‍ROAS - a marketers favorite word

If you ask any performance marketer or agency how good they are, 9/10 will mention the ROAS they got for their last client and the number will be super impressive like 6, 10 even 25!

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But then if you ask more questions, the reality unfolds…

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4/9 were sharing a Blended ROAS (All Revenue / Ad Spends), i.e. they counted all revenue the client generated, not just the revenue attributed to their Ads.

2/9 were talking about that 1 campaign with a 50% discount offer where ROAS touched a high of 10!

And in some cases, like real estate and premium jewelry, the industry average will be naturally higher.

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So is ROAS a bad metric?! 

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Not at all.

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It's a very effective metric, but ROAS alone doesn’t tell the entire story.

But when you club it with other metrics, a Founder can get a clear picture of their marketing effectiveness.

In this article we will try to map key marketing efficiency metrics and how can a Founder leverage them to understand and improve their marketing strategy.

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So let's start with every marketer's favorite…

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ROAS

Definition: Return on Advertising Spend = (Revenue generated from Ads) / (Ads Spend)

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Performance Measurement: 

It helps in assessing the performance of individual ad campaigns, allowing marketers to identify which ones are delivering the best return.

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Budget Allocation: 

By understanding which campaigns are most effective, marketers can allocate their budgets more efficiently to maximize returns. However, Meta and Google are now advanced enough to auto-allocate budgets to the best performing campaigns. So for Founders this is not a big advantage of ROAS.

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Optimization: 

ROAS helps in optimizing ad spend by indicating which strategies or channels are the most profitable.

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Goal Setting: 

It assists in setting realistic revenue goals and benchmarks for future campaigns.

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This is perhaps the best use for ROAS, but there are limitations:

1. ROAS in January cannot help predict February performance due to fluctuations in seasonality. Best to look at Jan 2024 vs Jan 2023. Hence, you need annual data for better goal setting, so if you are a new brand less than a year old, the use of ROAS is limited.
2. It doesn’t account for impact of product and creative improvements unless you set up A/B experiments - a luxury not every startup can afford. This is where you need to club it with other metrics like CTR and Product Conversion.

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‍Conversion Rate

Definition: The percentage of users who take a desired action (usually purchase or complete a lead form) on your app or website

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Conversion Rate = (Number of Conversions / Total Visitors) * 100

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Impacts effectiveness of marketing campaigns in driving a particular action: Ideally every campaign should be optimized towards your revenue-driving action. Examples: Purchase, Payments, completed lead forms.

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Conversion rate is determined by the quality of your landing page, i.e. where does the user land after clicking on your ad. This can be the app store for app install campaigns, a website for traffic campaigns, and even a simple form for lead generation campaigns.

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Founders should be obsessed with the conversion rate. It is the determining factor in how effective your marketing campaigns are, if your marketing communications, both in ads and the landing page, align and add value to the user.

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Conversion rate optimization is an art form in itself.

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Click-Through Rate (CTR)

Definition: The ratio of clicks on your ads over the number of impressions received on your ads.

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Formula: CTR = ({Number of Clicks} / {Number of Impressions}) * 100

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CTR is the former favorite of marketers.

Before startups got wiser and started asking questions on return from marketing investments, Freelancers and agencies would boast of impressions and CTR.

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It is a very good indicator of the effectiveness of ad creatives and messaging. But more importantly also an indicator of whether you are targeting the right audience.

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Early stage Founders can leverage CTRs by looking at what value props used in the ad messaging is appealing most to their target audience, run multiple A/B experiments on these ads and use them to refine your offerings.

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Even for late stage Founders, CTRs are a good metric to keep checking every alternate week or once a month.

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But it is still not a metric that defines your return on marketing investments.

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Return on Investment (ROI)

Definition: Measures the profitability of marketing efforts by comparing net profit to the cost of marketing.

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Formula: ROI = ({Net Profit from Marketing} / {Cost of Marketing}) * 100

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This metric is the holy grail of marketing efficiency, it also gives marketers nightmares.

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This is the first question the finance team at any company asks their CMO/Marketing VP, and they let out a long sigh…

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For startup founders as well this is a critical metric, because in the end you need to make a profit! 

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With the shift in funding styles of VCs, profitability is the key metric.

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Then why doesn’t everyone talk about ROI!?

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Well for starters it is not easy to measure.

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If you notice the formula, it is “Net Profit from Marketing”.

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The challenge comes in calculating the “...from Marketing” section:

• Do you include only the direct revenue from ads? 
• But there is spillover to organic also!
• Why not the recurring revenue? (see LTV)
• How much recurring revenue? 1 month, 3 months, 6 months?
• Which attribution model to use?

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All these considerations can drastically alter your ROI number.

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So here’s my take on marketing ROI for startup founders:

1. Early stage: Look at overall ROI of the business and don’t burn more than required on marketing, conserve your runway
2. Growth stage: Start tracking this and CAC, build upper & lower thresholds, and worry only when you start going beyond these thresholds. Make sure you are not overly reliant on one marketing channel.
3. Late stage: Make this the #1 metric to track for efficiency, make sure this improves over time, and be very critical of how it is tracked. Hold the team accountable.

