As an e-commerce brand, you’ve probably asked yourself, “What is a good ROAS to target?”
Understanding and optimizing your Return On Ad-Spend (ROAS) can make or break the success of your digital advertising campaigns. ROAS is a powerful metric that helps you understand the return you’re getting on your advertising efforts.
When determining a successful ROAS goal for your brand, some key factors must be considered. In this post, we’ll explain how to determine what your ROAS target should be in order to ensure your advertising campaigns are profitable.
What is ROAS?
Return On Ad-Spend (ROAS) is a metric used to measure how much return you get for your advertising campaigns. You can calculate ROAS by dividing your revenue by your ad spend. For instance, if you spend $100 on a Facebook Ads campaign, and that campaign generates $200 in revenue, your ROAS would be 200% (2x).
ROAS helps you determine campaign profitability, but it’s important to understand if your ROAS is profitable or not. If your advertising campaigns are bringing in more revenue than what you spend on your ads, you will have a positive ROAS. However, without considering what your actual profit margins are, you might still be losing money on your ads. The difference between profiting and losing on advertising campaigns comes down to knowing your numbers.
What is a Good ROAS target?
It’s common for e-commerce brands to not know what is a good ROAS to target. As a rule of thumb, the higher the ROAS, the better — but what is a good ROAS specifically? It depends on what your store is selling as well as your profit margins. Some brands can be profitable at a 200% (2x) ROAS, whereas others can lose money at a 1,000% (10x) ROAS. To find your target ROAS, you first need to find your break-even ROAS, then decide based on your profit goals.
How to Calculate Break-Even ROAS
Now that you know the answer to, “What is a good ROAS?” you must factor in your break-even ROAS. Before you can calculate break-even ROAS, you’ll need to calculate your gross profit margins for all of your products. This may seem like a chore, but without knowing your profitability for all products, you won’t know where your ROAS becomes profitable.
How to Calculate Gross Profit Margin
Below is the formula to calculate the Gross Profit Margin:
Gross Profit Margin = ((Total Sales – COGS) / Total Sales) x 100
Before you can calculate Gross Profit Margin, you’ll need to calculate Total Sales and COGS (Cost of Goods Sold). Below is some example data that we’ll use to complete this calculation:
- You sell a product for $100
- The product costs you $25 from your manufacturer
- In 2022, you sold 500 units
First, find your Total Sales:
Total Sales = Product Price x Units Sold
Total Sales = $100 x 500 = $50,000.
Next, find your COGS:
COGS = Product Cost x Units Sold
COGS = $25 x 500 = 12,500.
Now that you’ve calculated Total Sales and COGS, you can plug these numbers into the Gross Profit Margin formula as shown below:
Gross Profit Margin = ((50,000 – 12,500) / 50,000) x 100 = 75%
In this example, our Gross Profit Margin is 75%, which may have been pretty obvious from the beginning, but it can be more complex working with real numbers and a lot of different products.
Be sure to calculate your Gross Profit Margin for all of your products.
Break-Even ROAS Formula
Once you have your Gross Profit Margin calculated, you are ready to calculate your break-even ROAS.
Break-Even ROAS (Return On Ad-Spend) = 100% / (Gross Profit Margin%)
Using the Gross Profit Margin that we calculated (75%) in this formula, our break-even ROAS is 1.33 as shown below:
Break-Even ROAS: 100% / 75% = 1.33 ROAS
In this example, we would need a 1.33x (133%) ROAS on any advertising campaigns for this product in order to break-even. If we want to profit on our ads, we will need to set our target ROAS higher than 1.33.
How to Ensure Profitability For All Products
Now that you know what is a good ROAS to target and how to calculate break-even ROAS, the next step is to ensure product profitability. If you have multiple products, as most brands do, you will need to segment your campaigns based on your profit margins. Doing so allows you to have a clear target ROAS set for products with different profit margins. If you put all of your products into a single campaign, and take an average target ROAS, you could potentially be unprofitable for specific products.
The best way to separate your advertising campaigns is first by category, then by Gross Profit Margin. To understand the importance of doing this, here’s an example:
Let’s say you have a campaign with two products: Product X and Product Y.
- Product X sells for $500 and has a 50% profit margin.
- Product Y sells for $30 and has a 5% profit margin.
Using the break-even ROAS formula, Product X would need a 200% (2x) ROAS to break-even and Product Y would need a 2,000% (20x) ROAS to break-even.
In this example, putting both products into a single campaign and finding the average break-even ROAS (1,100% – 11x) would not be accurate enough because Product Y would most likely lose money. Instead, you should create a separate campaign for each product, and calculate the break-even ROAS for each campaign to ensure you have control over profitability.
Consider Net Profit Margin
Using Gross Profit Margin is the best way to find your break-even ROAS. However, Gross Profit Margin does not take operational overhead expenses into account. Calculating your business’ overall Net Profit Margin and comparing it to Gross Profit Margin is a good way to ensure your campaigns are still on track to be profitable.
