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®.
In this example, we apply the ROAS tactic Highest break-even ROAS (Tactic 3). The ROAS target is set slightly higher than the Highest break-even ROAS among the four orders to ensure every order is profitable.
Notice the considerable variation of the break-even ROAS. The frying pan only requires ROAS 2.12 to break even, whereas the mixer requires ROAS 8.88. This scenario is not uncommon in e-commerce, where webshops often have high-profile brands and private-label brands in their product range.
If we compare the ROAS target of 10 to the actual ROAS of the four orders, we realize that the responsible online marketer would shut down the advertising for three out of the four product campaigns.
Now, let’s look at what happens when you integrate ProfitMetrics.io and enable your online marketer to use POAS® as the key metric to measure online ad performance.
As we’ve established, a POAS® above one (1) is profitable. A primary advantage of POAS® is transparency; you know which campaigns make money and which do not.
In this example, it turns out that all four orders are profitable! Also, the three orders that were shut down, using ROAS based on Revenue, are the most profitable – an insight that is impossible to get without using ProfitMetrics.io.
Now you might say: “Well, my margins don’t vary a lot – so I guess POAS® is irrelevant to me?” The answer? “Absolutely, not!”.
Variations in margins are just one of the factors accounted for when using the POAS® metric with ProfitMetrics.io. Other factors include product promotions, discount codes, variations in shipping costs, payment fees, and all the other variable and fixed costs of your business.
Let’s illustrate this with another example…
In this example, the margins between the two products are almost identical, but as you may have guessed, the product promotion on the right-side product affects the break-even ROAS. If you have continuous product promotions, it could become quite challenging to keep track of and balance your ROAS target.
As we switch from the revenue-based ROAS tactic to profit-based POAS® in the example below, you will see how POAS® makes it much easier to measure and understand your real performance. With POAS®, you do not have to set special targets for promotions; as long as the order is above POAS® 1, you have made money. ProfitMetrics.io considers all costs, and you can rest assured that you do not get any unpleasant surprises when the accountant looks into the numbers.
Profit data and POAS® in Google ads and Facebook
ProfitMetrics.io is built on two key values - transparency and actionability. We build software products that enable you to easily understand business performance and take the necessary actions to improve it. To reap the fruits of profit data and POAS®, you need to have the data where you optimize. In other words, you need to have profit data in your marketing channels like Google Ads and Facebook Ads.
Our Plug'n'Play connections enable you to have profit in Facebook Ads, as well as, profit in Google Ads. The data is attributed to the individual campaigns, ads, keywords etc. according to the attribution of the specific marketing platform.
With profit in Google Ads, you will be able to shift smart shopping/bidding targets to profit and do profit bidding. We've seen examples of customers saving up to 60% on ad spend from simple change, while revenue went up. It makes a real difference. Guide to activating profit in Google ads.
ROAS vs POAS® summary
ROAS has only become the best practice because it was the best practice that was readily available. Using a revenue-based metric like ROAS leaves you with an untransperant setup that necessitates a high level of one-size-fits-all rules and guesswork to compensate for its shortcomings. In short, ROAS is complicated to understand and use. And more importantly, you will miss out on potential profits no matter which ROAS tactic you apply.
POAS® is a straightforward best-practice that is easy to use and understand: If your gross profit is higher than your ad spend, you’ve made money. With ProfitMetrics, POAS® is available for use directly in Google, Facebook, and other paid marketing channels, you can dedicate time and budget to the ads that make you the most on the bottom line. Full transparency and no guesswork!
POAS® outperforms ROAS any day.
Read the danish version about POAS®
Read more about our profit bidding and POAS® marketing software
