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Social Media Advertising

How to Calculate ROAS and Assess Profitability for Paid Social Ads

September 6, 2022
February 22, 2022
Maurice Rahmey

High return on ad spend isn't enough to guarantee a successful digital ad campaign. Context matters, and so does profitability, according to a paid social media marketer and Facebook alum.

Table of Contents

Originally published in February 2021, this blog post was updated in February 2022.

Every marketer in e-commerce wants to attract new customers, efficiently and at scale, and many of them want to do it through paid social ads. 

With Facebook, Instagram and Snapchat ads, advertisers can reach more than four billion monthly active accounts — and all three platforms offer ways to exclude your CRM contacts and target audiences that have never bought from you before. 

But what’s the best way to measure paid social ads’ success? 

That became an especially important question when Apple’s iOS 14.5 update last spring threw paid social measurement as we knew it into disarray. 

In my career with Fortune 500 companies and DTC brands — first as a client solutions manager at Facebook, and now as a co-founder of performance marketing Disruptive Digital — I’ve spent more than $100 million on paid social, and learned a lot about how to measure performance.

I’ve noticed that often, marketers use their ad spend’s return on investment (ROI), also known as return on advertising spend (ROAS), as their KPI. 

It pops up over and over on industry blogs: If you can keep your ad spend low — with efficient targeting, say, or low CPMs — and your conversion rate high — with incentives like flash sales and coupons — you can achieve a sky-high ROAS. 

However, this approach can hurt profitability.

High ROAS isn’t everything, and it doesn’t exist in a bubble; it should really be just one element of a more complex assessment of your marketing efforts, that also include factors like gross profit margin. 

How can marketers calculate ROAS, and set realistic ROAS goals without getting tunnel vision? Why is profit ultimately more important than ROAS — and what does that mean for ubiquitous discount codes and flash sales we all see online? 

Let’s get into it.

How to calculate ROAS in 2022

Before we get into the nuances surrounding ROAS on paid social ads, here’s the latest two-stage playbook for calculating it.

1. Attribute sales to paid social campaigns — or at least channels.

This is harder than it sounds. Social media platforms’ native ad analytics used to make this a breeze — advertisers could calculate ROAS for an ad group, or an individual ad.

But Apple’s recent privacy update made it impossible to track most conversions from iPhones, and now social platforms can’t reliably count paid social conversions. 

In September 2021, Facebook’s native dashboards were undercounting conversions from Facebook Ads by about 15%, according to Facebook itself — and the issue persists.  

Personally, I’m seeing social platforms undercounting conversions by more than 50%, though other practitioners have seen overcounting.

Tracking paid social conversions in the current online advertising landscape takes some DIYing. At my agency, we link channel- or campaign-level paid social spend with purchases in digital storefronts like Shopify, using tools like campaign-specific landing pages, UTMs and marketing mix modeling

Once we have cost and new-customer revenue, we can take a look at ROAS. 

2. Calculate new customer ROAS.

ROAS is the ratio between ad cost — the amount you spent on a paid social channel or campaign — and ad revenue — the amount of revenue it brought in from first-time customers.

Focusing on new customer ROAS makes most sense for digital marketers, because you shouldn’t be paying paid social acquisition costs for a customer you could just email. 

Here's how to calculate it:

ROAS = Ad Campaign Revenue / Ad Campaign Cost

You can test out some example scenarios with our ROAS calculator:

Now, ROAS is a bit of a short-term metric. It typically only counts the price of a new customer’s first purchase towards an ad campaign’s total revenue. 

Especially for online businesses working in the monthly subscription space, a customer’s lifetime value (LTV) — the total amount they spend with you long-term can be much higher than this.

It’s important to consider both ROAS and LTV. For new companies that can’t yet robustly measure customer LTV, though, ROAS is a great initial, real-time litmus test for whether a campaign is working out.

Calculating your ROAS on its own won’t tell you much, though; you need a goal ROAS to compare it to.

How to set realistic ROAS goals

Maybe it goes without saying, but not every company should chase the same ROAS goal. An appropriate target ROAS will depend on factors like industry, average order price, average purchase frequency and more. 

