Measuring return on investment (ROI)
When you use AdWords to increase conversions such as sales, leads, and downloads, it's a good idea to measure your return on investment (ROI). Knowing your ROI, you'll be sure that the money you're spending on AdWords advertising is going to a good cause: healthy profits for your business.
ROI is the ratio of your net profit to your costs. It's typically the most important measurement for an advertiser because it's based on your specific advertising goals and shows the real effect your advertising efforts have on your business. The exact method you use to calculate ROI depends upon the goals of your campaign.
One way to define ROI is (Revenue - Cost of goods sold) / Cost of goods sold.
Let's say you have a product that costs $100 to produce, and sells for $200. You sell 6 of these products as a result of advertising them on AdWords. Your total sales are $1200, and your AdWords costs are $200. Your ROI is ($1200-($600+$200))/($600+$200), or 50%.
Why ROI matters
By calculating your ROI, you'll learn how much money you've made by advertising with AdWords. You can use ROI to help you decide how to spend your budget. For example, if you find that a certain campaign is generating a higher ROI than others, you can apply more of your budget to the successful campaign, and less to the ones that aren't performing as well. You can also use the information to try improve the performance of the less successful campaigns.
AdWords essentialROI: focus on profits by measuring your "return on investment"
Using conversions to measure ROI
To identify your ROI, you first need to measure conversions, which are customer actions that you believe are valuable, such as purchases, sign-ups, web page visits, or leads. Conversion Tracking is a free tool that helps you track how many clicks lead to conversions. You can use Conversion Tracking to determine the profitability of a keyword or ad, and track conversion rates and cost-per-conversions.
Many AdWords advertisers use Google Analytics to track conversions. It's a free web analytics tool that helps you learn how your customers interact with your website. Learn more about the differences between Analytics and Conversion Tracking.
Once you've started to measure conversions, you can begin to evaluate your ROI. The value of each conversion should be greater than the amount you spent to get the conversion. For example, if you spend $10 on clicks to get a sale, and receive $15 for that sale, you've made money ($5) and received a good return on your AdWords investment.
Calculating your ROI for sales
Determining your ROI is straightforward if your business goal is web-based sales. You'll need 3 numbers:
- Your revenue made via AdWords advertising
- Costs related to the products you sold
- Your AdWords costs (available in the Campaigns tab of your AdWords account)
Calculate your net profit by subtracting your overall costs from your AdWords revenue for a given time period. Then divide your net profit by your overall costs to get your ROI for that time period. Here's an example:
|($1300 -||$1000) /||$1000 =||0.3|
|Your revenue (measured by conversions)||Your overall costs||Your overall costs||Your ratio of profit to overall cost is 30% -- this is your ROI.|
Calculating your ROI for page views, leads, and more
Sometimes your ROI may require a different formula. For example, if you're interested in calculating the ROI for a page view or lead, you'll have to estimate the values of each of these actions.
A Yellow Pages ad for your business may cost $1000 per year and result in 100 leads. Ten of those leads become customers, and each customer provides a net profit of $120, after taking your business costs into account. So the value of each lead is $12 ($1200 net profit/100 leads), and your ROI for the Yellow Pages ad is 120% ($1200 net profit/$1000 advertising cost) x 100.
Here's the formula used in this example: (Total revenue - Total cost)/Advertising costs x 100 = Advertising ROI %
A simple alternative to estimating values for your leads and page views is to use a cost-per-acquisition (CPA) measurement. Acquisitions are the same thing as conversions: they're actions your customers take that you think are valuable, such as completing a purchase or signing up to receive more information.
Using this method allows you to focus primarily on how your advertising costs compare to the number of acquisitions those costs deliver. Using the Yellow Pages example again, your ad may cost $1000, resulting in 10 sales. So your CPA for that ad is $100. Here's the formula for CPA: (Costs/Sales) = CPA
Your CPA shouldn't exceed the profit you made from each acquisition. For your Yellow Pages ad, the CPA is 20% less than the profit the acquisitions provide.