Incremental ROAS or iROAS (incremental return on ad spend) is a more recent approach to measure the performance of marketing indicators in your marketing campaigns. This method has gained a lot of popularity worldwide because it’s a more accurate approach.
Incremental ROAS’s goal is to measure the incremental lift in sales from a marketing campaign. The sales actually caused by that campaign. Normal ROAS measures the attachment sales from that campaign.
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The Difference Between ROAS and Incremental ROAS
ROAS is a metric that you can use to determine the profitability of your advertising campaign. You can calculate it by dividing the revenue by the cost. Let’s say you spent $50 on ads and you get $100 revenue, then your ROAS is 2. However, it’s important to remember that ROAS does not express causality.
To avoid wasting ad spend, you have to assign a budget to your campaigns with high ROAS efficiency. But you have to be careful in doing so because wasted ad spend can hide behind great-looking high ROAS numbers.
If your audience was already planning to make a purchase from you even without seeing your advertisement, your ROAS would be high. However, in this case, your ad budget would have been spent unnecessarily on ads that didn’t contribute to the sale.
ROAS does not give you an accurate representation of your campaign’s true value. In some cases, like the one mentioned above, you’ll see inflated numbers which could create a false perception of exceptional performance.
To truly understand where your sales are coming from and how to steer your campaign in the right direction, you have to understand incremental ROAS which offers a more precise solution.
Incremental ROAS measures the effectiveness of your marketing efforts by making an incrementality adjustment. First, you have to divide your revenue into two parts. The incremental return is the part you would lose if you had not run the advertising campaign. The remaining return is non-incremental. That’s the part that really shouldn’t be attributed to the campaign.
To get the value of incremental ROAS, only the incremental returns are factored into the equation. This results in a modified version of the standard ROAS calculation. The iROAS reflects your marketing campaign’s value more accurately.
For example, you spent $300 dollars for an advertisement, and your campaign said that it drove $1,000 in revenue. BUT. Your overall sales only increased by $450.
By using the formula above, you would get an iROAS of 1.5 and a ROAS of 3.3.
What’s happening here is the marketing campaign is showing the ad to people that would have bought anyways. The campaign’s attribution model is “stealing” the sales away from another channel. In this case, the campaign took credit for $550 that it didn’t cause.
Why does this happen? Advertising platforms are incentivized to make their ROAS look as high as possible. If they can convince the advertisers that they’re getting a good return, they’ll throw more money at the platform.
This is why you need to be very careful in your measurement and spend time differentiating between your ROAS and your incremental ROAS.
How to Calculate Your Minimal Incremental ROAS Needed
People naturally tend to click on ads, which may lead to potential sales for your business. In the early days, it was believed that the last click directly caused the sales. However, over time, some have begun to question the relationship between clicks and sales, and differentiate between correlation and causality.
In order to accurately find out whether your campaign is profitable, you also need to align your incremental revenue with your profit, as it’s your profit that pays for the ad spend.
To calculate your total revenue, you need to add your sales revenue and shipping revenue together. For example, you’re selling a product for $45 and you get $5 for the shipping. Your total revenue is $50.
Fixed costs are your expenses that remain constant, regardless of the number of products you sell. This means that even if you increase production or sales, the amount of fixed costs you incur will not change.
On the other hand, variable costs are your expenses that go up in proportion to the number of products sold. With every new sale, you incur variable costs such as the cost of the product itself, shipping, and other related expenses.
The flow-through margin is what you will use to pay for your variable costs. To calculate this, you need to deduct your fixed costs from the total revenue.
For example, this is a simplified representation of your income statement. Consider the following.
You’re selling an item for $85 and charging $15 shipping for each sale. Your profit percentage or EBIT (earnings before taxes and interests) would be 50%. Using the formula to compute the flow-through profit, you would get 60%. Since fixed costs remain constant regardless of the number of units sold, each additional item sold contributes $60 to the EBIT line.
To determine the incremental ROAS required to be profitable, you would divide $100 by $60, since the flow-through profit will fund your advertising expenses. Once you’ve calculated your iROAS, you should continue to spend on advertising as long as each additional dollar spent on ads generates an incremental ROAS that exceeds this figure. In this case 1.67.
Even at a 1.7 iROAS, some profit is still being directed to the EBIT line, although to a minimal extent.
This is the reason why it’s critical to retain your customers, encourage cross-selling, and motivate them to make repeat purchases. Even with this imaginary very high margin business, you have to continuously spend most of your profit to acquire customers.
By increasing your customer’s LTV through retention and cross selling, you can invest more in advertising knowing that the revenue generated from future purchases will flow to the profit line.
How to Measure Incrementality
If you want to improve your conversion rates, you must prioritize accuracy over raw data. However, measuring the long-term impact of incremental branding and marketing efforts can be challenging. You must adopt different strategies for incremental measurement because it will have a significant impact on the overall accuracy of your marketing strategies and plans.
