Return On Investment (ROI) vs. Return On Ad Spend (ROAS): Important Distinction

Isaac Rudansky
A free video tutorial from Isaac Rudansky
Certified Google AdWords Pro |Co-founder of AdVenture Media
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English Edwards fans welcome back to this exciting chapter we're going to start talking about understanding the profits in our account. Once we start running these accounts and we start generating conversions and we have our conversion data we have our values purse for conversion. You want to get a sense of are we profitable. Are we making money. How can we improve our account to be making more money. How can we improve our count to be generating a Higher R A Y A higher Aroha Yes. And that question essentially starts with asking how much should I pay per click How much am I willing to pay per click. Remember when we first initially created our default Max CPC bids when we first created the campaign we needed to create just a basic default Max CPC because we didn't have any data. We didn't know how much our clicks were going to cost. We didn't know what our conversion rate would be. What percentage of those clicks were going to lead to a sale. We didn't even know how much a conversion was worth to us at that point. So we have to we start off our campaigns and our account with educated guesses of our default Max CPC bids but that's not how we should always manage the account. Eventually once we start seeing our conversion rates and once we start seeing our value per conversion once we start seeing our real actual live cost per click we should be able to start getting a very good understanding of what would be a profitable Max CPC bid by going through a number of calculations. The first step in understanding and being able to develop your own profitable bidding strategy is understanding the difference between ROIC and our way yes. Okay return on ad spend which is our goal. Yes. Refers to a very simple calculation that doesn't take your company's profit margins into account. It's simply looking at your returns from what you spent on adds to what you made in conversions the value of those conversions. Okay so for example if you're an e-commerce store and you sell physical goods and you sold 10 items that cost the consumer at $10 each and you're using that conversion tracking to track those values. So your value is a hundred dollars for those sales. But that's not necessarily that's not necessarily the profit your company got because for example let's say you only make a 50 percent profit margin because you have to buy the goods. And there's a cost of shipping. Then your value per conversion your profit per conversion is really only $50 not $100. But our goal is does not take that into account. Return on ad spend simply looks at your return the total revenue the total revenue that you made divided by the cost of advertising and total revenue here refers to the total value of those conversions not necessarily the profit are A-Y which is return on investment is a more thoughtful calculation that takes into account your company's profit margins in order to calculate our why you need to know your margins you need and you need to have a good understanding of your business. And now I'm not talking about your lighting bill. You don't have to necessarily calculate that from the outset or the cost of your internet provider or the cost of rent for your office. Those are all things which should eventually be taken into an R Y calculation but we're what we're really talking about is the cost of goods shipping and the associated costs with a consumer or a client for example if you're in the service industry there might be certain costs that are associated with every client you have to pay for certain software for them. You have to go and meet with them in person. Perhaps those are costs associated and those will go into your overall profit margins per conversion . Okay. So you need to know your profit margins in order to calculate our why. And obviously I can't help you create your profit margins. You need to know what your profit margins are for your business. And when I say profit margins I mean how much of every dollar do you put in your pocket at the end of the day. Okay if you have 50 if we say you have a 50 percent profit margin that means that every dollar you make 50 percent goes to servicing the client or the cost of goods whatever that may be. And 50 percent goes in that 50 cents goes in your pocket. So why the calculation the formula for our why is revenue meaning the conversion value minus cost revenue minus cost divided by cost of advertising revenue minus cost divided by the cost of advertising. Okay that's going to be your A-Y calculation. A couple of things we have to know when we talk about Hakkinen drivers are OAS. One is we must have our conversion tracking in place. Okay that's very important in us for us to be able to even start talking about calculating Arnwine or Edwards account if we're not tracking conversions we'll have no idea with our conversions are or what the convergence values. Number two which is what I just said. Conversions have to have values you need to be tracking some sort of you need to be attaching or attributing some sort of value to each conversion. If it's e-commerce it's really easy because you could use Dynamic transaction conversion tracking dynamic value conversion tracking and we'll know exactly how you'll know exactly how much money of products revenue of products you sold. If you're talking about form commissions as a conversion tracking or as a phone call is something that we touched upon previously. Need to figure out how much is a form worth to your business how much is a lead worth to your business . For example if you close one of the 10 clients and every client brings an X amount of dollars you'll be able to calculate exactly how much each forms emission from afterwards is worth. You have to attach some sort of value to each conversion. And number three you need to know your margins like we just said OK. So you have three primary prerequisite prerequisites to tracking conversions. And now we have two formulas we have our way return on ad spend which is total revenue divided by cost of advertising and our Y which is revenue from the advertising minus the cost of advertising divided by the cost of advertising. Okay. These are two formulas that's super important for you to remember and of course don't forget in order to calculate are why you need to know your profit margins. Okay. So those are some really important things. Let's have a let's let's go through a real life example to give you some context in which to understand our A-Y and our OAS Yes. OK let's come at the example and we get a different colored marker here. Let's take a