Unraveling The Google Adwords Algorithm - Part 1

Why Should We Care About The Adwords Algorithm Anyways?

Todays’ Internet Marketing professional has to be proficient in much more than just SEO. As much as we all wish it to be, “SEO” is NOT a business strategy. If it were, no doubt all of our lives would be much simpler.

It’s no news alert either that Pay-Per-Click (PPC) is crushing Organic in the “commercial intent keywords” arena; to the tune of three to one. Yes, that’s right; almost 75% of commercial intent keyword searchers are selecting paid and sponsored results to satisfy that instant gratification need.

So your clients should be engaging in PPC, and we as Internet Marketers should be proficient… Nay, we should be expert at the practice.

The first question I hear 99% of clients ask?

“How much should I budget for PPC?”

Aaaah, the eternal budget question!

For any of you who have read my posts before, you’ll know that I’m a little obsessive about measuring ROI on a per sale and product level, using Contribution Margin.

One of the many beautiful things about measuring campaigns this way, is that it allows us to reverse engineer the cost-per-click as it should be in order for each sale to fall within the acceptable contribution margin.

The aforementioned post is a required read for the rest of this article to make any sense, so if you haven’t read it, I would recommend stepping back at this point to have a look at it.

How Does Contribution Margin Relate To PPC Bidding?

Okay, bear with me here, we’ll break out the process into steps:

Step one is to determine Traffic Cost :

(Monthly Searches X Est. Click Thru Rate = Traffic From) X Cost Per Click = Traffic Cost

Then we need to determine the Estimated Number of Conversions:

Traffic From X Est Conversion Rate = Est Number of Conversions

Now we want to know the Estimated Cost Per Conversion:

Traffic Cost X Est Number of Conversions = Est Cost Per Conversion

Riveting As This Math Is, The Next Bit Is Where It Gets Interesting

We now want to measure the estimated cost per conversion (at Adwords’ suggested bid price) against our acceptable cost per conversion (Contribution Margin):

Contribution Margin / Est Cost Per Conversion (X 100 or displayed as a percentage)

100% means that they are on par, while a figure below 100% means you will spend more than the acceptable contribution margin to acquire that sale (again, at the suggested adwords bid). Examples with over 100% are your gold keywords, and an obvious case of the low hanging fruit.

So what happens if you have a ton of keywords below 100% and you will end up spending more at the suggested bid to obtain this client than your acceptable contribution margin?

Well, then you have one of two options:

1. This is a lost leader. Think grocery store milk sales. Grocery stores lose money on the sale, but they prevent their clients from going to the competition, therefore it’s an acceptable loss.Or:
2. There is a maximum we can spend to keep the client acquisition within our acceptable contribution margin.

How To Determine The Maximum Acceptable Spend Per Sale?

More math! Let’s pick up the equation from where we left off:

(Est Number of Conversions X Contribution Margin)/ Traffic From = Adjusted Bid

Say What?

The Estimated Number of Conversions multiplied by your Contribution Margin gives us the total dollar value that would be an acceptable expense. When we divide that number by your Traffic From, that tells us the maximum amount per click that would be an acceptable cost and still falls within our Contribution Margin on a per sale level.

Remember: If a sale “falls within our Contribution Margin” you have

• Covered your cost to deliver the sale
• Delivered stakeholders expectation of profitability
• Protected your profitability on the product level.

“Okay okay okay. I’m confused. Give me a real life example.”

Imagine you’re an SEO Agency and you figure bidding on the keyword: SEOMoz is a great idea. You’ve determined (using our handy dandy ROI tool) that your Contribution Margin is $50. You figure you can get a 2% CTR and a 2% estimated conversion rate. Your math should look a little something like this:

Then:

In this scenario, the keyword “SEOMoz” is a goldmine. But what if just one these criteria changed? If we change CTR to 1% the numbers look like this:

Then:

Suddenly the picture has changed rather drastically. In this scenario, the maximum acceptable bid on the keyword “SEOMoz” is: $0.50 in order to meet contribution margin expectations.

Hopefully that sheds more light on this process.

Contribution Margin “unravels” the Google Adwords algorithm. This will be the subject of my next post. In the mean time, Tweet me your thoughts, input or questions: @AinsleyMuller . I’ll post this equation in an excel template on this page if anyone wants it, just comment or tweet me.