To begin to understand the meaning of PSM (Profitable scaling margin) and why it’s important, we first need to understand why ROAS/ MER is not the metric that we should be using to assess the returns of your advertising results.
ROAS (Return on ad spend) – Is not projectable, actionable or stable. It is highly relative and we cannot optimise towards it, you cannot base your business growth and objectives on an out-of-context data point which is a reaction of multiple variables we cannot control.
What we can control is the CPA (Cost per acquisition)
Have you ever wondered “Why Does My Ad Do Worse When I Raise My Budgets?”
What Facebook Charges you for the conversion (your Bid) = Budget x Estimated Action Rate x Advertiser Score
When you raise your budgets on Facebook, it is to be expected that you will get less efficient with your CPA. This is a given, which is why when we want to scale results we have to understand how the platform works and how to get more efficient to give us a profitable scaling margin.
The profitable scaling margin is the difference between the maximum you can afford to pay to acquire a customer and the net total cost that you are currently paying. Remember, ROAS is HIGHLY VOLATILE for many reasons, the simplest being that the order value of any 1 sale can vary wildly. CPA is what actually matters.
Remaining profitable requires that you do not pay more than you can afford to acquire a conversion. As you begin to scale your budgets and what you pay to acquire each new sale goes up, eventually you reach a plateau where you can no longer spend more without the cost of acquiring a sale being undesirable. The solution to this is to scale by creating a greater margin, basically making the work that you do better and more efficient.
We can do this by either improving the estimated action rate of our ads, via creative testing or, we can improve our advertisers’ score by making our site and our customer experience better.
Testing different audiences are not an effective way of making your ad better.
Bid caps and cost caps won’t improve the quality of your ads.
Lowering your cost per conversion without focusing on improving the ad that you’re using is ultimately an unsustainable method. When you reach the law of diminishing returns on your ability to “hack” Facebook, things will go bad and they will go bad quickly, forcing you to have to start all over from a slightly worse place than when you started.
Profitable Scaling Margin = ————
(CPA + COGS)
A good example of showing PSM & ROAS in a real-life example would be if you had a ROAS of 0.5x but a PSM of over 2.
That means you could double your acquisition cost tomorrow.