Why you should never forget this!

While you obviously want to pay the least possible amount for each hit you get, you’re going to have to bid more if you want a higher listing and, therefore, more traffic and a higher ROI . You have to carefully track the traffic you get from the ad so you know the value of that traffic. If you don’t know the value, you could be paying too much for your traffic or missing great opportunities to generate more traffic if you can afford the higher price.

You should focus on calculating your ROI as all your other calculations like counting hits on your page, tracking your results, and budgeting depend on how cost-effective the traffic to your website is.

It is absolutely essential that you work out how much money you make on average per person that clicks on your Search Engine ads. You need to know that the amount that you are paying per click for the ads is less than the amount you are earning. Otherwise if you are spending MORE than you are making, you could be throwing money down the toilet and not even knowing it (and there are plenty of companies who are doing this).

How to calculate the ROI for your Google AdWords ad

Let’s assume you’re selling an item with a $25 profit margin. If one (1%) percent of visitors to your site buy the product, then each visitor is worth twenty five ($0.25) cents to you. If you get the traffic for less than that, you’re making money on each sale.

Another strategy to improve ROI involves bidding for several keywords at low prices such as 5 cents each. This way you get listed very frequently. Each keyword won’t bring you much traffic by itself, but the total may be a hundred or more hits per day. If you’re only paying a couple of pennies per hit for this traffic, then it should be profitable for you. However, Overture may reject some of the keywords terming them irrelevant.

Example of calculating ROI

Basic ROI can be calculated if you know three variables: (1) the amount you invest in a pay-per-click search engine, (2) the total sales generated by that PPC and (3) the revenue earned from sales (through that particular PPC).

It is very important to calculate ROI after a few days or weeks of putting up your ad. Once you have done your initial ROI calculations, then you should look at doing a monthly analysis of ROI. Just because an estimate like 5 cents bid for every click on your choice of keyword with a reasonable sales conversion rate sounds alluring, it does not mean that it is profitable to you. The word ‘return’ in ‘Return On Investment (ROI)’ implies profitable return.

Let’s assume that you are paying 5 cents for every click on your ad and you receive 400 unique visitors to your website. Out of these 400 visitors, 4% of them are actually buying your product.

Your total cost will be 5 cents x 400 = $20 for 400 unique visitors. Out of these 400 visitors, 400 x 4% = 16 of them are purchasing your product. Your cost per sale will be (20/16) = $1.25. Assume that your minimum tolerable return on investment is 150%, which means that every $1.00 you spend on click-throughs, you want to get $1.50 as your return. Let us assume your profit margin to be no more than $2.25.

ROI is calculated by dividing profit by Cost per Sale (CPS) and is expressed in the percentage format. In this case, your ROI will be (2.25/1.25) * 100 which will be 180%. 180% is not a very impressive ROI, hence if you had settled for that 5 cents deal for every 400 clickthroughs, you probably wouldn’t have made lot of profit.

You can calculate in reverse to find out the suggested bid per click if you want to earn reasonable ROI. For that, you need to have a few figures handy. First, you need your profit margin, which is $2.25 in this case, and then you need your total sales conversion rate (the percentage of unique visitors to your site actually buying your product), that is 4% here and most importantly, the percentage of your profit return which you are willing to commit to the PPC for that particular keyword. This figure ranges from a mere 1% to 80% where you barely leave any profit for yourself. Generally, 20% is a good figure to aim for (although it might not be realistic for all types of products). Let us assume it to be 18% in this case.

Now, let us calculate your suggested bid per click.

This will be [Profit Margin (2.25) * Sales Conversion Rate (4%) * Profit Margin committed to PPC (18%)] = $0.0162

This means that you need to bid 1 cent for every click in order to get the desired ROI. Let us now calculate the ROI you will get if you bid 1 cent.

CPC = (0.1 * 400) = $4 for 400 visitors.
Sales Conversion Rate = 400 * 4% = 16 visitors will buy your product
CPS = 4/16 = $0.25

Your ROI will be profit/CPS, which will be (2.25/0.25)* 100 = 900%.

Now, this is nice ROI. Comparing your 5 cents bid with 1 cents bid, you will find that even though your 5 cents bid will probably raise your rank on the PPC and will receive more clicks than 1 cents bid, it will generate only 180% ROI. On the other hand, you will be ranked lower on PPC and you will receive fewer clicks, but your ROI will be 900% if you bid 1 cent per click.

What is my cost per click and what is my revenue per click?

If you found the ROI calculation a little bit complicated then let’s look at a more simple way of looking at it.

Basically you want to know two figures:

1.    How much money do I pay on average per click for people to click on my
       Adwords ads.
2.    How much revenue do I make on average per click when people are clicking on
       the ads.

No 1 is easy to calculate because you simply look on your Google Adwords stats and they will tell you much you have earned. To work out no 2 you need to do a little more calculation.

Let’s use a realistic example so you can see how the figures work in real life. Say you are selling an electronic book, and the commission you get per sale is $35. The conversion rate is around 0.5% … in other words about 1 in every 200 people who click on your ad buys the product. This means that for every thousand people 5 would buy the product. For every 1000 people that click you would make 5 times $35 which is $175. This means that you make on average $175/1000 which is 17.5 cents for every person who clicks on your ad.

If you were to pay any more than 17.5 cents per click for people to click on your Google Adwords ads then you will be losing money. If you were paying 5 or 6 cents you would be making a reasonable return of about 3 times your money.

How much will I be paying per click, in reality?

The Google AdWords Select has a tool known as ‘bid gap’ which helps you keep your place above your competitor and at the same time making sure that your cost per click is in accordance with how much your competitor just below you is paying. Thus, if you are bidding $1.05 per click and your competitor is paying $0.90, then all you have to pay is $0.91. If that competitor drops out and the one below that one is paying $0.75, then you end up paying $0.76 per click.

You need to understand the full implications of this system to understand how much you end up paying. Let’s take the following example where there are 10 people bidding for a certain keyword phrase. (The Google system is much more complicated than the example shown below, however the example will give you a rough idea of how things work).

So there are 10 people bidding and there are their bids:

Person 1:   $8.50
Person 2:   $5.20
Person 3:   $3.10
Person 4:   $2.00
Person 5:   $1.20
Person 6:   $1.00
Person 7:   $0.60
Person 8:   $0.15
Person 9:   $0.06
Person 10: $0.05

Firstly it is important to know that the position that these people get depends upon the average click-through rate of their ads as well as the amount that they bid. For example, if the person 2 has a click-through rate that is 2 times higher than Person 1, then they will end up number one even though they are paying less money.

The amount that these people pay is one cent more than the person below them. So here is how much they would pay (remember this is not an exact example as the Google system is more complicated than this, but it gives you a good idea).

Person 1 pays:   $5.21
Person 2 pays:   $3.11
Person 3 pays:   $2.01
Person 4 pays:   $1.21
Person 5 pays:   $1.01
Person 6 pays:   $0.61
Person 7 pays:   $0.16
Person 8 pays:   $0.07
Person 9 pays:   Person 9 will not get placement or will only occasionally get placement
Person 10 pays: Person 10 will not get placement or will only occasionally get placement

What you can see from this example is that there is a huge difference in the amount that people pay for each bid. Person 8 is paying only 7 cents whilst person 1 is paying $5.21. Person one has the advantage of going first which means that they will get their ad clicked on more often, but do you really think it is worth paying so much more for this privilege? Unless you are a major player with big pockets it is unlikely to be worthwhile to go for the number one spot.