money on some orders.
A high risk of closing ads for profitable products and orders with low sales price but high margins.
Continuous need to validate ROAS target as product catalog and order mix change over time.
Tactic 2: Differentiated ROAS strategy
To limit the negative effects of the average ROAS based on Revenue, it has become standard to use a differentiated ROAS target. In short, you do the same as with Tactic 1, but you divide the products into different ROAS targets – usually three different targets.
This approach does have a positive effect, compared to Tactic 1. However, it has one major pitfall:
People do not necessarily buy the product they click on in your online advertising. In other words, people can enter your webshop via a low ROAS target ad and purchase a product with a higher break-even ROAS – meaning you lose money but have no way of identifying the issue.
Tactic 3: Highest break-even ROAS
A third tactic is finding the highest break-even ROAS in your product catalog and use this as your target ROAS. This approach is an effective way to make sure that you never lose money on individual orders. However, this tactic has an obvious downfall:
You very likely put an unnecessary limitation on the order volume of products with lower break-even ROAS.
It’s simple. If you are willing to pay less per order, you will receive less exposure and sell fewer products. So we have concluded that ROAS does not allow you to fulfill your online advertising’s full potential. Let’s have a look at POAS and how POAS will enable you to do just that.
What is POAS?
POAS = Profit on Ad Spend. ROAS = Return (revenue) on Ad Spend
POAS is short for Profit on Ad Spend. It is an alternative abbreviation for the original ROAS which, as explained, was meant to be Return on Ad Spend but ended up becoming Revenue on Ad Spend.
To find the POAS of your online advertising, you divide the gross profit attributable to the online marketing channel with the ad spend. These numbers are directly comparable, meaning that a POAS higher than one (1) means you have made money.
Why POAS is the better metric
Let’s make this easy with an example. We will show you how the outcome of the same four orders looks entirely different with ROAS compared to POAS.