Is a 4X ROAS Killing Your Business?

How you measure ROAS (Return on Ad Spend) is more important than you may think

One of our longtime customers, “James,” was ecstatic when he shared news of a breakthrough with his ad agency, his ROAS (Return on Ad Spend) had skyrocketed to 4X. After months of effort and investment, it seemed like his business had hit a significant milestone. He even joked that it felt like he was “printing money.”

But when we dug deeper into James’ numbers, the reality was far from celebratory. While his ROAS was high, his profits were still nonexistent. In fact, James was barely breaking even. What was going wrong? Where was the cash from all these profits?

The issue lies in how ROAS is traditionally calculated: by dividing revenue by ad spend without accounting for all the direct variable costs involved in purchasing and selling products in an e-commerce business.

Traditional ROAS formula

The traditional formula for ROAS is Gross Revenue / Ad Spend, but this oversimplified formula hides key expenses, like product costs, fees, and shipping, which all eat away at your bottom line. Ad agencies can sometimes use this oversimplified formula to measure success and performance bonuses. Beware! You need to ensure that you are using a measure based on profitability, not on revenue.

We sat down with James to walk through his actual numbers. Using what we call True ROAS, which factors in all the relevant direct variable costs, we uncovered the full picture. Here is how it works.

The traditional calculation looked healthy: gross revenue of $10,000 divided by ad spend of $2,500 gives a 400% ROAS. Now look at the same campaign with the real costs added back in.

True ROAS calculation, $10,000 revenue campaign

That is a True ROAS of just 20% ($500 profit contribution divided by $2,500 ad spend), and a real loss of $2,000 after ad spend ($500 - $2,500 = -$2,000).

Going from a positive return to a negative return?

James went from thinking he had made a 4 times (or 400%) return on the investment in advertising spend, to realizing that in reality, his return was only 0.2 times (20%) his investment on advertising spend. After reviewing this, James was not so happy to pay the agency a further $300 for an incentive on a loss-making campaign.

James has now learnt how important it is to supply his agency with accurate costing and profit information so that they can measure their performance in an accurate manner that results in truly profitable growth for his business.

Why does True ROAS matter?

If you only focus on traditional ROAS, you might think you are doing great when, in fact, you are losing money. True ROAS accounts for all of the direct costs that can quietly erode your profitability, including:

• Landed costs: the total cost to get products into inventory.
• Marketplace and merchant fees: Shopify, Amazon, PayPal, and Stripe fees.
• Outbound shipping: costs from FBA, 3PL providers, and couriers.

Get better insights, make better decisions, earn more profit

By shifting to True ROAS, you can set more meaningful KPIs (Key Performance Indicators) based on profit, not just revenue. This ensures your business stays profitable while advertising to grow, no matter how high your ROAS climbs.

Important note: make sure you are using an accurate landed cost for the product costs that is up to date based on recent purchase orders delivered. If you are just using the supplier’s buy cost without any landed cost adjustments for freight and customs, you may end up with inaccurate profitability measures.

Do not let a misleading ROAS put your business at risk. Take a closer look at your financials today.

One way to keep track of this is by reviewing your income statement and measuring profit contribution before advertising as a percentage of net revenue. This gives you a clear view of your performance on a monthly basis and helps you set a meaningful Key Performance Indicator (KPI) to target.

Using this method you will get a better understanding of the true costs and can make changes so that you actually make money.