Knowing and managing your return on ad spend (ROAS) metric is critical to the success of your e-commerce business. But, what’s considered good and where can you make the most impact?
We explain in our metrics guide that ROAS is a metric which measures the amount of spend on advertising (typically digital spend) in comparison to the revenue it generated in a certain period of time. It’s either expressed as a number or a ratio, so the higher the number, the better the return. For example, 5 or 5:1 means that for every £1 spent on advertising, you make £5 revenue. While there’s no set benchmark, generally a ROAS over 4 would be considered good, but the ROAS you need depends on a number of factors. For example, a business with a high gross margin could survive and thrive on a lower ROAS than a business with lower margins.
What's a good ROAS benchmark?
It can be challenging to determine what a good benchmark should be for your own business. In a recent article on BeProfit, they offered this insight. “An average ROAS for e-commerce is difficult to determine because it can vary greatly depending on the type of product being sold, the target audience, and the competition. Generally, the average ROAS comes in at 2.87, a ratio of 2.87:1, or a 287% return on investment…a good ROAS ratio varies depending on the industry and platform. However, a good rule of thumb is that for most industries, a ROAS target of 3 or 4 is viewed as a reasonable return” (‘BeProfit.co, What’s a good e-commerce ROAS?, March 2022).
By measuring ROAS you can see the relative return on marketing regardless of the size of spend in that period, or the revenue generated. This shows a normalised view when you compare two or more periods.
Knowing your ROAS is important as it allows a business to measure the effectiveness of advertising spend, whether across the entire business or segmented down to specific channels, campaigns or geographies. Understanding your ROAS will allow you to better use marketing budgets, focusing on areas that generate a higher ROAS.
flinder CFO Julian Cappelli offered:
“Measuring and controlling ROAS is key to understanding the effectiveness of your marketing activity for delivering sales to your business. Setting the required ROAS for your business and actively controlling ROAS as campaigns are delivered means you’re making sure your marketing activities are delivering the required level of sales and can allow you to proactively manage if not. Digital marketing is easily spent so keeping an eye on ROAS and a hand on the lever to turn it up or down depending on return is vital to using your capital effectively.”
Investors will often look at ROAS and expect to see an improvement over time, demonstrating traction and brand growth. A higher ROAS will also indicate your marketing has been effective, targeted at the right audience, potentially less reliance on paid advertising and you have a more sustainable business model.
Being able to test fast and react quickly is key, making sure digital marketing spend isn't wasted on campaigns which are ineffective. By closely monitoring ROAS, e-commerce companies can make informed decisions on where to invest their advertising budget and how they can become more efficient with their marketing spend. Segmenting ROAS is key to understanding performance by channel, but while geography can be relatively easy to segment, attribution to channel can be somewhat more challenging to calculate.
One thing to consider when measuring ROAS is timing of digital spend and realising customer clicks or even recognising shipped revenue. ROAS can fluctuate based on when digital marketing is paid, and corresponding customers’ products are shipped.
How ROAS can be effective
Establishing a few ongoing, long- term practices can help build consistent and reliable ROAS in your customer base:
- Building ongoing and effective loyalty and referral schemes as well as subscriptions to reward new and seasoned customers.
- Email marketing through nurture sequencing whether that’s for new subscribers, customers who haven’t logged on in a while or those that abandoned their carts.
- Use SEO and content strategy tactics for page ranking and save on web marketing CPC.
- Use chatbots to act as a site navigator or basket recommendations for upselling to help increase AOV (average order value).
In ‘The 7 keys of ROAS For Long-Term e-commerce growth’ on Klientboost.com, they offer that referrals are one of the most highly valuable ways to leverage your existing customers. “Customers who love you are the likeliest to refer their friends, and what does that do? Attract more high-value customers. (A real-life lookalike audience, if you will.) Consider splitting what you’d typically pay for a customer between the two parties and give it to them upon purchase. Because it’s offered at purchase, this kind of investment is virtually immune to unexpectedly low ROAS. If you’re ready to go the extra mile, loyalty programs get returning customers even more excited to shop with you.”
The foundations of ROAS
Understanding the foundations of ROAS can help you determine whether your ROAS is on track and considered ‘good’ in your business plan.
- Know your gross margins - this will help you determine what ROAS is acceptable.
- Know your customer LTV – Klientboost.com say, “repeat customers are 9x more likely to buy than first-time shoppers while also having a higher AOV” (‘The 7 keys of ROAS For Long-Term e-commerce growth’).
- Know your AOV (average order value) – this can make a big difference between a low or high ROAS.
All e-commerce businesses should track ROAS and consider segmenting it to better understand what the drivers are. Understanding ROAS and adopting a strategy around what’s acceptable, based on gross profit, returns and other factors will help make better strategic decisions on how much, when and where to invest in digital marketing spend. While there are other factors to take into account, generally, the higher the company’s ROAS the more effective the advertising is.
How effective is your ROAS strategy?