ROAS: The Driver of Successful Ecommerce Companies
It's time for the Wednesday Hustle, where I give you a "behind the scenes" of building a 7-figure dropshipping business from scratch in 12 months.
First, the actions I took the last few weeks to increase conversion rates have helped, conversion rates bounced back in August to just below 1.5% and I'm now aiming for a 2% conversion rate in September.
Always practice what you preach :)
Today I want to discuss ROAS.
Every marketeer (maybe even every entrepreneur) needs to understand ROAS. Because if you don't understand your marketing efficiency, you're throwing money in the toilet. And on a higher level, when talking to investors your marketing efficiency is a core topic as well, so it's good to go granular.
WHAT ROI IS FOR VC'S, IS ROAS FOR ECOMMERCE ENTREPRENEURS.
▶️ ROI is a business-centered metric
▶️ ROAS is an ad-centered metric
ROAS refers to Return On Ad Spend and it's a pretty straightforward metric that shows you the revenue an ad campaign has generated. The ROAS formula looks like this:
1️⃣ Revenue = $1,000
2️⃣ Ad spend = $500
3️⃣ ROAS = $1,000 / $500 = 2x
Basically, this means that you 2X every dollar that you spend on your ads, $1 dollar in, $2 dollar out, a good start...on the surface.
What’s The Average ROAS?
If you do some research and have been in the digital game for some time you'll see all types of benchmarks but I personally believe that a ROAS of 4X is a good benchmark to aim for. Yes, there are different industries and products, but in general aiming for a 4X ROAS is a good goal. This means you’re generating $4 of revenue for every $1 that you spend on ads. So what are the pillars of ROAS?
Pillars of ROAS
Every industry has its own benchmark, where some industries are thriving with a 1X ROAS others might be walking on a thin rope with 5X ROAS. The reason is that it always depends on the context you're working in and that's why it's important to understand the key pillars for ROAS. My general rule is:
THE HIGHER THE ROAS, THE BETTER
PILLAR 1: GROSS MARGINS
Before we talk about ROAS you first need to understand your gross margins, because this gives you the "playing field" you have. For example, a 2X ROAS might not seem like a lost cause. You’re making $2 for every dollar you spend. Follow me?
For example, let's say your ROAS is 2X which means that you generate $2 for every $1 you spend. Sounds pretty good. Wait up...
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In case your gross margins are 25% and you're selling at $100, you'll find that after covering your COGS ($75) you're left with a gross margin of $25.
With a 2X ROAS, this means that with $25 you'll generate $50, in this case, it would not cover the COGS. Not an ideal situation, even though the ROAS didn't look that bad.
So, how do you at least break even?
If your product sells for $100 and you have 50% gross margins, then you’ll need at least a 2x ROAS to break even. If you have 25% gross margins, you’ll need a 4X ROAS.
Always know your margins before doing any ROAS calculations.
PILLAR 2: AOV (AVERAGE ORDER VALUE)
The second pillar behind your ROAS is your average order value (AOV). Your AOV is the average amount your customers pay at checkout (mine is currently around $32), and how much your customers spend at checkout can quickly make the difference between a low ROAS and a high ROAS. You can run a quick calculation of your AOV for different time periods or different channels by dividing the total revenue by the number of orders.
Now, if your goal is to get a profitable return from paid advertising, your AOV has a strong influence over whether you’ll have a thriving eCommerce business or a surviving one. For example, if your AOV is very small, i.e. $10 and you’re paying $1 per click, then you’ll need at least a 10% conversion rate (as we have seen a this is pretty high, I'm currently at just under 1.5%) just to pull off a 1X ROAS. This is a difficult starting point.
If your AOV is higher, i.e. $100, then there is more room to play and make mistakes. Assuming your margins are 50%, and we'll add another cost like payment processing and shipping fees as well, roughly another 15%. This means you spend $65 on just processing the order, and you don’t want to pay more than $35 in order to actually break even.
If you’re paying a dollar per click, you have thirty-five chances to gain a conversion. In this case, you’d only need a 2.8% conversion rate. This makes more sense than a 10% conversion hurdle. Have a strong AOV that gives you room to grow your conversion rates and optimization.
PILLAR 3: CUSTOMER LIFETIME VALUE
Any eCommerce entrepreneur can dream of CAC and LTC. What is the Cost of Acquisition and the Life Time Value of a customer? My rule of thumb is that it's always easier to get an existing customer to buy than to get acquire a new customer.
The reality is that acquiring customers is expensive. Especially in developing markets where it's really a change of behavior that you're investing in. Research shows that existing customers are 9 times more likely to buy from you than first-time customers and have a higher AOV because the trust is already there. So make it a focus to develop that relationship with existing customers.
It's crucial to really understand the buying patterns of your customers over a period of 30-60-90 days so you can optimize the ratio between the CAC and LTV.
Hope this is helpful for what you're building and let me know how you're optimizing your ROAS below ⬇️
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Andrew Senduk resides in Bali and is happily married to Melissa and the proud father of Rocco and Zion. He is a serial tech entrepreneur, global keynote speaker, author, and growth advisor to entrepreneurs & CEOs. If you want to work with Andrew please shoot him a message via hello@andrewsenduk.com or check out www.andrewsenduk.com.