The ROAS Profitability Hockey Stick
A ROAS of 4 or 5 ?
Your agency assured you that a ROAS of 4X would be a great success outcome. They delivered 5. Don’t pop the champagne yet as your brand might still not making money via your ecommerce channel of choice.
Don't worry the agency said. As you scale, your costs will come down. That was five years ago. Your parents are still paying your rent.
The hard truth is that for many CPG brands, a ROAS (Return on Ad Spend) of 4 or 5 or even 6 is only making Amazon (and the agency) richer.
Where is the return?
ROAS is misleading. It paints half a picture in that it leaves out all the other costs that actually impact profitability. There is no "return" in that metric. COGS, logistic expenses, other trade/digital marketing fees and discounts are all missing from that equation.
If you think about it, ROAS is highest when Ad Spend approaches zero. No brand is that viral. You need Ad Spend but you need to manage it wisely. (Did you know there are only 5 possible scenarios for ROAS to increase? Likewise there are 5 for it to decrease.)
If you have been following my LinkedIn posts or reading the articles on the insights section you will know that I recommend a focus on Sales Contribution. (Sales Contribution = Gross Sales - Trade/Digital Marketing - COGS - Selling and Logistics Expenses).
Sales Contribution pays for overheads. It captures all the relevant direct marketing and sales costs and it avoids the games and potential pitfalls when only calculating and reporting gross profit or gross margins. (See my other articles.)
The ROAS Hockey Stick
There is no need to throw out ROAS, but you can reframe the metric to uncover the real relationship between ROAS and profitability. Sales Contribution is my first choice.
When you reframe ROAS in terms of Sales Contribution, you will find that a brand-pack’s unit economics will yield a curve that resembles a hockey stick. There is a shaft, a blade edge and a lie angle.
In this case study, a CPG brand-pack that exhibits a ROAS of 5 is also only delivering a Sales Contribution % of Net Sales of 10%. For many emerging CPG brands, a path to profitability can imply that you need at least 30% for the total portfolio.
So for this brand-pack, with its specific unit economics, the Gross Revenue to Ad Spend relationship, known as ROAS, would have to be 12.50 to deliver a 25% Sales Contribution margin. This means that, on average, your campaigns really need to be more effective to get to sustainable profitability.
For some emerging brands, this ROAS might actually not be possible for the levels of Dollar revenue flow that you need. and for the current unit economics that shape this curve.
Getting to Profitability
The ROAS Profitability Hockey Stick can also help explain why so many emerging DTC or ecommerce brands fail. The heavy investment in paid acquisition and ad spend might be delivering a high revenue, but that revenue is still only yielding a very low (or even negative) sales contribution. Even though the ROAS might be considered an “excellent” 4 or 5.
The insight here is that a brand-pack’s specific unit economics DETERMINE the “length” of the shaft and whether the “blade” ramp up will lie in a sales contribution zone that will work for your brand-pack and portfolio as a whole.
Can a 4 or 5 ROAS actually be beneficial and profitable?
High gross margins, strong brands that don’t need that much discounting, that exhibit low logistics fees per size or ring value of pack…all extend the hockey stick shaft and thus impact the amount of ROAS needed to deliver a target Sales Contribution.
Extending the shaft… shifts the blade. This means that your unit economics are such that they allow for:
A lower ROAS relationship between Revenue and Ad Spend
A higher Sales Contribution
The bottom line
While improved unit economics will amplify the impact of ROAS, sustainable profitability cannot depend on short-term sales activation and a reliance on paid acquisition approaches. I have not seen many emerging CPG brands achieve acceptable Sales Contribution levels (Dollars and %) this way. This is also a reason why so many DTC emerging CPG brands have had to accelerate efforts to enter and grow in bricks ‘n mortar channels.
Longer term brand building activities that build organic growth and velocity are vital. There is a curve for that too.
Don't be a ROASS. Get to know your unit economics and profitability thresholds and realties.