I'm decreasing our revenue on purpose.

And I'm confident it'll make me a lot of money. Here's why.

I've always had the feeling that most brands are squeezing the lemon too much with their ad spends. It didn't feel right to push ad spends to a place where you're only getting a ~1.7 return. But as I never crunched the numbers, I didn't have any actual arguments.

Now, I do. And they're not pretty if you're an ad agency paid based on your ad spend.

The Problem

When evaluating your ad account, it's easy to think that, e.g., a ROAS 1.9 is excellent because your break-even point is at 1.4. You're making a (small) gross profit, getting new customers, and the returning customers will certainly make you even more money when they're coming back organically.

However, that's a flawed way of thinking that ignores the following:

• What is the marginal return on each $ spend? What if by squeezing out 20% more in ad spend your decreasing your ROAS by 50%?

• Is the revenue coming from returning customers really off-setting the lower ROAS?

• What kind of profits are you looking at?

An Example

I think the best way to make this understandable is through an example of the numbers I crunched. All my input numbers in the model are real, actual numbers from one of our brands. So the calculations are real, expected results for my business.

Consider a scenario where we're spending X dollars on customer acquisition with a ROAS Y through Facebook ads in year 1, again in year 2, and again in year 3. Each year, 35% of the new customers acquired in the year before will come back and place another average order organically (no ad spend). 35% of the returning customers from the previous year will also come back. In year 4, there's no ad spend on prospecting and hence only revenue from returning customers.

If I run the numbers with a hypothetical $100K on prospecting each year at a ROAS 2 versus $50K at a ROAS 3, I get the following results over the 4 year period:

Notice how both the revenue and gross profits look are higher with more ad spending. However, when you subtract shipping costs, salaries, and ad spending, you're pocketing ~78% more in net profits with only half the ad spend.

Why? Because the lower spending allows Facebook to use the spend more effectively. You're essentially getting more bang for your buck. Historically, the argument against this has been that the returning customers will make up for it in the long run. However, as I account for this in the model, this is clearly not the case - despite the convenient assumptions that are returning customers requiring zero ad spends and a, for most businesses, high repeat customer rate (35%).

The effects of increasing/decreasing your ad spend on your ROAS will vary with your business and your ad account. But due to the disproportional impact on net profits, your ROAS doesn't have to increase much to offset the loss in revenue and net your more profits. A $100K ad spend returning 2x equals the same net profits for my brand as a $50K ad spend returning 2.38x per $ spend.

This effect might be more prevalent in the smaller European markets I'm navigating in. But I'm sure the same diminishing return happens at some scale in larger markets like the US.

Recommendation

If your business is at a scale where you push a lot of ad spends with a relatively low ROAS, run your own numbers and consider decreasing your ad spend. The increased effectiveness (ROAS) will most likely make up for your lower ad spend and net you more bottom-line profits.

Other Learnings

Revenue isn't just revenue, and orders aren't just orders. Unless you have an excellent reason, don't accept low ROAS campaigns. You're just exchanging revenue for your product - and your work - not profits. Previously, you might have thought that the returning customers would make up for it. It turns out they don't.

Remember: We're here to make profits, not revenue.

All the best,

Mathias