Return on advertising spend (ROAS) is a metric marketers use to determine how well their advertisements are performing overall, and which campaigns specifically are performing best. By taking the revenue you received from advertising and dividing it by the cost of the ad, you get a metric that tells you how much money was generated per dollar spent.
Example: If you spend $500 on advertising, and the revenue from your campaign is $1,000, then your ROAS is 2:1, or 200%. This means that you made $2 for every $1 spent.
If you search around the web, you will notice that most articles say marketers should simply divide the revenue by cost to determine their ROAS. What they don’t tell you is how to actually track the revenue and calculate all costs associated with a particular advertising campaign. In this article, we will answer the question of how to measure ad performance.
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Step 1: You need to know what advertising source generated a new customer.
To have a better understanding of how your ads are performing, you will need to be able to trace new customers back to their source. In other words, you will need a way to:
- Track new customers
- Know what advertising source they came from
For a lot of small businesses, this simply means asking new customers how they heard about you. If you are a doctor, you can have your receptionist ask new patients how they heard about your practice. If you give out a questionnaire before you start working with a new client, have “how did you hear about us?” as one of the questions.
If you have a situation where an online advertisement is sending people to a signup page on your website, you can add code to your website that shows you where on the web users are coming from. So, if you have a “contact us” button on your website, the code will enable you to see that the person was on your Facebook page before filling out your “contact us” form.
Here are some ways you can track new customers:
- Promotion code – By using a discount code that is specific to an advertising campaign, you will be able to tell when a customer purchased your product after seeing your ad. Unfortunately, you won’t know every customer that came from the ad, as some will forget to use the code, or purchase after the code has expired.
- Ask your customers – Ask new customers how they heard about you. This tactic works well for a doctor’s office or a real estate agent, but not as well for a clothing store or restaurant.
- Tracking phone number – Use an 800 number that is separate from your business number to track people who call your business after seeing your ad. Learn how to set up call tracking here.
- Tracking URL – Create a custom URL for the advertisement that tracks visitors (such as yourwebsite.com/ad), by using a redirect to a tracking URL.
- HTML code – By attaching a code to the backend of your website, you will be able to track where on the web users were before visiting your site.
Though you will probably not know every new customer that comes in from your advertisements, by using the methods above, you should get a good idea of how your ads are performing.
Step 2: You need to know how much each new customer is worth.
You should now understand how to get a rough estimate of how many new customers you are getting from your advertisements.
Another issue with most definitions of ROAS, besides not mentioning how to track customers, is that they don’t take into account the future revenue that will be earned from each new customer.
“In a perfect world, Return On Ad Spend (ROAS) would be based on the Lifetime Value of a new customer or prospect. Marketing strategists may risk making decisions with incomplete data if they only focus on the revenue generated in the initial transaction.”
–Andrew Miller, Co-Founder, Workshop Digital
Acquiring one new customer will probably mean more revenue for a dental practice than a shoe store. Not only are dental services generally more expensive than shoes, but dental patients tend to be recurring, high-value customers. That is why you need to think about a customer’s lifetime value when determining your ROAS.
What Is Customer Lifetime Value?
Customer lifetime value (CLV) is a prediction of how much profit your business will gain from a customer throughout their lifetime.
A customer’s lifetime value is important in determining return on ad spend because the revenue generated from customers is not just what they purchase today. You also need to consider how much they will purchase in the future. If your customers have a high lifetime value, then you can afford to spend more on your advertising now than a company that attracts customers that only need to buy from them once or twice.
Investing In “Good” Customers
Different customers will have different lifetime values. Though it typically costs more to acquire a “good” customer, they will spend more in the future. It may be worth it for your business to spend more on advertising to get good customers who will spend more in the future, even if you could get more business from customers now who will likely never buy from you again.
Example: If you own a gym and advertise a class for beginners, you will likely get more sign-ups as beginners won’t already belong to a gym. However most of them are unlikely to be long term customers. Instead, if you market an advanced class and are able to get people who belong to other gyms to try your class, it’s more likely that they will have a higher lifetime value if they become members.
We are not saying that each new customer needs to be assigned an exact dollar value that you believe they will spend at your business during their lifetime. Just keep in mind that a new customer is probably worth more than just the initial transaction.
Step 3: You need to understand that a customer will have multiple touch points with your business.
Before someone visits your local business, they have probably driven by, heard about you from a friend, or saw your business name in the newspaper. If you ask this customer how they heard about you, they will most likely only refer to the last interaction they had with your business.
This becomes an issue because the other touch points that the customer had with your business are not getting any credit. Since studies have shown that a potential customer needs to hear about your business 7 times before making the decision to purchase your product or service, it’s important that you are advertising through multiple channels, not just the channel that is highest performing. This is an important consideration when measuring ad performance, and is lacking in most definitions of return on ad spend.
So if an advertising campaign is not generating much revenue, it’s still possible that it is increasing sales in the long run by making people aware of your business. That campaign could be one of several touch points that are needed to encourage the customer to purchase from your business sometime in the future.
By understanding what type of value (whether it be awareness, direct sales, or a contact form fill-out) an ad is bringing to your business, you will have a better idea of whether your ad is benefiting your business, even if it’s not generating much revenue. Want to learn about more ways you can market your business to increase the interactions potential customers can have with your business? Read our article on on types of marketing strategies.
How to Calculate Advertising Cost
When evaluating how well your ads are performing, you will need to calculate cost. However, what exactly is included in the “cost” that is referenced in the definition of ROAS?
The cost is not strictly the amount you pay to post your advertisement. You need to take into consideration the following factors to make sure you’re accurately accounting for all costs:
- Cost to run ad – This is the amount you are paying to display your ad.
- Employee costs – Take into account how much time your employee(s) are spending to create and track the advertisement. Their time costs you money.
- Cost to create ad – If you use a designer to create the look of your ad, you will need to factor this cost into your total.
What Is a Good ROAS Ratio?
Every advertiser wants to make sure their budget is going towards successful ads. However, there is no magic number that all businesses should strive for. An acceptable ROAS for your company is influenced by your profit margins, operating costs, and overall health of your business.
According to a study by Nielsen, the average return on ad spend is 2.87:1, meaning for every $1 spent on advertising, the average company makes $2.87. However, you might need to strive for a higher ROAS, or you might be able to have a sustainable business with a lower ratio.
Each company should determine a benchmark ROAS that makes sense for their business. Small businesses can’t afford to spend a ton of money on advertising that won’t bring in much revenue, but large companies will often spend millions on advertising just to keep people aware of their brand.
Return on advertising spend (ROAS) isn’t a perfect metric, but it’s still useful in understanding ad performance. If you keep in mind the holes in the definition of revenue divided by cost, you should have a good understanding of how your ads are performing.
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