“Am I profitable?”
It’s a question every PPC account manager is asked, but it’s also a question many account managers struggle with answering. As an agency owner, I make sure our entire team develops a fluency with these essential ROI formulas. PPC marketers aren’t necessarily statistics wizards or mathematically oriented by nature. I’m not—that’s for sure.
While understanding AdWords and the pay-per-click auction process at a deep technical level is crucial to the success of any campaign, understanding a business’s financial metrics is just as important—if not more so.
Moreover, the better you can explain these sorts of financial metrics to your clients the better you will look, the better your clients’ campaigns will perform, and the longer you’ll be able to retain your clients’ business.
Formula #1: Determining ROAS
The difference between ROAS (return on ad spend) and ROI (return on investment) is whether or not you’re accounting for a company’s cost of doing business (often referred to as COG—cost of goods or profit margin).
When you talk about ROAS, you’re looking at PPC profitability in a linear way. In plain English you’re asking, “did we make back more money in revenue than we spent on advertising?”
When you talk about ROI, you’re looking at your PPC spend in a multidimensional way. ROI seeks to answer, “after accounting for the costs of the products or service and after accounting for the cost of advertising, did we make a profit?”
What you need to determine ROAS:
- Total Conversion Value
- Total Cost of Advertising
Total Conversion Value / Total Cost of Advertising
Your client runs a lead gen website that sells its leads to attorneys throughout the United States. The client asks you what their return on ad spend has been over the past 30 days.
They spent $17,547 on their AdWords campaigns which brought in 489 leads. 375 of those leads were sold to attorneys for an average of $130 / lead.
Their total conversion value: $48,750 (130 x 375)
ROAS: 2.78 or 278% (48,750 / 17,547)
You can report back to the client that their ROAS for the past 30 days was 278%, which means that for every dollar spent on advertising they made back $2.78.
AdWords actually has a column specifically built for ROAS called Conv. Val / Cost. If your campaigns are accurately tracking conversion value then you can use this column to calculate your ROAS quickly.
However for non e-commerce sites that aren’t tracking conversion values for each conversion inside the account, you’ll need to calculate ROAS by hand using the information your client gives you.
Formula #2: Determining Break Even ROAS
ROAS is nice and all, but it doesn’t give you the full profitability picture. Most businesses can’t service or sell their products for free (in fact I don’t think any business can), and just knowing your ROAS doesn’t tell you if your client is losing or making money.
For example, you can have a client whose ROAS is a whopping 400%, but they’re still losing money once you calculate their profit margins.
As a PPC account manager it’s important to first set a break even ROAS for your clients. Every client will calculate profit margins differently (do we include rent in our profit margins calculations or do we not include rent), but determining a basic profit margin is the first step in determining your client’s break even ROAS.
What you need to determine Break Even ROAS:
- Profit Margin
1 / Profit Margin
Your client is a travel agent that specializes in booking first and business class airfare. Each ticket they book generates an average of $1600 in revenue.
About 65% of that revenue goes to the cost of booking the ticket and 6% of the revenue is paid out to salespeople for commission.
65% of $1600: $1040 (1650 x .65)
6% of $1600: $96 (1600 x .06)
Out of the $1600 in revenue, your client makes a profit of $464. In essence, your clients profit margin would then be 29%.
Keep in mind, this calculation of profit margin does not take into account other potential costs of doing business like rent, taxes, and other overhead. This is simply the cost of servicing the booked airfare.
To calculate your break even ROAS you simply divide your profit margin by 1.
1 / .29 = 3.4 (or 340%)
In other words, your client needs to make $3.40 for every dollar spent in advertising.
To explain break even ROAS in a non-mathematical way, you can look at it this way: In order for your client to make a $1 of profit, they need to generate $3.40 of revenue ($1 is 29% of $3.40). You then subtract the $1 spent on advertising and your client breaks even.
In our above scenario, if your client generates more than a 340% ROAS, they are making money. If they are generating less than 340% ROAS, then they are losing money.
Some of your clients may be overly concerned with linear profitability (making more money than they spend after accounting for profit margins). If you are struggling to maintain a profitable account for your client, try determining the lifetime value of your clients’ customers.
Do customers come back and buy again? Do customers typically refer friends?
Determining the average lifetime value of a client or customer can increase your profit margins and in turn decrease your break even ROAS.
Formula #3: Determining Cost Per Conversion for Forms
Many of you track form submissions as a conversion action in your client’s PPC accounts. However attributing a value per conversion is tricky since some form submissions don’t represent any profit or revenue for your client.
As a PPC manager, you want to know what your client’s true cost per conversion is. In other words, how much your client pays for a form submission that turns into a sale or a deal or whatever it is that makes your client money.
What you need to determine CPA for forms:
- Average cost per conversion (cost per form submission).
- Average Form conversion rate (the percentage of forms that turn into sales)
Avg. cost per conversion in AdWords / Form conversion Rate
Let’s use our travel agent client from the previous formula. You are tracking form submissions in your account as a conversion action. You know that your average cost per conversion in your AdWords account is $37. In other words, you’re generating form submissions at $37 a pop.
Your client tells you that they close about 15% of all the forms they receive through the PPC campaigns.
37 / .15 = 246.67
You can report back to your client that their true average cost per conversion is $246.67, based on their close rate of 15%.
Taking this one step further, we can calculate your client’s ROI based on the numbers we have above. We know that the calculation for ROI is (profit – cost) / cost.