Below is the formula for calculating Net Profit Margin:
Net Profit Margin = ((Total Revenue – COGS – E – I – T) / Total Revenue) x 100
- E (Operating and Other Expenses)— this includes expenses like rent, utilities, salaries and wages, office supplies, and machinery
- I (Interest) — this includes any interest you’ve paid on loans
- T (Taxes) — this includes any taxes your business pays (excluding corporate income tax)
Below is some example data that we’ll use to complete this calculation:
- Total Sales = $100,000
- COGS = $35,000
- E = $25,000
- I = $1,000
- T = $5,000
Using the example data and the formula, the calculation looks like this:
Net Profit Margin = ((100,000 – 35,000 – 25,000 – 1,000 – 5,000) / 100,000) x 100 = 34%
In this example, our Net Profit Margin is 34%, which is a lot lower than our Gross Profit Margin of 75% for a single product.
If you take into account your Net Profit Margin, you’ll find that your overall break-even ROAS is higher because you’re taking other expenses into consideration.
Although it’s not best practice to calculate break-even ROAS using Net Profit Margin, in this example a 34% Net Profit Margin would have a 2.94 break-even ROAS. It’s a good idea to take Net Profit Margin into consideration when you’re setting your actual target ROAS for each product and product category though. In our example, setting the target ROAS to 4-5x (400-500%) would be more than profitable.
Ways to Improve Your ROAS
After knowing what a good ROAS is for your brand and calculating your break-even ROAS, you may find that it is higher than your current ROAS. Now that we answered, “What is a good ROAS?”, below are some steps to improve your ROAS, although strategies differ depending on the advertising channel you’re using.
1. Narrow Your Targeting
Whether you’re advertising on Facebook, Google, or Amazon, you can narrow your reach to become more specific. If you are using search engine marketing, exact match keywords may be more expensive per click, but because you are reaching more relevant traffic, your conversion rate will be higher, thus lowering your customer acquisition costs and increasing your ROAS.
2. Understand Your Audience
In order to properly optimize your advertising strategy, you need to truly understand who it is you are marketing to. One of the best features of Facebook is the ability to create lookalike audiences. With this, you can target users who are more likely to make a purchase.
3. Retargeting Campaigns
One of the most impactful steps you can take today is to utilize retargeting campaigns. You will want to create an ad that targets people who visited specific pages of your website but didn’t convert. Seeing your brand again increases the chance of converting previous website visitors. You can improve your chances of conversions if you entice them to follow through with their purchase by offering them a discount code.
Tracking How Your ROAS Changes
As you track and optimize your ROAS, it’s not only important to know what is a good ROAS for your brand, but it’s key to watch it and how it changes over time. There are three scenarios that can happen, and all three of them will likely occur at some point.
ROAS is Increasing
If your ROAS is increasing, that’s the ideal position to be in. If you’re putting in effort to improve your ROAS, it feels great when it actually works and you can see the results from your efforts. If you see it increasing, this is a good indicator that you are doing something right and that you should continue the path you’re on.
ROAS has Plateaued
Unfortunately, your ROAS can’t go up forever. Everything has its limits, including the revenue you generate from advertising. If your ROAS is stagnant, it could be due to a couple of reasons. If there’s still room for improvement in optimizing any aspect of your marketing or brand, it might be time to start making some changes. These changes could be anywhere from fixing your ad campaigns, optimizing your website for higher conversion rates, or testing some new messaging.
If your ads can’t be optimized any further, it might be time to start tweaking the smaller details and split-testing different parts of the customer experience. However, at some point, you’ll run into a wall where there is nothing else you can do to improve your ROAS. It will eventually peak, and when that happens, it’s important to continue optimizing and testing new offers to prevent a decline.
When your ROAS starts to decline, it’s time to take a look at what you can do to fix it. A decline could be the result of various factors. If you made any recent changes to your website or marketing campaigns, this could cause your ads to be less efficient. It could also be due to reasons that are outside of your control, such as economic factors or new competitors entering the market.
When occurrences happen beyond your control, the best you can do is try to adapt. If the economy is in a bad situation, you may not be able to prevent a decline, but you can rework your strategies and optimizations to soften the blow to your ROAS.
Optimize Your Target ROAS Strategy & Increase Profits with Ranksey
Now that you understand how to determine your target ROAS should be, the next step is optimizing your advertising strategies to get the ROAS goal that you’ve set for your brand. However, reaching a profitable ROAS goal with your advertising campaigns can be challenging and time-consuming. If you’re still asking yourself “what is a good ROAS?”, you might need some professional help.
If you’re looking for some help getting the most out of your advertising, check out our e-commerce marketing services. Before we launch or manage any ad campaigns, calculating break-even ROAS and setting a target ROAS for products and categories is our first step if you’d like help with that too.