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226: Are You Spending Too Much On Advertising?

Posted by Austin Brawner on November 19, 2019

 

Two common questions I get from clients are: How much should I spend on advertising and what is a good return on ad spend? 

Andrew and I are tackling these questions today by breaking down the calculations you need to do to determine what a good ROAS is for your business.

We also discuss how to have an open conversation with your advertising agency and the first question you really need to ask yourself before you can realistically estimate the ROAS you need to be successful.

Enjoy!

Episode Highlights

  • 5:15 The inspiration for this episode: one of the most common questions Austin gets in the Coalition.
  • 6:55 What is a good return on ad spend (ROAS)?
  • 9:08 The first question you need to ask yourself to help determine what ROAS is realistic.
  • 11:05 Why you have to know your math before you start telling your advertising partner what ROAS you “need.”
  • 12:15 The first question you should really be asking to figure out a good ROAS for your business.
  • 13:04 Breaking down ROAS calculation and how to discuss it with your agency.
  • 15:49 The importance of making the distinction between warm and cold traffic.
  • 19:27 A further look at how to calculate the ROAS you need for your business.

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Transcript

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Austin Brawner: What's up everybody? Welcome to another episode of the Ecommerce Influence Podcast. My name's Austin Brawner.

Andrew Foxwell: And I'm Andrew Foxwell. And here we are coming to you live from the Chicago Athletic Association, a hotel in Chicago. The first of the Chicago session podcasts.

Austin Brawner: Exactly. Live, previously recorded, direct to you, wherever you are. You could be in Germany, Denmark, Iowa, Nevada, Australia. It's been really interesting, we've been hearing from listeners all over the world and it's really exciting. So we're fired up here, we're at the Chicago Athletic Association, and we did a little podcast retreat to record some episodes, do some planning and think about the future of the podcast.

Andrew Foxwell: Yeah, we came in and wanted to make sure that, I think Austin and I both feel... And it's weird because now I'm looking at you when I'm speaking to you, which isn't something that normally happens.

Austin Brawner: No.

Andrew Foxwell: We actually don't record on video normally either in our podcast. So it's interesting to be able to see your reaction. I think what Austin and I both feel, and a lot of it is thankfulness and gratefulness for you, that are listeners, and the amount of the podcast has grown and continues to grow with real quality people that are actually saying, "Hey, we're really getting tangible help out of this and we want to say thank you."

And so the challenge for us is, how do we continue to step it up and make a better product for you each and every day? And how do we make sure that every week when you're listening to the podcast, you're able to walk away with things that you can translate in your business right out of the gates? And so the retreat's kind of an effort towards a lot of that planning and just making it better.

Austin Brawner: Exactly. And it's been interesting because we got to hang out and spend basically the first day just talking about things that were interesting to us. And so we put together a list of topics that we want to go through, things that came up in our conversation, things that are common questions or common issues that we see with our clients.

And so this episode, we're going to dive into one of the first one, which is related to advertising, return on ad spend, and a question that I get, it's kind of was inspired from a question I get all the time working with clients in the Coalition, which is, "how much should I spend on advertising and what is a good return on ad spend?"

Andrew Foxwell: Yeah, exactly. And I asked Austin, it came out of me saying, what are the number one questions, your top questions that you could ask? And then what are the ones that you commonly see that are mistakes that people are making? And your response was, "I think generally people spend too much money on ads and or they don't understand the numbers."

And so we're going to talk about this from our perspective of doing the numbers and actually establishing gross margin and understanding what ROAS you need. I've certainly heard from a number of advertisers saying, "Hey, I was running ads and actually it turns out it wasn't as good as I thought, and I actually need to turn the ads down or off." I've also heard from media buyers saying, "The client pulled the rug out from under me and it's not my job to do their math." So we want to talk about that and their perspective that way a little bit.

Austin Brawner: And the relationship between the two, because when you have a media buyer, whether they're in-house or somebody who you've hired from an agency or a freelancer, the relationship is different. And as a business owner, you have to come in with an understanding of your numbers and your business, to allow this person to have success. So you can give them the metrics they need to have success.

So again, this episode we're going to dive into it and kick off with a couple of things that I noticed consistently. So let's go into the first question, which is, what is a good return on ad spend?

Andrew Foxwell: Right. So I think the number one thing that is... So there's a couple of things to mention here. I think it's important to establish as an advertiser that for us, a good return on ad spend at this point in time depends on how much you are spending and where you are spending that money.

So I think just generally as a baseline out of the gates, it's important for you to understand that in the United States right now, for accounts that are spending north of $500,000...

Austin Brawner: A month.