However, when you’re trying to come up with a realistic ROAS goal, it’s smart to start by considering your break-even point. What is the ROAS target you need to hit to avoid losing money on a new customer?

1. Calculate break-even ROAS

To calculate your break-even ROAS, you need to first calculate your gross profit margin on an average order. 

To start, add up all of your variable costs on an average order — in other words, your per-unit costs, which grow as your order volume grows. 

These might include, but aren’t limited to:

  • Manufacturing costs of goods sold
  • Shipping
  • Payment processing fees 
  • Discounts and other incentives (often neglected, which we’ll talk more about in a minute)

From there, you can use your average order value (AOV) — the price of an average order — to find your gross profit margin with the following formula:

Gross Profit Margin = (Average Order Value - Variable Costs) / Average Order Value

You can test out some example scenarios with our gross profit margin calculator: 

Then calculate your break-even ROAS target with this formula:

Break-Even ROAS = 1 / Gross Profit Margin

You can test out some example scenarios with our break-even ROAS calculator: 

If you achieve this ROAS, your advertising costs will exactly pay for themselves — and it’s a good benchmark for marketers to keep in mind. 

But that goal isn’t right for every e-commerce marketer.

2. Decide whether break-even ROAS enough — or too much.

“Good ROAS” is subjective. A reasonable ROAS goal in one industry might be a catastrophe in another. And the right goal for you depends on an interconnected web of factors including your product, your average order frequency and your price point.

Which companies should shoot for break-even ROAS?

This is a popular benchmark for companies whose customers buy from them several times a year, but not quite routinely. 

Under these circumstances, it’s sustainable to break even on winning new customers and then turn a profit on their second orders. DTC shoe and apparel brands, for instance, might shoot for break-even ROAS.

Which companies need more than 100% ROAS?

Profitable customer acquisition can be key for e-commerce companies selling long-term investments, like mattresses or furniture. Customers buy these expensive products so rarely that postponing profit until a new customer’s second purchase could leave a company in the red for years.

Which companies can afford less than 100% ROAS?

ROAS of less than 100% can work for companies that sell consumer packaged goods that people buy regularly (and rarely shop around for) — like daily contacts, seltzer or paper towels. 

If customers buy frequently enough, and at a low price point, the company doesn’t necessarily need to break even on first orders; it can rapidly earn back initial acquisition costs.

Why profit is a more important metric than ROAS

Early-career marketers might balk at this, but whatever ROAS goal makes sense for your business, it shouldn’t be your only focus — or even your top priority. 

If you aren’t prioritizing low CPAs and high ROAS, what should you be focusing on?

The answer is simple: gross profit margin.

It’s common practice to tack a hefty discount code onto ads to entice new users to convert. This can be effective — and boost ROAS. 

The bigger the discount, though, the higher your break-even ROAS. Even if your ROAS spikes because your discount code drove conversions, ROAS might not go up enough to hit your elevated break-even point.

I’ve seen advertisers lose money that they never earned back on ad campaigns by forgetting to center profitability. 

Ultimately, a business can’t scale without profit, unless it’s one of the less than 1% of startups with venture funding — and even venture capitalists like to see a path to profitability for their portfolio companies. 

Gross profit margin offers essential context for ROAS stats. For example, a high ROAS tied to a steep discount or sale actually be less profitable for an e-commerce business than a lower ROAS linked to a full-price product.

After all, profit and break-even ROAS are inversely related: 

Break-Even ROAS = 1 / Gross Profit Margin * 100%

That means focusing on high ROAS and ignoring profit margins can lead to serious losses in short-term profitability — and in long-term LTV. 

1. Attracting deal-seekers can tank LTV.

Many advertisers try to lead with free samples, limited-time offers, and first-time discounts. They assume that the customer will try the product, love it, and stay on, but that just doesn’t always happen. 

Discounts often attract price-sensitive customers who aren’t as loyal — and it can end up hurting your overall LTV as well as the profitability of a given paid social campaign.

For example, if a DTC retailer sells $100 organic pajama bottoms, they’re seeking a very specific type of customer: someone willing to invest in loungewear.

If their paid social ads offer new customers half off their first purchase, they’ll likely see a surge of conversions — but not necessarily from customers in their target demographic, who can afford a steady stream of $100 PJs.

