Why PPC ROI is often a PPC LIE

Or: Three ways to get around misleading paid search reporting:

Most of us feel good when we see a positive ROI on our paid search campaigns. And most analytics tools give us plenty of opportunity to feel good about our campaigns.

But there is an inherent lie in the majority of PPC reporting tools, and that lie is based on the assumption that you have zero cost of goods. With few exceptions your products DO cost you something and thus any ROI analysis should be influenced by profit which in turn requires knowledge of margins.

When your campaign performance is measured by raw revenue, you won’t know which campaigns are making profit and which are losing money. Base your campaign measurement on profit and you’ll know very quickly which campaigns to adjust or cut.

Many measurement tools, like Google Analytics, IndexTools and ClickTracks, report ROI based on raw revenue. We can’t really blame them because profit is hard to expose (and collect) in the analytics tool. However, Google goes a step too far when they add a column to the campaign report that pretends to be “Margin” While the help tip says, “Margin is (Ecommerce revenue + Total Goal Value – Cost) divided by Revenue,” the only “cost” reported here is the ad cost and not the cost of goods, which makes the ad performance look far better than it really is.

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ClickTracks reports ROAS or “Return on Advertising Spend”. For every dollar you spend, this is how much you get back.

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At least ClickTracks acknowledges the need for margin markups in the help text: “… for a full cost/benefit analysis, you need to consider not only the revenue which a group of visitors brings in, but also the profit which you make from that revenue…”

How does this affect you? An Illustration:

Let’s say we bought 100 Marshmallow Shooters at $11 each and sold them all for $16 each. We spent $800 in Google AdWords to close $1600 in sales. Google Analytics will show this at 100% ROI and 50% margin. According to this report, we made 50 cents on the dollar and should invest even more in AdWords. This is how most advertisers (and some agencies) react to the report.

Marshmallow Shooter

In reality, we’re operating at a loss. Our cost of goods was $1100. With the $800 spent on advertising, our COGS (cost of goods sold) is $1900. With $1600 in sales, the business has lost $300. Actual ROI is -38%, not 100%. The business is losing 15.7 cents on every dollar spent. Run a business this way and it won’t last for long.

How do you really measure ad performance? Solutions fall into three categories:

  1. Rely on gut instinct to tell you which ads are generating profit. Many marketers do, so you won’t be alone.
  2. Expose profit rather than revenue to your measurement (analytics) tools. This is the most accurate method. Implementation requires that your revenue collection system be modified to calculate margin on the fly and expose it to your analytics tool. This makes sense for catalog and retail businesses, but for many advertisers, a simpler solution will suffice.
  3. Use the tools as they are and adjust for inaccuracy. After doing a small calculation, you can know what the reported ROI must be to indicate a performing ad campaign.

Let’s expand on the third solution. You’ll need to know your average margin and plug this into a simple formula. There are already great pages that discuss the definitions of margin, but for the purposes of this example, we’ll use profit divided by revenue, which looks like this: (sales-costs)/revenue. (Also for this example, we’ll leave advertising out to the ‘costs’ and focus on basic product costs.)

So, if I sell a product for $10 that costs me $6, my profit is $4. $4/$10 = .40 or 40% margin. Once you’ve got your own margin number, apply it to the following formulas to find your ROI break even point (as reported by your analytics tool).

To translate Google Analytics ROI , use the formula:

(1 / margin)-1

For example: If your margin is .3125, then (1/.3125)-1 = 2.20 or 220%. So, any Google analytics-reported ROI above 220% are performing ads.

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To translate Google Analytics Margin column , use the formula:

(1 – margin) * 100

For example: If your margin is .3125, then 1 -.3125 = .6875 or 68.75%. So any Google Analytics-reported margins above 68.75% are performing ads.

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To translate ClickTracks ROAS , use the formula:

(1 / margin) * 100

For example: If your margin is .3125, then (1/.3125) * 100 = 320 cents or $3.20. So all campaigns generating $3.20 or more ROAS are generating profit.

To save you some time and paper, here’s a simple tool that will do the calculation for you and display the rates for each analytics tool covered here.

Understand the real value of your ad campaigns, and you’ll be able to focus your investment on ads that are truly performing for your business.

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Comments

  1. Tim Leighton-Boyce says

    Thank you. This is a point I find myself having to make again and again (and it’s further complicated here in the UK because many systems report revenue inclusive of tax, which really needs to be deducted first).

    Now I can point people at a blog post which explains it all well.

  2. Darcy Foster says

    Hi Michael,

    Great post and ranked #1 on Google when I was looking for some 3rd party advice on how to explain this to a client.

    I don’t think that it can be understated

    1) Calculate the business’s margin (make a rule of thumb).
    2) Teach the PPC account manager to optimize against that number – ie margin must be greater than for this campaign to succeed.

    Optimizing this way is far superior to optimizing for cost/conversion

    Cheers

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