Google AdWords Workshop – Part 7:
What’s a Click Worth?

The following article is part 7 in our series on running your own pay-per-click advertising campaign with the Google AdWords program. If you are new to AdWords, read the introduction here first.

Before you start bidding on keywords for your Adwords campaign, it makes sense to work out how much you can afford to pay for a click. If you don’t, it’ll be like driving at night with the lights out!

The price you should pay for traffic is largely dictated by the campaign objectives I talked about in the very first post in this series. You’ll recall that for those generating sales leads, we talked about generating a specified number of leads during a given period, at a target cost per lead.

Sales Lead Objective:
X No of Web Site Registrations at $Y Cost per Lead

For those working on generating direct sales, the objective was a specific number of orders for the period, at a target cost per order.

Direct Sales Objective:
X No of Web Site Orders at $Y Cost per Order

Once the objective has been set, it’s actually a simple matter to calculate the price you should pay for traffic to meet that objective. But how you set an appropriate objective in the first instance is a little more involved and that’s what we’ll be looking at in this post.

For the purposes of illustration, I’m going to talk about a scenario where an existing real world business wants to establish a new profit center to generate extra product sales via AdWords.

To figure out what the objective for that new profit center should be, we need to establish a baseline budget for it.

So where do you start with an AdWords budget?

If you’re like most people, you’ll be interested to see what a break-even scenario looks like, so let’s start there.

At the macro level, the budget components you’ll need to ascertain are sales revenue, cost of goods sold, advertising expenditure and overhead.

One approach to break even analysis is to establish the overhead required to manage your AdWords campaign first . . . and then work backwards to ascertain what sales will be required to cover that cost and meet the associated advertising expense.

For example, let’s say that we intend assigning day-to-day management of the profit center to an existing employee . . . and we estimate that this will occupy 20% of the employee’s time.

If salary and other employment related costs for that employee amount to $60,000 per annum . . . that suggests a budget allowance of $1,000 per month for overhead.

Next, we need to establish a relationship between sales and the advertising cost associated with generating those sales.

The orthodox approach by marketing professionals is to allow a percentage of gross profit for that purpose.

For arguments sake, let’s call it 30% on this occasion. That means a monthly gross profit of $1,428 will be required to break-even on overhead costs.

And if our product normally sells at a gross margin of 40% . . . then the break-even point for sales will be $3,570.

Be sure to include transaction completion costs like credit card processing fees and shipping costs in the cost of goods sold figure, not just the cost of stock.

Next, you’ll want to ascertain what level of sales activity is required to cover costs and make a satisfactory profit.

Again, the orthodox approach would be to nominate a nett profit that represents a normal margin on revenue . . . let’s call that margin 20%.

In our scenario, a 20% nett profit requires monthly sales of $12,500 from an ad spend of $1500.

Of course in practice, all costs, ratios and margins will be unique to your individual situation. The management cost in particular will vary depending on the size and complexity of your campaign

Overhead in the initial period might also include an allowance for non-recurring campaign set up costs and testing . . . or you may decide to amortize those costs over a longer period. And depending on your business, you may need to budget extra for promotions and holiday periods.

That’s not the end of the budgeting process . . . these scenarios are just points of reference for further discussion. But in order to have that discussion, we need to translate what we’ve got into a campaign objective.

To do that, start with the sales target and the initial ad budget. You’ll also need to know your average order size.

Historical data for the average order size of any existing web site sales would be useful here . . . otherwise, you should use data from your brick and mortar store, assuming you have one.

For purposes of illustration, let’s call that average $500.

That means the number of orders required to meet the sales target is 25 . . . and therefore, the allowable advertising cost per order is $1500 divided by 25 . . . or $60 per order.

Marketing professionals refer to that figure as the ‘Allowable CPO’.

The campaign objective is therefore 25 average sized orders at a cost per order of $60 or less.

Understanding the significance of ‘allowable cost per order’ is easy. The higher the allowable CPO, the more you can afford to pay for a click.

For example, let’s examine the situation where your conversion rate is 1%. That means, on average, you make 1 sale for every 100 users that click your ad.

And if the allowable CPO is $60 . . . then you can pay up to 60 cents per click and still meet your budget.

If the allowable CPO was $120 . . . your maximum cost-per-click would be $1.20

Remember . . . those maximums are actual cost, not the bid amount. The operation of the AdWords Discounter means that the bid amount could be significantly higher.

If you’re into formulas, here’s what that calculation looks like . . .

There’s also a couple of other items that deserve a mention before we move on.

Firstly, for the sake of simplicity I’ve talked in this segment about calculating an overall AVERAGE cost per order target. But you can also have CPO targets based on the profitability of individual products.

If product A has twice the margin of product B, then other things being equal, you can obviously afford to pay more for the keywords that target product A than those that target product B.

Likewise, we haven’t yet considered the concept of Lifetime Customer Value. Up until now, we’ve assumed that a customer buys from you just once.

However if your average new customer normally buys from you, say 3 times a year for the next 2 years . . . then that obviously increases the amount you can afford to pay to get him as a client in the first place.

And depending on your business, you might even be prepared to take a loss on the front end, in order to make a profit over the lifetime of that new customer.

Lifetime value is not always easy to calculate, which is one reason why many marketers base decisions on the immediate return on investment. But if you find yourself consistently out-bid by competitors, you may need to factor it into your allowable CPO to compete.

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