Show Me the Money: Bidding for Profitability

This week I’ll discuss a topic that’s difficult for many PPC advertisers: setting ad group bid prices at the beginning of a campaign. If you’ve followed the advice in previous installments regarding building tightly-themed ad groups, you won’t need to be concerned at this point with individual keyword bids, since the few keywords in each ad group will likely exhibit similar performance behavior.

So how much should you bid on each ad group? Should you start with low bids and “go high” later, or vice versa? When should you change your bids? What’s more important: ad rank, CTR, click volume, or conversion rates?

There aren’t easy answers for questions like these because, as in all marketing efforts, there are different valid strategies. Which ones are “best” depend on your company’s budget, timing, market position, and business objectives.

Determining optimal bidding strategy shouldn’t be viewed as a choice between the “right way” and the “wrong way.” The best bidding strategy is the one that’s most appropriate for your company’s situation (e.g. how much can you afford to spend?) and your objectives, including brand awareness, revenue growth or profitability.

The ultimate objective of most advertising campaigns, including pay-per-click advertising, is to maximize conversions. And one of the main reasons that pay-per-click advertising is so attractive and efficient is because measuring conversions and ROI is easy.

What’s a conversion? It’s the action that you want site visitors to take. Often that’s a sale of your product or service. Or it could be a sales lead, submitted via a web form, a sign-up for a newsletter subscription, or a request for the research results or a white paper your company distributes.

In order to serve larger marketing and company goals, it makes sense to continually decrease the average cost per conversion, so that your campaigns are increasingly profitable, and maximize return on investment (ROI).

Measuring PPC Success

Let’s examine the calculations required to measure the success of your search marketing campaigns. Although the math is simple, the concepts are powerful. Your ability to calculate and track these metrics will be largely responsible for the success of your advertising efforts.

Conversion rate is simply the percentage of clicks that have resulted in conversions. For example, if one of your ad groups results in 200 clicks, and 40 of those clicks result in conversions, then the ad group’s conversion rate is 20%.

40 / 200 = 20%

Cost per conversion is easily calculated, too. Simply divide the total spent on clicks by the number of conversions. In the previous example, if each click cost $1.50, then the cost per conversion is $7.50.

(200 x $1.50) / 40 = $7.50

Max CPA and Max CPC are the calculations you perform to match PPC campaigns to your advertising budget. Before launching an ad campaign, you first need to estimate what you’re willing to pay for a sale or sales lead, which is the maximum cost per conversion (also known as CPA, cost per action). Then you can calculate the maximum click price you can afford (also known as CPC, cost per click).

Before even starting a campaign, you need to determine (or even just estimate) your maximum acceptable cost per conversion. This should be the maximum you’re willing to pay for a sale, a lead, or whatever constitutes a conversion for your company.

If you only sell one item, this calculation is easy. If your product price is $35.00, and your gross profit on a sale is $20.00, then you might set your maximum cost per conversion to be $10.00 to allow for a net profit of $10.00.

$35 – $15 = $20 gross profit / 2 = $10 CPA (cost per conversion)

It gets a little trickier if you sell more than one product, or if your primary objective is to obtain sales leads, and you do not yet have enough data to estimate revenue stream or gross profit. But you need to start somewhere; so use average transaction revenue, or calculate the value of a lead based on your historical ability to convert leads to sales.

Armed with the maximum cost per conversion above, you’re now on track to calculate the maximum click price (cost per click or CPC) you can afford.

First, you need to calculate the number of site visitors it will take to obtain one sale or action.

If you have historical data on how well your site visitors convert, this calculation is a snap. The number of visitors you need to receive in order to make one sale is 100 divided by the conversion rate (represented as a whole number rather than a percentage). For example, if your conversion rate is 4%, your site gains a sale for every 25 visitors.

100 / 4 = 25

Second, you need to use the previous two calculations to determine the maximum click price: maximum conversion price divided by the number of visitors needed for one sale.

Continuing our example, if your maximum cost per conversion is $10.00, and your conversion rate is 4%, then your maximum CPC or maximum cost per click is $10.00 multiplied by .04, or $0.40 (40 cents).

We can boil this Max CPC equation down to:

max cost per click = max cost per conversion x conversion rate

Max CPC as Profit Guidance

This final calculation of maximum cost per click is not simply a dry mathematical exercise; it’s crucial to the success of your ad campaign. If you bid higher than the maximum cost per click, you risk losing money. If you bid at or below the calculated maximum CPC, your campaign will remain profitable (assuming sufficient conversions).

What should you do if you don’t have historical data that lets you calculate the conversion rate, as in the case of a new product launch? There is no need to bid blindly. Start with your best guess. Be conservative or optimistic, but guess.

Rules of Thumb:

  • For most PPC campaigns, minimum conversion rate should be 1 to 1.5%.
  • Good conversion rates range from 2 to 4%.
  • 5% and above is a Very Good to Excellent conversion rate.
  • Anything in the double-digit percentages is Extraordinary.

For example, if you’re launching a new product and have determined the maximum cost per conversion to be $32.00, a conservative approach would be to assume a conversion rate of 1%. Thus, the starting maximum cost-per-click bid would be $0.48 CPC or:

$32 x .01 = 32 cents per click

Next Monday I’ll describe various bidding strategies to help you decide how to set campaign budgets. As always, let me know your comments and questions via the feedback form below.

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