Let’s look at the methods you can use to gain quantitative data.
Pre-Post Test
This is the most crude of ways of measuring incrementality but it’s also the most applicable to most businesses.
A pre-post test is measuring something before and after a change and comparing the difference. The process goes like this.
- Measure the ROAS of the marketing campaign and overall revenue before you make a change.
- Make a change to the marketing campaign. This can be:
- No marketing campaign then turning on a campaign to max spend.
- Taking the marketing campaign to $0 in spend after the campaign has been running for a few weeks.
- Doubling a campaign’s spend.
- Cutting a campaign’s spend in half.
- Measure the effect of the overall revenue and revenue attributed to the campaign.
- After a period of time, usually a month or two, reverse #2.
- Measure the effect in #3 again.
- Analyze the results.
Marketing Mix Modeling (MMM)
The most commonly known method is marketing mix modeling, which assesses the incrementality through an econometric modeling approach. The use of econometric modeling involves analyzing intricate marketing trends so that you can identify the factors that contribute to the expansion or shrinkage of demand for a particular product or service.
MMM has gained popularity among prominent retail and pharmaceutical brands for the past two decades. Its effectiveness is dependent on meeting two specific criteria:
- If you are analyzing an immense paid marketing budget
- If the vast majority of relevant marketing efforts are non-trackable
Oftentimes, you may find it difficult to track your marketing activities because they are delivered to your consumers through various marketing channels, or simply because they are not directly trackable. If your marketing is mainly non-digital or if sales occur through third-party distributors or physical stores that are not owned by the company, then MMM may be a suitable option.
One disadvantage of using MMM is that the results you will get are relatively general and more focused on inventory types, such as Google Ads, Facebook Ads, Display, or network TV instead of individual campaigns. Additionally, it takes a significant amount of time to generate results.
For this reason, it’s nearly impossible to make real-time optimization on your digital advertising based on this method.
Public Service Announcement (PSA) Testing
PSAs are marketing campaigns delivered through public announcements. This approach is particularly useful when you’re conducting incrementality testing. This approach involves dividing your target audience into two groups.
One group receives the PSAs, while the other is exposed to branded marketing efforts. By comparing the conversion rates between the two groups, you can determine which approach is more effective. Most of the time, the group that receives the PSA is considered the baseline minimum for purchasing your products or services.
On the other hand, the branded marketing group is used to measure the incremental lift generated by the revenue and your marketing efforts. The PSA method is highly effective because it enables you to measure the effectiveness and efficiency of your marketing tactics.
Conducting PSA testing requires a significant amount of time and financial resources. You must allocate a substantial budget to purchase inventory for the underperforming PSA group. Additionally, you can’t fully leverage the outreach, marketing efforts, and conversion speed of the PSA group without having to compromise the control group, which will then lead to imperfect results.
You also have to add multiple exclusions to the paid ad segments of your marketing strategies to make sure that there is no overlapping purchase. This control is so delicate and may require extra effort to monitor.
Causal Attribution
Causal attribution is a recent improvement over PSAs and is known to enhance the measurability of marketing inventory and ad spend. This method uses the Rubin Causal Model, a statistical approach that eliminates the limitations associated with the PSA method in measuring incrementality.
In the PSA method, you establish groups to separate the target audience, then track each metric based on the control or test group for ad spend and marketing. With the causal model, groups are formed based on the data collected from the marketing campaigns, eliminating the need to invest extra time and effort in creating groups.
You can use this method to compare the conversion rates of groups who were exposed to paid ads with those who were eligible for the ads but didn’t make a purchase. You can also track the conversion rates of customers who were shown an advertisement against those who were not to gain insights.
By using the causal attribution method, you can track the changes in conversion rates between groups who were exposed to baseline consumer behaviors without any ads, and those who had complete exposure to branded content and other marketing materials.
Comparing these two groups using causal attribution is much easier to measure incrementality. It requires less of your time and money, and yields more measurable data in the long run. Because of its advantages, causal attribution has become increasingly popular, especially if you want to have an accurate insight into the incrementality of your ad spend and other marketing strategies.
Using Incremental ROAS to Optimize Your Campaigns
Incremental ROAS is a useful tool to analyze and compare complex marketing strategies. By examining the percentage values, you can get valuable insights into the effectiveness of your marketing campaigns.
A low iROAS with a high ROAS can suggest that there are factors beyond your marketing efforts that are driving sales. Some examples are your returning customers being targeted, referrals, or even word-of-mouth.
To make it simple, iROAS is a powerful tool that can help you optimize your marketing strategies and drive success to your business. While this can be challenging to understand and interpret at first, it can give you important analytical benefits in the long run. By using this metric, you can assess and redirect marketing spend to make a great impact on your overall strategy.
Leveraging iROAS can be highly effective if you want to scale your return on investment from marketing in your ad campaigns. You need to be very critical when you see the numbers so that you can discover which channels are driving the sales.