They could ultimately spend a lot on ads and discounts, only to attract customers who will never convert at full price — because they were deal-seekers, not value-seekers. 

Deal-seekers are notoriously fickle and often lack brand loyalty. They typically aren’t worth acquiring, and definitely not on a paid social platform where you’re taking on acquisition costs. 

Tracking ROAS alone won’t capture the resulting LTV and profitability issues, though, as this example from a real company shows.

2. Case study: ROAS can mask LTV decline.

Once upon a time, my agency had a client in the consumer packaged goods space with what I lovingly call “Bed Bath & Beyond syndrome.” 

Their marketing team always ran coupons and flash sales, trying to leverage that buyer’s FOMO. As a consumer, you were expected to buy with a coupon.

This can work. In the early days of Bed Bath & Beyond, the company’s giant blue coupon was cheaper to produce than a catalog — and it lured people into the store, where strategic merchandising often got them to buy more than they originally intended

In 2020, though, even Bed Bath & Beyond began moving away from the constant-discount strategy. Coupons can have diminishing returns over time; they quickly go from an exciting opportunity to a constant expectation.

We suspected that in our client’s case, the discounts-for-everyone approach was limiting their ability to scale not only their ad campaigns but their entire business — so we set up a split test to find out.

We offered four different versions of their hero product at four different price points: 

  • $90 (their initial offer)
  • $95
  • $99 with a gift card
  • $99 with no gift card

For each price point, we set the following ROAS goals:

ROAS goals based on price point

We ran the test at scale, and the results were interesting.

While the $90 offer was the ROAS winner, the $99 offer with no gift card was the second-best performer and had the greatest chance of profitability. 

ROAS goals at scale - and the best performing price points.

The $90 offer, which had the lowest gross profit margin offer, looked most promising based on raw ROAS — but it was closer to its break-even ROAS goal, and we thought the customers who spent $99 might be the higher-value customers. 

We waited, and after two weeks, we looked at the LTV on the new customers the campaign had attracted. 

Not only did the customers who spent $99 spend more upfront — two weeks later, they had spent 20% more than their counterparts who spent $90.

Two week LTV by price point

While ROAS was higher at the $90 price point than the $99 one, the $99 one had a better gross profit margin — and the customers who bought at that price point seemed more likely to buy again. With a 10% price increase, Facebook’s algorithm showed the ad to higher-quality users. LTV and profitability improved. 

In other words, the more profitable campaign paid off in both the short- and long-term.

4 non-discount incentives to try

Incentives and discounts still have their place, of course, and can result in more loyal customers. However, the goal should be to create incentives for value-seekers rather than deal-seekers.

If you incentivize purchases by giving people more product, instead of by charging them less money, you’re unlikely to attract purely deal-seeking customers.

That means it might be worth replacing a trendy discount with a value-based incentive, like these four — all of which provide value to customers without dramatically eating into your profit margins:

  • A store gift card with a purchase, which incentivizes repeat business
  • A free product or product sample with a purchase, which can lead to a bigger order next time
  • A free product upgrade with a purchase, like having a product customization or monogramming, which can boost brand loyalty
  • A lightly-discounted bundle of complementary products, which can boost average order value

These value-based incentives can function as a win-win for you and your customer. Too often, steep discounts are a win-lose — a win for consumers, but a losing proposition for e-commerce retailers. 

Looking beyond ROAS 

In my professional experience in digital marketing, it’s easy to focus narrowly on a marketing metric like ROAS and miss the bigger picture.

Yes, if you steeply discount your product, ROAS will likely rise. But that might not matter much to your bottom line. 

High ROAS alone can’t guarantee a profitable, successful, scalable marketing digital advertising campaign. Before you achieve that, you need to have all the necessary pieces in place, including a scalable price point and gross profit margin. 

To set the stage for a successful campaign, focus more on profit and LTV, and test some full-price ads — you never know what you’ll find.

Lower ROAS may deliver more valuable audiences, and the real dream: sustained profitability.

Maurice Rahmey
about the author

Maurice spent 5+ years working with Fortune 500 and direct-to-consumer brands at Facebook and is now co-founder of Disruptive Digital, a performance marketing agency specializing in helping brands acquire new customers.

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