Google and Facebook both sell their ads via an auction. Facebook’s auction is more complex to understand. Most people use auto-bid and give Facebook a daily budget to spend. The higher your budget the more auctions you need to win to spend your budget. Facebook is trying to spend your budget for you. So in order to provide that service they will bid more aggressively the higher your daily budget. The end result is that the higher your daily budget the higher your CPM will be. In addition to higher CPM your ads will be exposed to less qualified customers the higher your budget is.
In short, small budget means lower CPM and better customer targeting.
This is why many people have trouble “scaling” their adspend. The quality goes down and the cost goes up as you increase your spend.
I’ve talked about the benefits of scaling down and the perils of scaling up in prior posts, but I’ve never talked about finding the sweet spot.
Let’s take a look at this scenario with a merchant who has 50% gross margins:
Notice that as your spend increases and your ROAS decreases you end up with $250 in contribution in 3 of the scenarios. But in the lower ROAS scenario you are doing more work so your costs are higher, but you’ve got no additional contribution to cover those costs. In the last scenario you are running a charitable organization dedicated to providing awareness and fulfillment for your product.
The scenario below illustrates the power of higher prices (and thus higher margins):
The sweet spot is the 4th column where you get $875 in contribution. Getting more aggressive on the ROAS you are willing to take starts to cost you money after this.
Don’t go entirely by the highest contribution, either. For one thing the more you spend the more your ROAS will fluctuate. These spreadsheets are handy but it’s not like you can wave a magic wand to get a specific ROAS. You also need to remember that your fixed costs don’t scale directly with your revenue. Maybe your software license has 5 seats, but you’ll need to buy 10 seats at the next level. Maybe your office space is maxed out already. Also, ROAS by itself can be tricky since it does not account for discounts, so you’ll need to adjust your margin any time you run a promotion.
If you want to get aggressive you can consider your re-order rate (don’t talk to me about lifetime value unless you sell subscriptions, because lifetime value is a metric that subscription companies use). Personally I want to make money on each and every order.