Calculating ROI and ROAS the right way
My college financial accounting professor often emphasized the importance of achieving a healthy return on investment (ROI), as it allows an organization to make relevant decisions that bolster the soundness of a company. Indeed, ROI is significant in measuring the performance of a company’s strategic investments and disposal of capital assets, but what about one’s return on ad spend (ROAS)? How does it fit into the big picture?
It’s important to know that while they sound similar, ROI and ROAS operate differently from each other, with ROAS acting as a comparison of the amount spent to the amount earned, while the other, ROI, takes earnings into account only after expenses have been deducted. Additionally, ROI is a business-centric, strategy oriented metric that measures how ad expenditures contribute to an organization’s bottom line.
By contrast, ROAS optimizes to a tactic and is an advertiser-centric metric that measures the efficacy of a digital advertising campaign. It focuses on growing business through incremental conversions and measures gross-revenue against every dollar spent on advertising.
Now that we’ve established the differences between ROI and ROAS, how is each one calculated?
Doing the math
How to calculate ROI:
ROI = (Gains – Cost)/Cost
Example: let's say you have a product that costs $100 to produce and it sells for $200. You sell 6 of these products as a result of advertising via Google AdWords. Total sales equal $1200, but your AdWords costs are $200 with production costs of $600.
ROI = ($1200-($600+$200))/($600+$200)=50%
How to calculate ROAS:
ROAS = revenue from ad campaign result/cost of ad campaign
Example: Your company spends $2,000 on an online advertising campaign in a single month. During this month, the campaign yields a revenue of $10,000.
ROAS = ($10,000/$2000)=5
Therefore, the ROAS is a ratio of 5 to 1 (or 500 percent) as $10,000 divided by $2,000 = $5. In other words, for every dollar your company spends on its advertising campaign, it generates $5 worth of revenue.
Remember, advertising costs include more than just the listing fee. To calculate the actual cost to run an advertising campaign, consider adding these factors into your ROAS calculation:
- Partner/Vendor costs: There are customary fees and commissions associated with partners and suppliers that assist on the campaign or channel level. An accurate accounting of in-house advertising personnel expenses such as salary and other related costs must be tabulated. If these factors are not accurately quantified, ROAS will not explain the efficacy of individual marketing efforts and its utility as a metric will decline.
- Affiliate Commission: The percent commission paid to affiliates, as well as network transaction fees.
- Clicks and Impressions: Metrics such as average cost per click, the total number of clicks, the average cost per thousand impressions, and the number of impressions purchased.
When to use ROI and ROAS
If you are selling a service or the goal of your ad campaign is a soft metric such as to raise awareness for your organization or to get people to attend an event, then ROAS is a great number to work from as it helps you evaluate which advertising method works best for your goal. Remember, ROAS tests tactics, so if your want to know which platform yields the greatest number of web clicks (e.g.Facebook or Twitter), you can calculate your ad spend to improve future advertising efforts.
However, as in the case of our ROI example, if you are selling physical goods with its associated production costs, you need to assess ad spend by calculating ROI. Fortunately, AdWords makes it easy for you to pass these variables to your account through the use of conversion values.
Understanding ROI and ROAS is a crucial step in launching a successful social media advertising campaign. Based on your campaign goals, continuously assess your ad’s effectiveness by drilling down into your ad numbers. This commitment will pay off by allowing you to spend your advertising dollars wisely.