ROAS + LTV = A well-rounded evaluation of your marketing performance
Immense pressure is placed on marketers to produce immediate results. This isn’t always the best strategy, especially if you fail to consider LTV.
In the world of modern marketing, measurement is everything. The digital era has made it possible to track KPIs much more easily and much more accurately than ever before. But measurement is only the first step. The order of the day is to analyze KPIs as a whole, comparing one to another and pulling out critical analyses of what those numbers—in tandem—tell about campaign performance, consumer behavior, and the effectiveness of the brand’s overall marketing strategy.
While many KPIs can measure marketing performance accurately and are often closely connected, each metric creates a different picture of the business that can mislead marketers who only pay attention to the KPIs individually and do not consider what they mean as a whole.
ROAS vs. LTV
ROAS stands for Return on Ad Spend and is a simple measurement of how cost-effective your ad campaigns are.
To calculate your ROAS, you simply divide your ad revenue by your ad costs. It looks like this:
ROAS = ad revenue / ad costs
You can apply this formula to just about any marketing campaign where you’re able to measure revenue generated by the campaign.
Basically, ROAS tells you if your campaigns are costing you more money than they make. They also tell you which campaigns are most efficient in relation to costs.
Of importance here, is that ROAS is a short term metric. It assesses performance of campaigns whose duration typically runs between a couple of days to a couple of weeks.
LTV stands for customer Lifetime Value (and sometimes goes under the acronym CLV). Under any name, it’s a simple measurement of how much revenue your average customer generates over the span of time during which they continue to be your customer and purchase products/services (and not their actual lifespan).
LTV is a little more complicated to calculate and is different for every business, but it basically looks like this:
LTV = Average transaction + Annual purchase frequency + Expected years of relationship
It’s also possible to calculate LTV using different time periods (like average revenue per customer per month), and it’s also possible to add in a calculation for the average discount each customer receives per period measured.
Essentially, LTV helps you understand what you actually paid for when you acquired the customer. CAC (customer acquisition cost) has to be paid for one way or another. LTV tells you what each customer you bought with your marketing campaigns is worth over time.
As opposed to ROAS, LTV is a long term metric, evaluating the customer value over months and even years.
Contrast ROAS and LTV to get a nuanced picture of your business
By themselves, these numbers may or may not be helpful to the average marketer. Let’s assume that you have some pretty stellar ROAS for a number of campaigns. High ROAS tells you that those campaigns are effective, but how much are those customers you’re acquiring actually worth?
If you check the LTV for those customers, you might be in for a shock. What if, despite the cost of acquiring those customers being relatively low, those customers turn out to have a really low LTV?
There are a number of insights we can pull from this. First, we can guess that we’re churning through customers pretty quickly, which is almost always bad. This insight can be invaluable when turned over to the retention team and can help them focus their efforts to figure out why they’re losing customers so quickly.
It might also mean that there’s a quality problem somewhere, or maybe that pricing needs to be set higher to make the most of each customer. Each business is different and will have different insights into what these numbers mean.
On the opposite end of the spectrum, let’s suppose that ROAS is low but LTV is high. Initially, we might believe this is great—despite paying a lot for each customer, that customer is quite profitable over time.
But if those high-value customers are taking longer to make a return on our investment, we might run out of money before we can realize the maximum value from each customer. This might mean that we need to work with our retention team to try to increase initial and ongoing sales, or that a new product/service might need to be added to the mix to compensate for these high costs.
We may also want to consider how to increase our ROAS, for example by optimizing our campaigns for efficiency.
Insights have consequences for marketing strategy
These types of insights have important consequences for marketing strategy, though of course every company is different and not every business is going to want to shift strategy due to low LTVs or ROAS. Immense pressure is placed on marketers to produce immediate results but this isn’t always the best strategy, especially if we don’t consider LTV.
Many businesses fall into the trap of focusing on ROAS without considering LTV. Their long-term strategy fails because they’re focused on short term goals without considering their effect and value over the long haul.
True, customer value may only become apparent over time, but as a marketer, it’s your job to understand these numbers, to analyze their deeper meanings, and to effectively present these numbers to management and convince them to stay on the longer, more difficult, and ultimately more rewarding path.