How marketing metrics impact your Profit and Loss statement: Beyond ROAS and MER

Develop a nuanced understanding of marketing efficiency

Linked to the "grow top-line revenue at all costs'' phenomenon that gripped our industry was an obsession with maximizing ROAS (Return on Ad Spend) and MER (Marketing Efficiency Ratio). But this simplified "up is good, down is bad'' view can be damaging. The best brands have developed a more nuanced understanding of marketing efficiency, clearly recognising how these metrics impact their bottom-line.

As we've outlined in a previous article, contribution margin is a critical part of any profitability equation, but it's completely absent from consideration on most ad platforms. Your marketing team wield a lot of power over the ultimate profitability of a business, so it would be a mistake to look at ROAS and MER in isolation. You need to consider how changes in these metrics flow through to your P&L.

As a reminder, here are the formulas for MER and ROAS:

marketing efficiency ratio (MER) = sales / ad spend

return on ad spend (ROAS) = platform attributed sales / ad spend on that platform

ROAS focuses on the platform-reported performance of individual campaigns, while MER is a more holistic company-wide measure of marketing efficiency. You should be monitoring these metrics closely to understand how marketing dollars are converting into product purchases. You can also use our benchmarking tool to assess your performance relative to industry peers and gauge a rough range for where you'd expect these metrics to be at.

EXAMPLE OF MER BENCHMARKED AGAINST INDUSTRY PEERS

If your primary goal is to generate as much revenue as possible, then put a laser focus on driving up MER and ROAS to get more sales per dollar of ad spend. But if you're looking to run a profitable business, you need to be wary of fixating on ad metrics alone and take your product margins into account.

To illustrate this point, let's consider another side-by-side comparison:

BizA has a higher MER, so is a better business, right? Not so fast. Let's now reveal the margin profile of each business.

At a MER of 5.0, BizA are more efficient with their marketing, investing just $20 in ad spend to make a sale. BizB spend double this at a MER of 2.5 and $40 ad spend per sale. But taking margins into account paints a very different picture of the financial health of each business than MER alone does. Consider the break-even MER of each business, or simply put: how efficient they need to be with their ad spend just to break even per unit.

break-even MER = selling price / gross profit

So, if we consider the actual MER for each business, BizB are actually exceeding their break-even MER and earn a contribution margin of $25 for each unit sold, while BizA are just about breaking even on each sale, not yet accounting for any fixed costs they need to cover.

Assuming both brands sold 10,000 units and have fixed operating costs of $100,000, then BizA would be making a loss of $100,000 despite having the higher MER. Meanwhile, BizB make a $150,000 profit because their far superior gross margins have afforded them a lot of wiggle room with their marketing efficiency. Their ads are less efficient, but their business is more profitable.

This is where a nuanced view of marketing efficiency is crucial. If BizA blindly looked at marketing metrics alone and thought "Woah! Our MER is super high. Let's put an extra $50k into the ad budget!", they'd likely be compounding the problem and pushing themselves towards a negative contribution margin, since marketing efficiency tends to degrade as you increase spend. The reverse could happen to BizB. If they saw marketing efficiency decrease from say, 2.50 to 2.00, they might make a panicked decision to reduce their ad budget. But as we've seen, this would mean leaving profit on the table, because even at a MER of 2.00 they are exceeding their break-even point and earning a positive contribution margin per unit.

Instead of taking the "up is good, down is bad" approach, you should ask yourself a more sophisticated question: is my next dollar of ad spend going to earn me more profits? Look at how your actual marketing efficiency compares to your break-even MER, not some arbitrary target.

Calculate your break-even MER

Use the calculator below to see how efficient you need to be with your marketing spend to generate a positive contribution margin. The gross profit figure is essentially your budget to acquire customers profitably. Stray beyond this and you risk adding unprofitable sales into your business.

Look at the efficiency of individual campaigns too

Up until this point, we've used the more holistic company-wide MER metric in our break-even calculations, but you can also assess this at the campaign or platform level with ROAS.

Input the selling price and the gross profit figure you've calculated above. This generates a "break-even ROAS" for that particular campaign or platform. Then input your campaign spend and what the ad platform is reporting as the ROAS for said campaign. From this calculation, you can see the contribution margin you're generating from a given campaign. If this is negative, you may want to align objectives with your marketing agency. They should have very clear reason for spending unprofitably. "But our ROAS looks great" won't cut it.