ROAS Is a Horrible Measure To Evaluate Your Paid Ads

You checked on your ads performance today, right?

In doing so, you looked at the return on ad spend (ROAS), right?

What if I told you that ROAS is a horrible measure to evaluate your ads?

As in, you're-probably-burning-money-by-using-it-horrible?

Let me show you why with a real-world example from one of my own ad accounts.

Assume that you can only run two ads. One ad sells pants, and the other ad sells a jacket. You know from your data that your ads perform like this:

Which ad do you run?

The jackets ad, right? It has the highest ROAS.

No. You're focusing on the wrong thing.

You can't buy a new Ferrari with revenue. Or reinvest in your business to make even more money in the future. For that, you need (gross) profits. And this is where the problem starts when using ROAS to evaluate your paid ads.

First of all, ROAS doesn't tell you whether you should even run the ads in the first place. What if the cost of goods sold (COGS) of each jacket is $150? Now the 3.04 ROAS doesn't look too good. $189 - $62 - $150 = -23, so you're losing money - and jackets - by running the ad.

Second, a higher ROAS doesn't equal higher profits. To see this, let's calculate the actual profit on ad spend (POAS) of each ad.

Profit = AOV - CPA - COGS. For example, $196 - $39 - $18 = $49.

POAS = Profit / CPA. For example, $49/$39 = 1.26.

So for each $1000 you spend, you get $70 more in profits by running the pants ad despite in having a lower ROAS.

That might not sound like a lot. But remember that it's profit, not revenue. That's $25.500 more in annual profits with even a modest $1000 daily ad spend.

As you can see from this, the Profit on Ad Spend (POAS) is a much better metric to evaluate your ads. First of all, POAS tells you whether you're actually turning a profit by running the ad. Second, POAS focuses on the right measure—profits.

Notice that you should include all direct costs in the calculations. Shipping, pick'n'pack, etc. Not just COGS. Maybe it's more expensive to ship one product vs. another. Or it takes longer to pick'n'pack.

So, how do I use this in practice?

If you're on DTC Twitter, you've seen a lot of talks lately about using bid caps. I use bid caps on my brands' accounts, and they fit perfectly into this notion of POAS.

If you run the default bidding setting, Meta directs spending to whatever ad Meta thinks brings you the highest ROAS or the lowest cost per conversion.

Suppose instead you use bid caps and set your bids to get the equivalent of, e.g., a POAS of 1. That's the same as telling Meta to try to get you AT LEAST $1 in profits for every $1 you spend.

That way, you don't risk Meta directing spending to an ad with a higher ROAS or lower CPA even though it has a lower POAS. If the ad doesn't return $1 in profits, it doesn't spend.

Learn How To Increase Your Conversion Rate and Sell More!

In my CRO Notion Handbook, you learn 81 guidelines for optimizing your store to sell the most. Optimizing your site makes all your other marketing work better. You get a higher return on paid ads, sell more from emails, and convert more organic traffic.

The guidelines fill more than 104 A4 pages when exported to PDF 🤯

At $99, it’s only $0.95 per page of actionable content that teaches you how to make your store sell more.

I guarantee you will find $99 worth of knowledge within the first few minutes of opening the handbook. When you open it, you’ll find a list of my favorite guidelines that are easy to implement. They should help you get started with some quick wins.

And if you’re eligible for GumRoad’s Purchasing Power Parity discount, you’re getting a dynamic discount depending on where you live.