By Jerry McLaughlin (Published January 2011)
“Half the money I spend on advertising is wasted—and the trouble is I don’t know which half,” famously lamented 19th century retail pioneer John Wanamaker.
Today, the marketing landscape has changed, but the challenge remains the same. How do you buy advertising that truly pays?
For small-business owners, Google AdWords offers an immediate, compelling allure: With the exception of a $5 start-up fee, listing on AdWords is free. You don’t pay for people seeing your ad; you only pay if someone clicks on it. Clicks usually cost between a few pennies and a few dollars. No minimum budget is required.
With such control over your campaign spending, you may think you can’t go wrong. And yet, too often, small-business owners realize too late that the extra business generated by their AdWords campaign doesn’t cover the cost of the campaign itself—in other words, even though sales went up, profits went down.
That’s the bad news. The good news is that, unlike in John Wanamaker’s day, if you do your homework, you can almost guarantee you won’t waste any money spent on AdWords.
The key is to figure out exactly what a click is worth to you and then never (ever!) overpay.
The Value Of A Click
Branders regularly monitors the AdWords bidding for the top keywords in our industry—terms such as “promotional products” and “corporate gifts.” We often find companies willing to pay as much as $5 for a click on these phrases.
We suspect that a lot of these bidders are unwittingly overpaying. What’s our logic? First, as the largest online promotional products company in the world, we have our own experience with these clicks’ value. This experience, based on millions of clicks, tells us the value of a click on the most popular keywords in our industry is generally around $1.
Second, we see a lot of turnover among the highest bidders. Our hunch is that they are learning the hard way that they’ve bid too much for their ads.
But, how do you know the most you can pay for a click and still make money on your first order?
Let’s use Branders as an example. I checked our last 1,000 or so orders that started as clicks on Google’s paid advertising program. The average first order size was $582, and our average gross margin was about 38 percent, meaning that we grossed about $221 per order. We also incurred some variable expenses, such as having an artist work on the logo and paying a credit card fee. After these expenses, our net was about $150.
This means we can afford to spend $150 to buy a click, right? Wrong. Remember that with AdWords, we pay for every click, not just the clicks that result in orders. Just as few salespeople close 100 percent of their leads, we don’t convert anywhere near 100 percent of our clicks into sales. In fact, at Branders, our actual conversion rate is only about half of one percent; and according to reports from the Direct Marketing Association, most companies have click-to-close rates of 0.002-0.003 percent—about half of ours.
What, then, can Branders afford to pay for a click without losing money on the first order?
Our highest profitable bid calculation goes like this: If we can only spend $150 to get a customer without losing money on that first order, and we only convert half of one percent of clicks to orders, then our budget per click is $150 x 0.005.
In other words, on average, the most that we should spend for a click is 75 cents.
How To Determine Your Own “Click-To-Close” Ratio
Before committing fully to an AdWords campaign, run a highest profitable bid calculation for your own business. The formula for calculating your highest profitable bid is: your actual click-to-close ratio multiplied by your average net profit per order.
Figuring out your click-to-close ratio is relatively straightforward. Google will tell you exactly how many clicks your ads generate (after all, that’s how it charges you); you just need to track the number of orders that began as AdWords clicks. Divide the number of click-based orders by the total number of clicks you bought, and the result is your click-to-close ratio.
The more clicks you use in determining your ratio, the more accurate it will be. I’ll spare you the statistical calculation involved in picking the right number and suggest that, if you can afford it, you buy 6,000 clicks for your test, using a representative sampling across your preferred keywords. The amount you’ll spend per keyword will vary, but if you figure an average of 75 cents, this means the budget you’ll need for your test is roughly $4,500.
Six thousand clicks will probably turn into about 200 phone calls—potential customers looking for ideas, quotes and samples. If you don’t want all 200 calls in the same day, spread out your bidding across days or weeks so that you can properly handle every call that comes in each day.
How To Determine Your Own Average Net Profit Per Order
A click has value to the extent it results in a sale: The more profitable the sale, the more valuable the click. This means the value of a click cannot be determined without estimating the value of the order that the click may produce. We’ll call this value the “average net profit per order.”
The average net profit per order is the gross margin dollars you expect to earn on the average sale, minus all the variable costs you incurred when you made the sale. For example, you would subtract the average costs of credit card processing fees because you don’t incur those charges unless you make a sale. Likewise, if you pay your reps a commission on sales, then you’ll also subtract the commission amount. After you subtract all the variable costs from your average gross margin dollars per order, you are left with the average net profit per order.
Here’s a tip that is expensive to learn the hard way: When you are calculating your bid amounts for AdWords, you need to separate out the orders that came from AdWords and figure out what the average net profit per order is on those orders alone. Why? Because the average net profit on an order from Google AdWords will not be the same as the average net profit you earn on repeat or referral business. In Branders’ experience, orders that come through AdWords tend to be smaller than orders that come directly to our site. Remember, the formula for determining what a click is worth to you is to multiply your click-to-close ratio by your profit on an average order. If you use the wrong average order size, you may wind up overpaying.
Likewise, remember that numbers can change over time, due to many things including recessions or other external factors. So periodically recalculate your click-to-close ratio and your average net profit per order to make sure they’re up to date.
Bid Without Losing Your Shirt
If you test a number of different keywords, you’ll find that some produce better than others. This means you can bid a little more for the best, and you’ll bid less for the weaker performers.
But, once you’ve established your average highest profitable bid, you’ll know never to bid above it. As Warren Buffett might say, “It is very hard to make money on an investment if you overpay for it.”
About the author
Jerry McLaughlin is co-founder, chairman and CEO of Branders.com (UPIC: BRAN8536)—the largest online promotional products company in the world.
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