If you’re wondering what ROAS targets to set for your ads, you should be asking a different question.
This content was published in the No Best Practices newsletter on 12.11.2021.
One of the most important questions marketers and media buyers need to answer: what KPIs should I use to manage my media spend, and what targets should I assign to those KPIs?
Many organizations will look at a P&L delivered by finance, see that performance marketing is 20% of the budget, and then assign a blended last-click ROAS of 5 to all media spend. That approach is extremely limiting to growth (I covered this in depth in the last newsletter).
Other organizations, typically venture-backed, will set media targets based on cost of acquisition:customer lifetime value ratios. They’ll say something like “the average customer produces a lifetime value of $200, so we can afford to spend $100 to acquire a customer. The only problem with that? There is no standard definition of lifetime value, so this approach often results in unprofitable customer acquisition.
Surely, there must be a better way, right? Yes. Here it is:
Setting The Right KPI Targets For Paid Acquisition
The goal of your acquisition efforts should be to break even or better on every purchase. Many marketers assume that media costs and the cost of goods are the only two expenses they need to cover. But that’s not the whole story.
If you really want a purchase to be profitable, it needs to cover your entire variable operating margin. These are all the expenses associated with selling one unit of your product. VOM includes things like the cost of goods, returns, and shipping fees. It doesn’t include fees that remain static no matter how many units you sell, like salaries and office rent.
Here is a very simplified example:
- Your AOV = $100
- Your cost of goods sold = $20
- You have a 10% off welcome offer used on 50% of 1st customer purchases = $10*.5 = $5
- Avg fulfillment cost = $9
- Avg cc/bank fees = $1
- Avg return rate = 20% = $20
- $100 – $20 – $5 – $9 – $1 – $20 = $45 VOM
This means that for every $100 order you’ll bring in $45 of profit before ad spend is factored in. So what does this have to do with marketing investment?
If you spend an average of $15 to acquire a customer, you’ll make $30 on each order net of total expenses. That is a 30% margin–excellent financial performance, but difficult to achieve. Putting it into perspective, that $15 CAC represents a 6.6x ROAS–this is completely unrealistic for most paid prospecting campaigns.
If you spend an average of $30 to acquire a customer you’ll break even on each order. So if you want to turn a profit, at least some of those customers need to come back and purchase again. A $30 CAC represents 3.3x ROAS. This is getting closer to feasible paid media performance, but it’s still out of reach for many young brands.
Now you can see why running a profitable eCommerce business is so challenging, especially if you’re leaning on paid acquisition to drive most of your revenue. You can also see why your finance team is perpetually cagey about all attempts to scale.
Sit down with finance and figure out your VOM, then determine the true profitability of your last few months of ad spend. The answer may surprise you.
Translating CAC Into Actionable Metrics
There is one problem with CAC: it’s hard to manage individual marketing channels using CAC as your guide. It typically takes 24-48 hours to get a CAC reading…if you’re lucky. And reading CAC on the day may not be the best way to look at things if your customers’ consideration period is long.
If Facebook is your only acquisition channel, you can use a correlation between MER and last-click ROAS to guide your day-to-day efforts. Your last click ROAS may perform below your profitability threshold, but last click metrics do a poor job of reflecting the role that prospecting takes in initiating a purchase. If you know that a certain ratio between ROAS and MER typically correlates with a profitable CAC, you can use that as a guide.
If you’re running multiple channels–Facebook, affiliate, email, SMS, etc–things get more complex. MER and CAC are your only true guardrails, but they aren’t available intraday. This is where it becomes important to understand the role of each channel and campaign in your funnel. You want to break out prospecting activities wherever possible, and reduce spend on retention activities that aren’t incremental.
Before iOS14, performance marketers worked on the assumption that an up-to-the-minute view of campaign profitability was always at hand, and campaigns could be managed with multiple small tweaks throughout the day.
That is simply no longer true. The keys to effective media buying in today’s environment are:
- Understanding your true profitability targets (VOM)
- Understanding how many new customers you need to hit your revenue goals (see the last newsletter)
- Structuring campaigns to focus on incremental acquisition as much as possible.
How To Find Room To Scale
You may calculate your VOM and AOV and find that your acquisition spend hasn’t been profitable. And you may look at the CAC targets you need to hit to become profitable and realize that they’re way outside the range of typical Facebook ads performance (or your other acquisition channel of choice).
In this scenario most marketers will default to what they know–testing creative, offers and landing pages. But you don’t have to stop there. Any steps you take to increase VOM will give you a higher CAC target to work with. Here are some things you can do:
Return Rate: this can be a huge VOM-killer, depending on your industry. Clothing and footwear have it exceptionally rough. On the media side you can remove items with high return rates from your ad creative and landing pages.
On the ops side, you’ll need to research what is driving returns for your specific business and find ways to address the issue(s). A common problem is a large delta between consumers’ expectations of the product and their reality. Do what you can to ensure the product is represented accurately online and in ads.
Of course, you can always make like a Kardashian and ban returns (jk, don’t try this at home).
Offers, Discounts & Promos: another huge VOM-killer, especially because the true impact of these tactics is rarely studied. You should run incrementality testing on all of your offers so you can understand if they’re truly driving an increase in conversion rate.
A big culprit is “sign up for our emails to get x% off”. Test your welcome offers at least once per year to see if you can get away with reducing the percentage or replacing it with something less margin-dilutive, like a giveaway. And study the behavior of customers who use the offer vs those who do not.
Fulfillment Fees: Big ops energy here, and probably outside of the marketing swim lane. Pick & pack and shipping fees can cause death by a thousand cuts. See what you can do to work cross-functionally to explore options here.
Shopify Apps & Other Tech: another sneaky profitability killer. When is the last time you’ve audited all the Shopify apps and other software that charges you a fee per order? I bet there are some apps that you don’t really use anymore, and others that can be replaced with cheaper alternatives. If you had to go through a live person to get the app up and running, you can probably negotiate your rates.
AOV: You’ll have to find ways to increase AOV that maintain your current level of VOM–not always easy. For example, offering 25% off might increase AOV but dilute VOM. Some ideas: creating sampler packs or other bundles, buy 2 get x% off offers, developing irresistible companion products, free shipping threshold testing.
Other Product Levers: If you have a broad assortment that covers multiple categories and price points you can probably increase your ad efficiency by being more strategic about which product you show to which audience. Certain products naturally perform better in certain advertising channels. Do some analysis and figure this out–it can be a huge unlock.
Tapping Into New Markets: another way to increase AOV is to find customers who are willing to spend more. Real talk: women over 45 typically have the most to spend and the fewest hangups about splashing out. So if your ad creative features mostly Gen Z models, why not test framing your product and creative for an older audience?
Increasing LTV: this is the riskiest one, because you’re paying today for projected results in the future. But if you can increase your retention rate meaningfully you won’t have to lean so hard on acquisition for growth. More on this topic in 2022.
There are a lot of options here–probably some that I’m overlooking. You’ll want to prioritize them based on the potential impact, as well as your ability to quickly implement changes.
For example, your highest leverage option might be decreasing return rate, but doing so would require buy-in and action from two other teams. You’d want to balance that with one or two other ideas that you could implement yourself.