ROAS: Bigger is Better Right? : The Commerce360 Blog

In the last few posts we’ve seen that ROAS is related but not directly or proportionally to the actual gross margin you earn from your paid search campaigns, and that believing that ‘keywords have an ROAS’ is a dangerous oversimplification because there are many other variables involved. Putting these aside for a moment, let’s look at a more fundamental question: is maximizing return-on-ad-spend even a good idea?

If the goal is maximizing revenue or profit, maybe not. The assumed correlation just doesn’t exist. Consider ‘keyword A’ with a 417% ROAS and ‘keyword B’ with a 375% ROAS – which one makes you the most money?

The answer lies in the interaction of the average cost-per-click and the conversion rate. If ‘keyword A’ has a $0.15 cpc and a 2.50% conversion rate, and ‘keyword B’ enjoys a 3.75% conversion rate with a $0.25 cpc, then ‘B’ produces a whopping 50% higher revenues and 45% more gross profit at the lower ROAS. (See the table above for a full breakdown.)

This example shows that for every keyword where you review the return-on-ad-spend to make future bidding and budget decisions, you really need to factor in cost-per-click and conversion rate. Add to that the importance of margin and the fact that keyword selection and max-bid are only 2 out of about a dozen factors you can manipulate to impact ROAS (and conversion rate) and we arrive back at the original premise - ROAS needs to die.

It would be great if paid search was a simple little game where the skills you’ve picked up in other endeavors prepared you to easily and consistently win. Once upon a time it might have been.

(Thanks to Bruce Ernst for the math and other guidance.)

Comments

Craig,

I have enjoyed the series on ROAS. Thanks.

But wouldn't it be a more real world assumption to say that the same amount was budgeted for A & B and therefore produced a different number of clicks?

I haven't covered all of the math yet, but I believe that would keep a positive correlation relationship between total profit and ROAS.

Also, the greatest leverage point in a CPC campaign in the conversion rate. That leverage is applied to the revenue and profit.

Further, unless I am missing an accounting standard for CPC advertising, the CPC expense would be subtracted from gross profit and not revenue. I believe that is a mistake that a lot of people make in setting the success of their CPC campaigns with revenue as the goal.

Thoughts?

Posted by: Wilson K. | September 6, 2007 4:37 PM

Wilson - Thanks for the comments and ideas.

It does appear that you need the spend, conversion rate, and CPC to all be higher to produce the 'lower ROAS = higher revenue' case, but there's no reason why that should be a particularly rare circumstance. I think frequently the spend in any ad-group has more to do with available inventory than budgeting, so there is little reason why a higher spend group shouldn't happen to see dramatically higher conversion.

As to your CPC comment, I think you're suggesting that normally you'd calculate ROAS based on profit and not revenue - sure you'd like to, but Adwords and Analytics programs don't have access to profit numbers so they calculate and display based on revenue - which has made that definition something of the standard for online marketing.

Let's hope we can get the market shifted over to a proft focus soon.

-Craig

Posted by: Craig Danuloff | September 7, 2007 1:04 AM