Andrew Foxwell: A month, spending $500,000 a month on ad spend or more, and potentially sometimes even more like $300, range, $300,000 a month, a good return on ad spend is going to be something like a 1.5 or a 1.6, that's good. And when people hear that, they're shocked, right? But that's the reality of where we stand.

If you're talking about other countries, and you're talking about smaller accounts, you can obviously bring that number up, that return on ad spend number into a 3X sometimes, I'm sure spending $50,000 a month or a 4X. But it is rare to see an account that's spending, let's say, over $100,000 a month at a minimum, to see that even rounding over a 2X.

So what's interesting about that is whether... we realize it's where your ROAS actually is, it's necessary and it's precipitated on the fact that you understand what the base ROAS is that you need. And as advertisers, we get that number told to us, so we don't necessarily know what that is.

So let's go into the second part of this, which is how does as a buyer, how do I say, here's how you calculate your gross margin and the minimum ROAS you need to be able to scale.

Austin Brawner: Well, I want to take a step back before we go into that because I think there's a key distinction that we forget about. So you talked about a larger brand spending $500,000 having a good return on ad spend somewhere around 1.5, 1.6, like that. So I think the big distinction, the first question you have to ask yourself about your company is, is it a demand capture based business or a demand generation type business?

Andrew Foxwell: Yeah, that's very true.

Austin Brawner: And how much education do you need to do for your potential customer to buy your product? Because the less amount of education, the higher potential for a high return on ad spend.

Andrew Foxwell: In the immediate term.

Austin Brawner: Generally.

Andrew Foxwell: Generally.

Austin Brawner: Generally, right? Let's say that you're selling a product everyone's familiar with, and you just do a good job of selling it better than everyone else, you can potentially have a very high return on ad spend.

I'm not talking about from paid social, because paid social is typically demand generation, but from Google advertising, you could have 4X, 5X, 10X return on ad spend, because people are searching for a product like yours and finding it.

If you are educating people about a new product, the more education you have to do, the lower your return on ad spend is going to be because you need to spend that money to educate them. You have potentially a lot higher upside because if you can establish this new product on a market, then you can dominate for years to come. And if you can be associated and build a brand around your product, that is a lot of potential there.

So, that's the first distinction I would make. And I think a lot of people can get caught up in this idea of needing to know what other people are getting a return on ad spend, and not thinking about how their business might differ from a company like MVMT Watches, right? Or like some of these companies that people are very familiar with, or like Native Deodorant.

So, that's kind of the first thing. And then going back to return on ad spend and thinking about that as a metric that you want to use and guide an advertising partner with. So the reason why Andrew was saying it's really important for you to know your math, is because return on ad spend is not a great metric to... You could have a really good return on ad spend and still end up going broke.

Andrew Foxwell: Totally, which we see. And I think we have become, as competition has increased as buyers, it's become more challenging. And we've seen more instances of people saying, "hey, I know that we're getting 2 point whatever, but, it needs to be a three." And a lot of times buyers aren't saying enough. That's not something we can deliver on. That's not something we can deliver on at this scale that we are currently at.

Austin Brawner: And so the question of why would someone need a three versus a two return on ad spend, right. That comes down to their gross margin. The higher the margin you have on your product, the higher potential you have for absorbing low return on ad spend over time.

And what I see often when people come in, and they're like, "What's a good return on ad spend?" That's not the first question to ask. The first question is, "what type of a return on ad spend do I need given my product to be able to make this viable, to be able to acquire a customer at a profit within 30 days?"

Because ultimately, you're going to be billed by Facebook within 30 days for your advertising. So if you don't want to raise money, and you want to bootstrap your business, you're going to have to make that money back within 30 days, to be profitable in 30 days.

And so that's where I feel like there's a big misunderstanding, and where people might be spending too much in advertising because they don't think about the fact that if you have a 50% gross margin, you need at the bare minimum, 2X return on ad spend. You can't even be profitable with a 2X return on ad spend.

Andrew Foxwell: Yeah, so let's talk about that calculation. I mean, I have had to learn this over time. So if I'm an advertiser and a client comes to you and says, "How do I calculate this? What's the best way to go about this?" How would you start that conversation?

And here's one other thing I want to throw in here as a complicating factor potentially. Is, a lot of what advertisers are doing to show true worth, which I think is valid, and you can tell me if you think this is BS or not, is they're waiting for a 30-day latency to pull in. So by latency, what we mean is of course you're going to see sale. Facebook measures on a 28-day click, one day view, on default.

