How to Increase Profit with a Lower ROAS

So, you’ve been working painstakingly with your ad buyer to squeeze every bit of improvement out of your ROAS. 

Higher ROAS = more bottom-line profit, right? 

Not necessarily. 

Today I am here to tell you something that may be shocking. 

A higher ROAS does not always equate to more bottom-line profitability. 

How is this possible? 

The answer lies within understanding how absolute contribution margin dollars impact the bottom-line of your DTC brand’s P&L. 

Unfortunately, most DTC brand founders don’t understand this finance concept. 

The result? 

Ad spend budgets are set with the goal of maximizing ROAS instead of maximizing absolute contribution margin dollars. 

The impact? 

You leave large amounts of bottom-line profitability on the table. 

But don’t worry, I’m here to help! 

Today I’m going to walk you through a simple example that clearly illustrates how absolute contribution margin dollars impact your bottom-line profitability.   

Armed with this knowledge, you’ll be a cut above the average DTC brand founder and will possess the ability to drive ad spend decisions that maximize profit. 

Let’s dive in! 

Absolute Contribution Dollars or ROAS? 

Absolute contribution margin dollars are far more important to profitability than ROAS.  

ROAS is merely a relationship between revenue and ad spend, whereas absolute contribution margin is the actual dollars that contribute to and increase bottom-line profitability.  

Many brand founders find this counter-intuitive, but if taking a lower ROAS allows you to scale ad spend and top line revenue enough to offset the margin decrease caused by the lower ROAS, the result can actually be an increase in absolute contribution margin dollars and thus an increase in bottom line profitability.  

I know this can be confusing, so let’s dive into an example with actual numbers so you can see for yourself how this works.

An Example – The Numbers Tell the Story 

To start off our example I want to define absolute contribution margin dollars.

Absolute contribution margin dollars = [revenue] x [contribution margin ratio**]

Let's assume that you can scale ad spend to $100,000 at a 3.5 ROAS, which would produce $350,000 in top line revenue.  

Let's also assume that at a 3.5 ROAS your contribution margin ratio is 25% of revenue.  

In this scenario you would generate $87,500 ($350,000 x 25%) in absolute contribution margin dollars that will go directly towards bottom line profitability.  

Now let's assume you can scale ad spend to $150,000 if you drop your ROAS target to 3.0.  

In this case you would generate $450,000 in top line revenue.  Decreasing you ROAS from 3.5 to 3.0 would decrease your contribution margin ratio from 25% to 20.2%.  

Now this is where intuition typically leads brand founders astray.  

Intuition may tell you that decreasing your ROAS and contribution margin ratio will decrease bottom line profitability because your margin ratio has dropped from 25% to 20.2%.  

However, because you were able to scale your ad spend and top line revenue, the absolute contribution margin dollars generated are actually $90,900 ($450,000 x 20.2%).  

So, in summary you dropped your ROAS target by 14% from 3.5 to 3.0 but in doing you scaled ad spend by 50% and topline revenue by 28%.  

The impact?  

$3,400 ($90,900 - $87,500) in additional absolute contribution margin dollars that increase your bottom-line profitability.

**Contribution margin ratio is your contribution margin expressed as a percentage of revenue

Summary 

In summary, sometimes your intuition can lead you astray. Scaling ad spend at a lower ROAS can actually increase bottom-line profitability.

Understanding and leveraging the concept of absolute contribution margin dollars will help you make ad spend decisions that maximize bottom-line profit, which doesn’t always involve maximizing ROAS.

If you study and internalize the example in this article, you’ll be able to quickly and easily lead your ad-buying team to drive profitability like never before.

The result will be healthier profit and cash flow to further fuel your scaling endeavors.

If you want more help understanding how to maximize profitability through your advertising efforts, feel free to reply directly to this email and let me know that you want help leveraging your contribution margin to make ad spend decisions that maximize profit.  

As a Fractional CFO at Free to Grow CFO, this is one of my areas of expertise and I’d be happy to point you in the right direction.

Until next time, scale on!