This is one of the most difficult questions for businesses that are just getting started in Google AdWords. While there is no easy answer, I’ll attempt to provide you with some clarity so you can make more educated bids in your Google AdWords program.
Understanding the Value of Your Conversion
To start, it is essential to understand the value of an onsite conversion. If possible, you want this value specifically for Google AdWords (even better, for the specific campaign, ad group or product/service line), since the value of an Adwords conversion might differ from another source, like organic search or referral traffic.
If you’re an eCommerce company (selling directly on your website), it’s pretty straightforward to analyze the value of each conversion. As long as you have the transaction information passed into AdWords, you know the revenue for your conversions. Just make sure to account for your profit margin and other related costs to get to the real value of the average conversion. The alternative would be to take a comfortable percentage of your average order value (AOV).
For lead generation businesses, it’s a little more complicated. Since you don’t actually generate revenue from your online leads, you’ll need to develop an understanding of your lead-to-client conversion rate (how many leads turn into paying customers). Armed with that knowledge and the average value of each customer (along with margin/overhead), you can back calculate to understand the value of each conversion. Remember, it’s important to understand the average profit for conversion – if you do this math with total revenue, you’re taking a big risk. You should also consider using lifetime value instead of single-event value if that information is available.
For many businesses, especially those just getting started with Google AdWords (and businesses that are just launching), you simply don’t have these metrics. If you’re in this category, you’ll want to put your tools in place to measure the information and get started with your best estimates around these values.
Let’s say you’re a nanny agency and the average lifetime value of a new family (client) is $10,000. From that lifetime value, you’ll want to subtract any overhead (like your staff, taxes, licensing fees, etc.). Let’s say that we determine our overhead to be $3,000. The average profit per family is $7,000.
Next, we need to determine how many online leads we need before we get a new family (offline conversion rate). Going through our internal data, we determine that we are able to turn 1 of every 10 online leads into paying clients (10%). Using our average profit ($7,000) and offline conversion rate (10%), we find that the value of each online lead is $700 ($7,000 x 10%).
Using Conversion Value to Understand CPC
Once you understand the value of each online conversion, your next step is to develop an appropriate cost-per-click (CPC) for your AdWords program. Before I dive into the math, it’s important for you to realize that the more specific your information is, the more precise your CPC will be. For example, if you’re a law firm, clients coming from divorce-related searches have a different value than those from personal injury-related queries. This means that those campaigns in your program will have different CPCs that lead to profitability.
The math described below will help you understand the break-even CPC. This is the CPC at which the amount you spend on PPC equals the lifetime value for each paying customer. Pay less than the break-even CPC and you’re making money. Pay more, and you’re losing money.
After running AdWords for some time, we know that the average online conversion rate for family acquisition programs is 5% (5% of clicks complete our online lead form). The break-even CPC is determined by the formula: CPC = Online Conversion Rate x Online Lead Value. For our simple example, CPC = 5% x $700 or $35 per click.
Armed with this information, you should have a maximum CPC of no more than your break-even CPC. Depending on your specific goals (volume or efficiency), you’ll actually want to bid somewhere below this amount. If efficiency is your primary goal, consider bidding about 50% of your break-even CPC. If volume is your focus (and you’re willing to sacrifice some profit), you can push your maximum CPC higher, to around 70-80% of your maximum CPC. Bidding higher will get you more visibility and click volume, but you’ll make less profit per conversion.
In out example above, you should probably look to limit your maximum CPCs to around $17-20 per click.
Reality Check: Adjusting for the Real World
The example above is an overly-simplified example purely for illustrative purposes. In reality, the conversion rates and values in your program will vary depending on the specific product or service and keyword by keyword. You’ll want to review your program regularly at the macro- and micro-scale to make adjustments. Here are some tips that will help you effectively manage your program:
- Group similar keywords into one ad group. This will simplify your analysis as well as help you create more targeted ads which will help reduce your CPC.
- Understand the difference between shorttail and longtail keywords: very general, broad keywords (shorttail) have a high search volume but lower conversion rate compared to more specific (longtail) search queries.
- For most small businesses, phone calls are often not considered. If you’re not actively using some sort of call tracking to understand how many calls (and sales) come from PPC, at least consider this impact when making decisions.
If you have questions about the math or overall concept, reach out to me on Twitter. If you’d like to get some help managing your PPC programs or would like training to help you understand PPC in more detail, please check out our Online Marketing Services page.