Predicting ROAS and Launching Better PPC Campaigns

Return on Ad-Spend, or ROAS, is a metric calculated by dividing the revenue generated from an ad campaign, by the cost of that campaign. It can be applied to any sales situation that has an advertising spend, even a bake sale:

Lets say your mother gave you a pan of brownies to sell at the bake sale, but it costs $50 to get your booth and marketing materials set (we’ll call $50 your ad-spend).

If your brownies manage to produce a total revenue of $50, you’ve broken even, or gotten a full return on your ad-spend.

If you had made the brownies yourself, and they’d cost you $50 to make (we’re talking primo brownies here),

then your total investment is actually $100, but ROAS only takes into account ad-spend. So in the same situation you’re still getting a full return on your ad-spend, just not a full return on your investment.

A handy exercise to go through with new clients before you launch a PPC campaign is to calculate the potential ROAS of the keywords you’re targeting.

There are a few unknown, and a few fuzzy variables – we’ll have some tools to help us come up with potential traffic and potential costs, but we’ll have to use some educated guessing to come up with reasonable estimated ranges of conversion rates and click through rates – in truth, the conversion potential of your keywords, through your ads, to your landing pages, for your clients products, are up to you and your marketing team. Sorry ’bout that.

Calculating ROAS:

In order to calculate a predicted ROAS in PPC advertising you need to know the revenue that each conversion brings for each product you’re marketing (which could be associated with the keyword, or ad-group level), the potential cost of the campaign, and a half-decent guess at what kind of a conversion rate you might achieve. Once you know what a conversion is worth, all of the info that you need is available in rough form from Yahoo and Google’s keyword tools.

Yahoo give us the estimated number of clicks and cost per click (CPC) for a keyword so we can calculate the expected cost of the campaign per month. Adwords give us approximate search volume along with the estimated CPC, which we can use to determine a rough estimate of traffic at different click-through-rates, and what it will cost us. If we supply a hypothetical conversion rate to calculate conversions, and we know the company’s revenue from each conversion, we have what we need to calculate ROAS. So like I said, it gets fuzzy, but it’s still half-decent for predicted information.

These simple equations are expressed like this: To further the confusion of the ROAS metric, it is commonly calculated in two *different* ways. One way subtracts the PPC ad-spend from the revenue right in the calculation, the other way does not. Let’s look at each equation and how to interpret the results.

Method one: With method one revenue of $100 and an ad-spend of $100 would produce a full return on ad spend of %100. So with this method of calculation seeing 100% ROAS simply means you’re breaking even. A 50% ROAS would mean you’re only recouping half of the ad-spend you’ve put out. With this equation in a situation where you have $200 revenue and $100 ad-spend, doubling your ad-spend is expressed as an ROAS of 200%.

Method two: In this formula the cost is subtracted from the revenue, forming a profit metric that is relative to the ad campaign. Plugging the same numbers into this, $100 ad-spend with $100 cost, break-even comes out to 0% ROAS. With this equation, in a situation with $200 revenue and $100 ad-spend, doubling your ad-spend is expressed as and ROAS of 100%.

Be sure you know which type of ROAS you’re looking at, because obviously the interpretation is different for each.

Experiment with a Spreadsheet:

I’ve put these equations into a simple spreadsheet (download). Here’s what it looks like: The heading ‘revenue of campaign’ might refer to a whole PPC campaign, an ad-group, or just a keyword – it is the revenue per conversion, times the number of conversions (and depending on your preference, minus the cost). You may want to set the sheet up based around just one variable, such as conversion rate: Or cost per click:

Useful, but comes with caveats:

The basic approach of pre-checking keywords for ROAS can help you launch campaigns that stand a better chance of being profitable quickly, rather than analyzing data after some time (and some money!) has passed. It can let you know going in, all else equal, approximately what costs-per-click should stand a good chance of performing well. The problem is, all else is never equal.

A number of variables affect your ROAS, and tweaking CPC is only one part of a comprehensive management approach. Some argue that ROAS should only be used as a general indicator because it is too broad in scope, and doesn’t take into account the overall costs of sales.

Remember from the bake-sale, if you’ve got extra costs external to ad-spend (like $50 worth of primo brownie ingredients), your ROAS metric is never going to reflect true ROI – only somebody who is familiar with overall costs associated with a product or service can really interpret ROAS calculations for that product or service. ROAS is not the same as ROI.

As long as you keep it in perspective of larger ROI influences, ROAS as a guide to see how each variable affects profit margins can be quite interesting to look at. For those account managers that understand both their products and the metric well, there can be a benefit to being able to monitor ROAS at each level of a PPC campaign over time (and yes, ahem, tools are available). It’s often worth going the extra mile and doing some solid ROAS/ROI research before launching – it can help you get started off on the right foot with both the search engines, and your clients.