blue marker. Okay. Now here we have an example written out already written I already wrote out the example for you your ad spend for example is eight hundred ninety seven dollars. OK so let's say your aspirin is 897 and the conversion value is 14:32. Now remember this could be done with any data point in your account. This could be at the keener level we could be looking at ad spend of a single keyword and the conversion value of that single key word we could be looking at ad spend of an entire AD group in the conversion value of that entire group we could look at we could be looking at the end of a campaign and the conversion value of that campaign and we could be looking at advent of the entire account. We could be looking at ads spend of a geographical location we could be looking at ad spend over the course of a certain hour in the day or a certain day in the week so any data point could undergo this exact same mathematical calculation. So obviously as advertisers we really want to be looking at things at the keyword level that's kind of where we want to see our data at the keyboard level. So for example let's say we have a keyword you know by office chairs online because we're advertising for pop and then we see over the course of the last 14 days let's say it doesn't matter what the date range is it's the same calculation for any date range you're looking at or ask was. Eight hundred ninety seven dollars. We spent eight hundred ninety seven dollars on that keyword by office chairs online that just put our key word here. So that's our key word is the office chairs on Monday. OK so that's our key word that we are analyzing. So our Aspen is once again 97 conversion values 14:32. So let's plug in our calculations for return. So total revenue would be our conversion value. So we have our way us equals 14:32. Right. 1 4 3 to our total revenue simply divided by the cost of ads divided by 8 97. And if you open up your calculator and take a look at what that is the answer is 1.5 9. Okay. If you don't believe me check it out for yourself but I'm pretty sure this is right. So return at spen we take 14:32 divided by 8 7. That equals 1.5 9. But what does that number 1.5 9 really mean. Okay. Well let me tell you you might hear people refer to this as a 1.5 9 Aroha return on ad spend. I would simply like to call this one hundred fifty nine percent return on aspects. I would call this number one hundred and fifty nine percent return. And what does that mean. That means you're making 59 cents on every dollar. Or in other words it means for every dollar you spend on an ad you make an average of a dollar and 59 cents back. So it's fifty nine cents profit and I say profit in quotation marks because we don't know our margins yet. But essentially we've been making a hundred and fifty nine percent back I'm a dollar which is 59 cents back me back on every single dollar. OK. So that's a very simple calculation to understand. R r o s I return them and spend but now it's going a little more complicated let's get little bit more thoughtful. So we wanted to figure out our profit our return on investment taken into account taking into account our profit margins. Okay. So now let's say for example let's move over here. OK so we'll get a little bit more view. It will change the color. Let's go to black here and we're going to use the same data. Okay. We're still going to be talking about this keyword same spend in 97 and conversion value of 14:32. OK now let's say for example we had a 70 percent profit margin. Okay. And this is the new information that we're going to take into account. So we have a 70 percent profit margin. P.F. stands for profit margin. Okay profit margins are 70 percent which means for every dollar that we make that pop'n makes or your company makes you make 70 cents. Pretty good profit margins. Okay. Now you might ask me how I got came to that number and I just made it up. You're going to have to be able to come to your own profit margin number yourself. So let's just say we have a 70 percent profit margin but what does that mean in terms of costs. What are our costs. If our profit margins are 70 percent that means simply 30 percent of the dollar is made up of costs . Okay. Now costs mean servicing the client costs coming cost of goods. You might even be taking into account your lighting bill your rent your salaries whatever may be but you determined that 30 percent your profit margins are 70 percent and 30 percent 30 percent is cost . So the first thing he has to do is calculate our total revenue. Okay. Our revenue taking into account our profit margins. Okay. So what we want to do is calculate our cost for every for the revenue that we made. Okay because here's our number if you look at our formula up here this number cost. How do we know what the cost was. Okay. And that's a very simple calculation. We take our total revenue which is 14:32 right. So cost equals 14 32 which is our total revenue multiplied by our costs. Okay. Multiplied by point 3 because 30 percent is our cost of advertising. So what's 14:32 times multiplied by 5.3. That comes out to and once again to check it up for 29 60. Okay. So this is it might look complicated but it's very simple. What we're saying is in this number this total revenue our outwards account told us that we made 4800 $30 1432 dollars from our ads. But because I know that 30 percent of that goes to service in the client or whatever it is it's not profit we need to take out $429 and 60 cents from 14:32. And now once we created a calculation to determine our cost based on the total revenue we get simply go ahead now and create our our A-Y calculation because now do revenue minus costs look at you know plug Plug-In this formula down here. So revenue minus cost is 14 30 to minus 4:29 60. Okay. And we're going to divide that by our cost of advertising which is 897. Okay that's how much we spent on advertising. So that's going to be our calculation to determine what our our A-Y truly is. Okay. And if you do this math you get a value of 1.1 one. Okay. This number is our our why now. Interestingly enough and this is something which you would definitely have realized just thinking about this this number 1.1 one is lower than 1.5 not so we have an ROV Yes a 1.5 9 so we're say hey listen we're making 59 cents on every dollar. But in fact once you take your costs into account you're only making 11 cents on the dollar. OK. You're making 11 cents on the dollar or you have. You could also write it as 100 and 11 percent are A-Y which is still good. Right. You're still profitable years as long as it's above 100 percent or something which is very important for you guys to know as long as you're ROIC above 100 you're making money. If it's exactly 100 year breaking even if it's below 100 you're losing money