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Customer Acquisition Cost (CAC)

Definition: The cost incurred to acquire a new customer.

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Formula: CAC = {Total Marketing and Sales Expenses}/{Number of New Customers Acquired}

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Excellent metric to measure over time and alongside LTV, but only tension inducing as a standalone metric.

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Founders should understand at every stage why the CAC is moving up or down. Map all product and marketing initiatives to the CAC movement.

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In highly competitive and price sensitive segments, like ecommerce and fashion, CAC is as good as looking at Cost per Order. So we recommend Founders the relevance of CAC based on which industry they operate in.

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Customer Lifetime Value (LTV) 

Definition: The total revenue expected from a customer over the entire relationship with the business.

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Formula: LTV = {Average Purchase Value} * {Purchase Frequency} * {Customer Lifespan}

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A very helpful but tricky metric to track.

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The question comes down to what is the customer lifespan you should consider?

• 12 months
• 6 months
• 1 month!
• 1 day!?

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All are viable options depending on the business and user stickiness.

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Unfortunately, there is no correct answer here. Founders can keep it simple by:

1. Use the standard measurement in your industry
2. If you have to invest a lot in retention, track cohort level retention and pick the timeline where is starts to flatten out
3. Track LTV (to keep investors happy), but don’t fuss over it as a standalone metric

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LTV/CAC

Definition & Formula: Customer Lifetime Value (LTV) / Customer Acquisition Cost (CAC)

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LTC / CAC has been the gold standard for tracking marketing efficiency for B2C startups.  

A close proxy for ROI, many startups played around with the calculations to show to investors and raise more funding.

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Biggest loophole in this metric is calculating a long timeframe for LTV and the one time cost of acquisition for CAC.

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However, the positive aspect is that it forces startups to think about retention.

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Founders should definitely track this but be vary of the pitfalls:

1. Be conscious of the timeframes considered in calculating LTV
2. Measure LTV/CAC at a cohort + channel level, example, compare the ratio of users acquired in March through Meta vs April through Meta
3. Like ROAS, it is best used as a comparison metric rather than just standalone given the calculations can vary a lot within the same industry as well.
4. Founders should be vary of using LTV/CAC to make short term decisions, by definition is should be evaluated over the “lifetime” of the customer

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Warning: We have seen a lot of startups building LTV based on assumptions and then back calculating ideal CAC. While this works well on paper and for investor presentations, but to be blunt, this CAC is as good as a random number pulled out of thin air. Better to use ROI and ROAS in combination. They are better indicators of efficiency.

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CAC Payback Period

Definition: The time duration in which you can recover your CAC from the profit per customer.

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A good alternative to LTV/CAC is the CAC payback period.

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Simply it measures how much time you take to earn back that CAC from a user.

Important to note for Founders, this only works when you are making a net profit.

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Now the question arises what is a good payback period?

• Ideal: The first transaction | Mostly happens in high ticket businesses: Premium jewelry, real estate, consulting services.
• Amazing: 1- 6 months | This is also very impressive, mostly seen in B2C and B2B SaaS products.
• Decent: 6-18 months | Depending on nature of business and how fast you are growing, this is the usual range of payback period, most common in B2B enterprise solutions
• Poor: 24 months+ | Anything longer than 2 years is not very helpful. 70% of startups fail within the first 2 years!

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Note: Confused between speed of growth and quality of acquisitions? Read out article on the Growth Trilemma

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Net Promoter Score (NPS)

Definition: Measures customer loyalty and satisfaction by asking customers how likely they are to recommend the business.

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Formula: {NPS} = {Percentage of Promoters} - {Percentage of Detractors}

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Now this may be controversial, but I find the NPS to be rather… useless.

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It’s basically a survey with the main question, “How likely are you to recommend XYZ company to your friends/family/colleagues'”, answered on a 10 point scale. 9s and 10s are counted as promoters and 1-6s counted as detractors.

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Now I can write a whole article on why NPS will not work for many. 

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But just one is enough to help Founders understand it - it doesn’t answer the why!

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Why are you a detractor, or why do you want to promote us?!

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There are multiple workarounds to this that startups have deployed, but my question is - why not just look at LTV and Churn rate?!

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Because in the end, actions speak louder than words (or surveys)!

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Churn Rate

Definition: Churn rate measures the percentage of customers who stop using a service or product over a given period.

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Formula = {Churn Rate} = ({Number of Customers Lost}/{Total Customers at the Start of Period}) * 100

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Critical health metric for not only marketing but also for your business.

Founders should track this to understand user stickiness and product/service value add. We recommend that Founders track churn at a granular level split by:

1. Channel of acquisition
2. Month of acquisition
3. Offer(s) availed during acquisition
4. Time to churn

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There is no good or bad churn rate, but yes it always helps to benchmark yourself to your competitors.

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Conclusion

By tracking these key performance indicators in digital marketing and applying them to various aspects of their marketing efforts, startup founders can gain a comprehensive understanding of their marketing effectiveness. With these alternatives alongside ROAS, marketers can gain deeper insights into their campaigns' effectiveness, optimize their strategies, and achieve better alignment with their overall business goals.

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