So if somebody clicks on an ad and then up to 28 days later on a rolling basis, converts, goes to the site and buys, that's going to be attributed back to the ad that they clicked off of. And so what's common you'll see people saying, "We had a 1.5, but on a 30-day look back, we saw a 1.9." And you'll see commonly a 30 to 40% rise off of the latency coming from that.

So, do you calculate the ROAS off of that 30-day lookback? Or do you calculate it based on the end of the month? And saying, "hey, this month we only had a 1.5," and your advertiser says, "well, actually, if you look at the previous month, we're at 1.9 is that acceptable?" Which one should you aim for as you go for that? So one is the calculation. The second one is, which one would you aim for if you got that question? Which inevitably you've gotten before in the Coalition.

Austin Brawner: I think it's a nuanced question, and one that you're going to have make the judgment call for your own business, because again, your incentives, like having a good partnership with a media buyer comes down to aligned incentives. And the media buyer is going to want to look as far and have the latency period as long and as open as possible to show results.

And as a business owner, you're looking at the shorter term, right? So it's kind of trying to find a happy medium between the two and see what happens. Because there's also all these other things that are a little bit harder to quantify, right? Like the halo effect of Facebook advertising.

Andrew Foxwell: I was thinking that all the time, which is very real and true thing, I think, and isn't BS as an advertiser, honestly.

Austin Brawner: No, it's not.

Andrew Foxwell: You can see it happen, right? If you turn off ads, you can see that having a huge impact on all these other things, organic SEM and whole bunch of stuff.

Austin Brawner: So much, so much. So I think one distinction that we're not talking about right now is the difference between cold and warm traffic. And again, I think we've hammered this over the years, but if you're a new listener and you haven't dove into some of the past episodes, one of the things that you need to look out for when you're looking for a return on ad spend calculations is the difference between top of the funnel, middle of funnel and bottom of the funnel.

And is your agency or your freelancer, are they rolling in all the numbers into one ad set, and reporting return on ad spend, blended between the top of the funnel and bottom of the funnel? Because if they are, then you're not getting a true representation of... You could be tanking and losing a lot of money on cold traffic and making it up with warm traffic.

Andrew Foxwell: Yeah, I mean that's interesting. I didn't expect you to say that. And hashtag, Chicago Sessions. As buyers, we rarely get asked what's the ROAS based on where it is in the funnel? Which is good. So if that's something that's actually the distinction that needs to be made, then we should be doing that more often.

I think that the idea is always from a buyer's standpoint that we can spend money on prospecting and potentially lose money, but the remarketing will make up for it, which is good.

But as you're saying, if the goal is to grow and scale, then you need to have a really floor base ROAS break-even for prospecting, and then you need to have basically a much rosier look from a remarketing standpoint, and the blended is still helpful, but you need to separate those two. I mean, I'd be interested in the calculation on that too in terms of how you should set that up by funnel placement.

Austin Brawner: Well, I think it's mostly having an understanding when you look into Facebook advertising that you're going to see a difference between the return on ad spend from cold traffic and the return ad and from warm traffic. And that judgment call based on how much you can spend on cold traffic versus warm traffic, is one that can get cloudy if the reporting is not clear.

And if your Facebook ad agencies, oh, we're getting a 3.5X return on ad spend, and you look in there, and it's all just retargeting coming from Google SEO, and the prospecting isn't working at all. Then that might be a sign that you might need to turn off the prospecting. So it gets complicated.

Andrew Foxwell: You're saying just as a first step, establishing numbers and then as a second step, being informed of what the ROAS is by different funnels.

Austin Brawner: Exactly, because I've worked with many clients that they have a really... Normally happens when someone's getting into Facebook advertising, they have another channel, it's working really, really well. They start retargeting and then their agency sometimes will blend in prospecting as well, and they'll spend a lot of money on prospecting. And at the end of the day, that's not really driving anything. It's all the retargeting that they're doing based on the other channel that's driving sales. That's an interesting dynamic that you have to be cognizant of.

But back to the calculations, right, we talked earlier about how you could have a 2X return on ad spend and go broke. And that comes down to looking at your gross margin, and trying to understand how much... Looking at overall, how much you're spending and what your business can tolerate from an advertising perspective to be able to still, at the end of the day, be profitable.

And that's a difficult calculation, but it starts by looking at your gross margin. You can say if you have a 50% gross margin, you know that if you spent $20 to bring in $40, you're technically breaking even, but losing money on all the expenses you have to run the business.

Andrew Foxwell: Yeah, so I think that's important. So you're basically, so that's the calculation I've been taught to do in the last couple of years, which is basically is to take the amount that you're spending, just expense and including agency fees.

