Measuring what works

Diminishing returns in advertising: why the next pound earns less than the last

Diminishing returns in advertising means that each extra pound you spend on a channel brings back less than the pound before it.

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The first £1,000 reaches the people most likely to buy; the fifth £1,000 reaches people who needed more persuading, or who have already seen the ad four times.

Why it matters

The decision it changes is how much to spend, as distinct from where. Most reports show a channel's average return, total revenue over total spend, and the average can look healthy long after the last increment of spend stopped paying for itself. Budgets set on the average overspend. Budgets set on the marginal return, what the next pound brings, stop at the right place.

How it works

Plot spend on one axis and revenue on the other and the line bends. It rises steeply at first and then flattens, until more spend brings almost no more revenue. That bend is the response curve, and every channel has one, at a different point.

Here is an illustration with made-up numbers. One channel, one week, spend raised in steps of £1,000.

Average ROAS is revenue divided by spend at each step. Marginal ROAS is the extra revenue from the last £1,000 divided by that £1,000. The average falls slowly; the marginal falls fast.

Now add a margin. Suppose the gross margin on what you sell is 50%, so the break-even ROAS is 1 ÷ 0.50 = 2.00. Every £1 of spend needs £2 of revenue to cover itself. At £4,000 a week the average ROAS is 2.80 and the channel looks comfortably profitable. The fourth £1,000, though, brought back £1,200, which is £600 of margin on £1,000 of spend: a £400 loss. The fifth £1,000 returned £800, only £400 of margin, so it lost £600. The right budget in this illustration is £3,000, where the marginal return meets break-even, and the average at that point is 3.33.

Someone reading only the average column would keep spending to £5,000, see a ROAS of 2.40, and call it a good week.

What it can't tell you

The curve is not stable. It moves with the season, with what competitors are bidding and with how fresh the creative is. The £3,000 that was right in March may be wrong in November.

You rarely get to see it cleanly. The table above comes from one channel with everything else held still, which real weeks never are. In practice the marginal return is estimated, either by varying spend deliberately and watching, or by a marketing mix model that fits the curve across many weeks.

The curve also says nothing about what the money would earn elsewhere. A channel at a marginal ROAS of 2.00 is at break-even on its own terms; if another channel is sitting at 4.00 at the margin, the money should move there first.

When to use it

Think in marginal terms whenever you are deciding whether to raise or cut a channel's budget. The average is for judging whether the channel as a whole is worth having.

The practical version, for a team without a model, is to change one channel's spend by a clear step, hold it for a few weeks, and compare the extra revenue with the extra spend. That is a marginal ROAS, measured rather than fitted, and it is enough to tell you which side of break-even the next pound sits.

Tracking it in a spreadsheet

The inputs are spend and revenue by channel by week, and your gross margin for the break-even line. A scheduled Fresh Sheets report can keep Google Ads cost and conversion value, Meta Ads and TikTok Ads spend, and Shopify revenue current in their own tabs. Fresh Sheets replaces each tab's contents on every refresh, so keep the spend ladder and the marginal arithmetic on a separate tab.