Determining the Point of Diminishing Returns
By Stephanie Courtney
Let's Play A Game
Which of these scenarios would have the most value for your business:
- Google Ads spend of €250,000 per month,
- Revenue of €2,500,000,
- ROAS of €10/€
- Google Ads spend of €190,000 per month,
- Revenue of €2,350,000,
- ROAS of €12.37/€
If you said A, is €150,000 in revenue really worth €60,000 in spend? The ROAS for the difference in revenue is €2.50/€.
Hypothetically, lets assume that your profit margins are 15%. In scenario B, you’ve lost approximately €22,500 in profit, but you’ve saved more than twice as much in capital.
Using the 15% profit again, and the most basic math, scenario A has a net benefit of €125,000 after spend; while scenario B has a net benefit of €162,500.
The Mystery of Diminishing Returns
If you’re running Google Ads campaigns, and you believe that increasing spend automatically means increased revenue and profits, you need to look deeper.
Diminishing returns occur when you over spend on campaigns to drive incremental sales rather than optimising for ROAS.
When profit from revenue is less than the cost of the ads and agency fees, you’ve hit diminishing returns.
Unless your campaigns are well structured and well optimised, this is very difficult to see – and even when businesses can see it, it’s hard to understand.
There is a sweet spot, where spend and well built campaigns drive optimal revenue. It takes a lot of time and effort to accomplish this sweet spot, but once it’s found, it’s like discovering a vein of gold. No amount of additional spending will improve returns, and in fact, flooding these campaigns with ad spend, will cost you much more in profits.
This concept is part of what informs one of The Alignment’s most important mottos: Better Not More.
Google Is More Than Happy To Make Money
There is a lot about Google that’s good – really good – but there’s a lot of misunderstanding, mismanagement, and intermingling of marketing efforts that blurs, if not completely wipes out, what’s really good about Google Ads.
We will be writing more articles about this in the future, but for the purposes of this feature, I’m going to stick to how Google Ads rewards effort by saving you money.
Since Google’s upgrade from AdWords to Ads in August of 2018, Google has automated almost all aspects of the platform – from keyword building, to ad creation, to the proliferation of ad extensions.
All things being equal, automation is good for businesses that don’t have or can’t afford expert help, and Google makes a lot more revenue by removing intrinsic barriers to ad serving that plague most ecommerce websites.
Google is making more revenue from automated ads, broad match keywords, and Pmax campaigns by broadening the reach and frequency of ad serving. While some of that also improves revenue volumes for advertisers, it can also lower ROAS and conversion rates, which eat up ad spend. It’s a kind of win/win for Google and advertisers, it’s an even bigger win/win for Google and agencies – but it’s not the best win/win.
While it is harder to work around some of the new automation, Google still rewards the expertise and effort of scenario B, but they are very happy making the revenue they make from scenario A.
Agency Fees Compound Diminishing Returns
If your digital agency charges fees based on a percentage of ad spend, Google isn’t the only business that’s happy to take your money.
Diving deeper into our game: if the agency that handles your Google Ads charges 15% based on monthly ad spend, the net benefit of scenario A goes down to €87,500; while the benefit of scenario B only goes down to €134,000.
The irony is that scenario B takes a lot more work, and Google Ads can save your business money (if it’s done well).
Agency’s that charge fees based on ad spend have absolutely no incentive to do it well. In fact, they have added incentive to spend as much as possible, and – especially with Google’s new automation tools – they have to put in very little effort for the privilege of charging more.
At The Alignment, we charge flat fees per month, and a bonus on revenue – so we don’t have a vested interest in what our clients spend. While the bonus gives us a vested interest in revenue, we are just as invested, if not more, in driving high ROAS.
The Alignment specialises in – and highly encourages – scenario B configurations. When we deliver scenario B results (and we do), the net monthly benefit would be €143,250 including our fees and bonus.
Spend Is Not a KPI
The difference between scenario A and scenario B is expertise and effort. Scenario B is also dependent on understanding that spend is not a KPI.
My first Google AdWords account, in 2008, was in Ireland for the nation’s top broadband provider. The budget was €300,000 and the target number of sales was 5,000. I reached 5,000 at a cost of €230,000 – and I’ve never come so close to losing a job.
The agency I worked for was furious because I had lost them €10,500 in fees. The client was furious because they claimed their marketing budget would be cut the following year if the €70,000 saved, wasn’t spent. I was utterly bewildered. How could saving that much money be such a bad thing? (If there hadn’t been a time limit to the offer, I probably could have reached 6,500 sales, but there was a time factor.) It’s little wonder why I only lasted 4 years in the agency world.
The graph is a visual comparison of 2 Mondays, Tuesdays and Wednesdays from July and August 2022 respectively. In scenario A, we focused solely on spend (per our client’s insistence). In scenario B, we focused on ROAS (what we do well).
It’s almost galling that scenario B spends less than A, and drives more revenue. It’s not only that ROAS goes up by 87%, 76%, and 66% respectively; it’s also how much more revenue comes through.
If you’re confused by how spending less could drive more revenue, there are a few explanations. One of the most important factors is conversion rate. Conversion rates are essential for Google’s machine learning – and when conversion rates go down, ad serving isn’t as effective.
Also, by expanding the reach of keywords, the number of clicks to conversion increase. Since 2021, Google has pushed broad match keywords and ad serving has proliferated beyond focused targeting, which increases Google’s revenue not yours. This is due to targeting search queries higher in the buy cycle, while searchers are browsing not buying.
When searchers are buying, the number of clicks to conversion goes down – and strict keyword targeting helps to ensure ads are served when potential customers are ready to purchase.
There are more factors at play, but I would have to write a book to cover them all. These are just a few examples of why spend is not a KPI.
Don't Drive To Diminishing Returns
Budgets are important, but budgets should create a target spend not a mandate to line Google’s coffers. Budgets are like speed limits, they set parameters but revenue and ROAS are the map and destination. If you find a short cut, that gets you to the same or better result, why take the long way just to drive the speed limit?
We're Expanding Our Client Base
If you’re interested in The Alignment Collective, give us a moment and take a look at our services:
- Executive contracts – takes all of the work and responsibility for Google Ads off your shoulders. The Alignment does all work, using all of our expertise. Our client sets KPI’s, and we reach or exceed them.
- Strategy contracts – that give you more control over messaging while using The Alignment’s strategical expertise.