So for our travel agency client:
($464 (average profit per conversion) – $246.67 (true cost per conversion)) / $246.67 = 0.88.
With our fictitious sales numbers your client is making 88 cents for every dollar they spend on advertising. Remember, they are not losing money (ROI could be a negative number). They are making $0.88 on every dollar which can also be referred to as a 188% ROI (making back $1.88 for every dollar spent on advertising).
Now that you know what your client is really paying per conversion, you can help identify areas that can increase ROI with more nuance. You’ll be able to tell your client that increasing their sales team’s conversion rate by a given percentage will decrease their cost per conversion by ‘x’ dollars.
Unless you’re armed with statistical data, most clients will push back if you deflect blame away from your PPC performance. But with accurate numbers and a thoughtful approach your clients will approach the conversation in a less defensive way.
Formula #4: Determining Break Even CPA for Forms
Continuing our conversation from above, you know that your client is profitable and you know that you’re generating sales at a $246.67 CPA.
But how do you know the most you can spend on a form submission without losing money? Based on your clients close rate of 15%, you know a $37 cost per conversion in AdWords is profitable. But what if you were generating conversions at $42? Would the account still be making money?
Granted, you can plug those numbers into formula #3, but there’s a better way.
What you need to know to calculate break even CPA for forms:
- Average profit per sale
- Form conversion rate
Average profit per sale x Form conversion rate
Let’s stick with our numbers from our travel agency client. We know our average profit per sale is $464 (after accounting for commissions and the cost of booking the airfare). We also know that our client closes 15% of forms.
$464 x 0.15 = $69.60
In plain English, your client can afford to pay up to $69.60 per form submission on average before they start losing money.
Sometimes it’s important to encourage your client to be willing to decrease their profit margins for the sake of increasing volume and acquiring more clients.
Instead of telling your client:
“We’re generating form submissions at $37 per form. The only way we could get more forms is if we increase our max CPC bids, raise our average position, buy more clicks and generate forms for $45-$50. What are your thought about that?”
You can now say:
“We’re generating form submissions at $37 per form. At that rate our ROI is 180%. If we increase our bids, we could generate 20% more form submissions at $45 per form, and our ROI would drop to 154%. I think that’s OK because it still gives us a nice cushion below our $69.60 CPA break even point.”
Doesn’t that sound better?
Formula #5: Determining Break Even CPA for Complex Sales Cycles
Not all clients will convert their visitors in one linear process. If your client turns a profit from sales directly from their website or even if a form submission is the final step before the sale, your work is mostly done.
But many clients have multiple touch points with a lead or prospect before closing a deal and generating revenue.
For this formula, let’s draw out the scenario first and then figure out the correct formula.
Your client sells a monthly subscription to a cloud-based small business accounting software. Their average customer generates $3,287 over the course of their lifetime.
Your PPC campaign sends traffic to a landing page that promotes a free webinar that explains the benefits and features of your client’s software. Webinar registrations are as far as your PPC conversion tracking goes.
45% of webinar registrants actually attend the free webinar. Of all webinar attendees, 15% ultimately sign up for a subscription to your client’s software.
You (and your client, of course) want to know the most you should be paying for a webinar registration from your PPC campaigns.
What you need to know to determine your breakeven CPA:
- Average profit per sale
- Webinar conversion rate (percentage of registrants that attend)
- Sales conversion rate (percentage of attendees that buy a subscription)
(Webinar Conversion Rate x Sales Conversion Rate) * Average Profit Per Sale
The first step in the formula determines our true, or actual conversion rate. Because the conversion funnel is a two-step process through which some of our leads drop out, we need to multiply the two conversion rates together.
Once we have our true conversion rate, we simply borrow our formula from step #4 and multiply our average profit by our true conversion rate.
In our scenario:
(0.45 x 0.15) x 3287 = 221.87
Put simply, your client’s break even CPA for a webinar registrant is $221.87
It’s always a good idea to be able to describe and explain these calculations to your clients in a simple, nonmathematical way.
In our case, try walking your client through a scenario where you generated 500 webinar attendees at their break even CPA of $221.87.
Here’s how you explain the scenario to your client:
- We generated 500 webinar registrants at an average cost per registrant of $221.87. In total we spent $110,935.
- Of those 500 registrants, we expect 225 of them to actually attend the webinar, based on our historic average of 45%.
- Of those 225 attendees, we expect 33.75 (15%) to buy a software subscription. In this case you can round up to 34.
- We know that an average customer represents $3,287 in profit. If we multiply 34 sales by $3,287 in profit, we get a total profit of $111,758, just about breaking even on our advertising spend.
Keep in mind that the above calculation can get more complicated if you need to first determine the average lifetime value of a client. In our scenario, we called it $3,287 just for the sake of this example.
You’ll find that many clients don’t really know the true average lifetime profit of their clients or customers. As a PPC manager, it’s your job to help them figure these numbers out so they can have a clearer sense of what’s going on and so you can manage a more statistically accurate campaign.
Knowing how to calculate these formulas by heart is great, but being able to explain how they make sense with scenario based, nonmathematical English is even more important.
If the why of these formulas makes sense to you, you’ll be able to apply them in different situations across all your client accounts.
I can tell you from a lot of experience that your ability to understand and convey these numbers to your clients will go a long way in retaining their business and building your relationship with them.
Feature Image: Image by Isaac Rudansky
In-post Photo: shutterstock.com (used with permission)
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