Austin Brawner: Exactly.

Andrew Foxwell: So let's say that your agency is charging $2,500 a month. Okay, well I'm terrible at math, so, if we have to pull out a calculator here, we can. $2,500 a month agency fees, let's say you're spending 10 grand on ads.

Austin Brawner: It's $12,500.

Andrew Foxwell: $12,500 and then you make a 2X, so you make $25,000.

Austin Brawner: Sure.

Andrew Foxwell: But your gross margin is only 40%, so you take the $25,000 times 40%, and that number should be greater than the $12,500.

Austin Brawner: But it's going to be less in that instance. And this is common where you start running, and you're like, well, I think I have a pretty good return on ad spend, you know 2X, 2.5X, but at the end of the day, you're losing money on day one because your margin's not high enough.

We're going to do another episode about what big brands are doing that you're not doing, and we're going to dive into the differences between margin and what that looks like.

But that's kind of the first place to start is, calculate your gross margin and then look at the fixed expenses that you have and what can you tolerate advertising-wise to, at the end of the month, get to a positive percentage of pretax net income.

Andrew Foxwell: I like that we went live on me showing just how bad I am at math. You see that, like, no calculator, just like you're like will be less, I'm like, Oh shit.

Austin Brawner: No, but that's, I think it's a great representation of how when a media buyer says it's not my responsibility to do math for a business owner, I just need to have the numbers in front of me so I can perform. That's what we're talking about.

Andrew Foxwell: And the reason that I think it's important to show my ignorance on this is, or I mean, learning on it, right? Without a calculator in front of me is, I think this is something that moving forward, ROAS is really important. Competition is increasing, and your ROAS is going to be lowering, the days of the money factory are over here, and like, we need as buyers to be doing this calculation more often. And I think being part of the conversation on it at least, and being informed of how you got to that number with your partner. I mean, even if you're internal, you know what I mean? So I think that's important.

Austin Brawner: Yeah. And I think that's potentially a great onboarding part of the process when you have a... If you want to have a longterm client, the first conversation you got to have is around having a little bit of a difficult conversation being like, "okay, if we did this, let's run the numbers and play out the model and see if it works out for you."

Because as somebody who's a Facebook advertiser, you're going to have a better idea of what you might be able to do with the product, but to look at the longterm ramifications and how that's going to work out for the business.

But that's kind of the takeaway. Some stuff, hopefully you can kind of maybe take some tangible ideas, think about it a little bit differently. Sit down, again, I have a couple of trainings in the Coalition about this specifically, because it is one of those, I have a forecasting model to help you kind of put in the expenses that you've got and try to calculate out, are you going to at the end of the year have what percentage of pretax and income you're going to end up with. And you want to be somewhere between I think 10 and 15% if you're running a bootstrap company, just to be able to survive longterm.

Andrew Foxwell: Sure. I think it's super helpful and good resources there. And I think as we move forward on understanding the complexities of this more and talking about ROAS more often, let's all be better in terms of from any side, the client or the agency, or the buyer perspective of understanding what it is.

And I think it makes a case also, once you start to think about this, my mind's going to the importance of having a higher average order value. You can have a higher ROAS, it's going to build in margin, having a better lifetime value, etc. Which I think we've obviously talked about in this podcast a lot, but I think it gives that importance. So yeah, hopefully this has been helpful for you.

Austin Brawner: Awesome. Thank you guys for listening and if you guys got any value out of this podcast, we'd love to have you head over to iTunes, give us a review, let us know what you think about the show, and we will talk to you guys in the next episode. 

Austin Brawner: Hey there, it's Austin again, and I have a quick message for you. If you enjoyed this podcast, I have something really exciting for you. For the last year and a half, I've been coaching eCommerce business owners and marketers inside a group called the Coalition. You might've even heard me talking about it on this podcast. We have a lot of members who come on and actually share their story.

Now, what launched as an experiment has become a game-changer for our over 150 members. If you like me and my team of expert marketers and eCommerce operators to coach you on your journey to scale up your commerce business, this is your opportunity.

You can head over to jointhecoalition.com to learn more. Again, head over to jointhecoalition.com to learn more. Everything we talk about on this podcast, we go into way more depth with actionable training. You can get actually one-on-one help from me to help you grow your business. Hope to see you guys inside.

Austin Brawner: What's up everybody? Welcome to another episode of the Ecommerce Influence Podcast. My name's Austin Brawner.

Andrew Foxwell: And I'm Andrew Foxwell. And here we are coming to you live from the Chicago Athletic Association, a hotel in Chicago. The first of the Chicago session podcasts.

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