June 19, 2010
The Profit Maximising Approach to AdWords
Google AdWords and other search engine marketing (SEM) platforms afford advertisers a great degree of control over the cost of their media placements.
By being able to control the maximum cost-per-click for every keyword, this puts advertisers in a position where they are able to monitor the profitability of every keyword they are targeting.
Search engine ads are one of the most trackable marketing activities available, and if you’re running some sort of eCommerce environment then you have the potential to track the exact return on investment (ROI) each keyword is bringing.
However, this degree of reporting can lead to misinterpretation of what is a “good” keyword and what is a poor keyword.
At the basic level, a decent Analytics setup will allow you to determine that for every $1 you put into AdWords, you are getting $X back. Clever operators will have this set up for each individual keyword.
However, relying just on ROI can be a big mistake. Let’s take the following example.
Keyword #1 – “widgets brisbane”
- ROI = $4.50
- Monthly Spend = $300
Keyword #2 – “widgets sydney”
- ROI = $2.80
- Monthly Spend = $700
From the above example, we can see that “widgets brisbane” is a better performing keyword. Therefore, if you only had $1000 in total monthly budget, you would spend all of it on Brisbane (presuming of course there’s enough traffic to use that much). However, if your budgets are flexible and you can spend more if you want, then would you turn off the Sydney keyword?
The answer is no. ROI is just one factor you need to consider. The other is profit. The Brisbane keyword makes $1,050 profit per month (300 x 4.50 – 300) while the Sydney keyword makes $1,260 profit (700 x 2.8 – 700).
Turning off the Sydney keyword would make your business worse off. Obviously you should also consider the profit-margin on the actual widget itself when calculating these figures.
Now most people when faced with the above scenario, would obviously choose to leave both keywords turned on, but for some reason when this scenario is expanded to hundreds of keywords, rational profit-maximising thinking tends to go out the window.
Let’s say an AdWords’ advertiser is spending $1000 per month across hundreds of keywords, and is getting about $5000 back (a $5 ROI). Based on this good performance, the advertiser decides to increase their budget to $2000 per month, which in turn lifts the revenue to about $9000 (a $4.50 ROI).
Looking purely at the ROI figures would lead an advertiser to incorrectly assume the increase in budget has not worked, and they might drop it back. However, looking at the profit figure clearly shows monthly profit rising from $4000 to $7000.
One of the questions we are commonly asked is “why does my ROI drop when I increase my budget?”
The reason behind this is actually tied to the economic principle of the low-hanging-fruit. The low-hanging-fruit principle basically explains that in business, there are some sales that are easier to get than others, like the low hanging fruit on a fruit tree is easier to reach.
In an AdWords context, a low-hanging-fruit keyword would be something like “buy online widgets now.” If a user types this into Google, it’s likely that they already have their credit card out of their wallet and are ready to purchase. These longer, more specific keywords are also often cheaper to bid on than generic terms.
By contrast, a user searching “widgets” is not a low-hanging-fruit. This term is highly generic and it’s going to take a good salesperson (in this case a website) to convince this person that now is the right time to buy.
Essentially, this is why ROI drops when you increase your budget. The AdWords’ algorithm has a built in “low-hanging-fruit” factor that shows higher performing keywords more often, meaning when you increase your budget, you’re starting to reach for the fruit higher up on the tree.
The lesson here is that the way to assess how your AdWords’ campaigns are performing is to find the point (budget amount) where total profit is maximised, not where ROI is maximised. This simple mistake could be costing your business thousands in lost sales.