Google AdWords Bidding Basics

So...you've heard about this "new" thing - Google AdWords. It sounds pretty exciting. It sounds like you get a lot of bang for your buck. Your ad shows up on the page that is returning pertinent search results. An ad can show up anywhere on any of the pages returned. The more you are willing to pay, the better your page position will be. Page position is auctioned off, but you can get better page position with higher quality AdWords, too. You only pay if someone clicks on your add. So, what you do is tell Google AdWords what your maximum cost-per-click and daily budget is. It then places your ad accordingly and when you’ve reached your daily budget, it pulls the ad. You can make the ads local, national, or international or base it on language. Of course the broader the audience, the more money you are going to spend.

But how, exactly do you go about getting space? Well, you bid on it. And the thing is, you don't necessarily win your space based on how much you bid, but also on the quality scores of your words and landing page. Let's start with the basics: the bidding.

Bidding

You can use the Google Traffic Estimator Tool to figure out an approximate result based on the keywords you select, maximum CPC, and daily budget. The more popular a keyword is, the more you're going to pay for it. The suggested method of figuring out how much you want to spend AND maximize your profits is:

1. Determine our maximum Cost Per Acquisition(CPA): (Sale price – cost of product = CPA)
   
2. Determine conversion rate: (number sales/number of clicks)
   
3. Determine value per click: Max CPA * conversion rate = value per click (expected profit from website visitor)
   Value per click is what you can pay per click and expect to break even, so naturally we wouldn’t want to pay that much.
   
4. Adjust your bids so your value per click equals your incremental cost-per-click.
   The incremental cost per click is the difference between what you pay for per click at one bid versus at another bid. Not very clear is it? This table was generated using the Google Bid Simulator Tool, which is only available if you have an AdWords account:

Bid	Clicks	Cost	Avg. CPC	Revenue	Profit	ICC
$5.00	208	$697.42	$3.35	$1040.00	$342.58	$5.73
$4.50	190	$594.27	$3.13	$950.00	$355.73	$5.20
$4.00	154	$407.02	$2.64	$770.00	$362.98	$4.63
$3.50	133	$309.73	$2.33	$665.00	$355.27	$3.99
$3.00	113	$230.00	$2.04	$565.00	$335.00	$3.32
$2.50	86	$140.37	$1.63	$430.00	$289.63	$-.--

As you can see above, the $4.00 click actually returned the highest profit, even though you got fewer clicks, but it doesn't necessarily maximize your profit. That's where the ICC comes in. How did I get that number? ICC is calculated by dividing the cost of the incremental clicks by the number of incremental clicks. Let's use the $5.00 and $4.50 bids for an example. The cost of the $5.00 bid was $697.42. Subtract the cost of the next lower bid from that, $594.27. That leaves a difference of $103.15. You received 208 clicks at $5.00. Subtract the 190 clicks you received at $4.50. This leaves a difference of 18 clicks. Now divide $103.15 by 18 clicks. The result of $5.73 is your incremental cost-per-click. If you look at the the ICCs above, the $4.00 comes the closes to your value-per-click without going over. In order to <b>maximize profit</b> you'll want to increase your bid until your ICC is close, or equal, to the value-per-click without going over.  

Generally you will pay less than the bid CPC. Once we’ve determined your CPC, you can run some simulations to maximize your profit. You may actually be more profitable paying less and getting fewer bids because the incremental cost-per-click (ICC) above a certain point may be more than the CPC.

I ran some keyword simulations with a standard bid of $1.00 CPC and daily budget of $50. In the “Est Ad Position” column, the lower the number, the better the position. The best positions are above 3.

Keyword	Global Searches	Local Searches	Est Avg CPC	Est Ad Position	Est Daily Clicks	Est Daily Cost
dog toys	246,000	165,000	$0.69	2.55	69.77	$47.92
puppy toys	33,100	18,100	$0.63	2.37	1.76	$1.12
chew toys	18,100	14,800	$0.57	1.25	1.7	$0.97
squeaky toys	9,900	6,600	$0.00	0	0	0

There is a pretty in-depth video tutorial by Google's Chief Economist, Hal Valerian, on YouTube. If you'd rather, you can read the script.

The Quality Score

The quality score is calculated using a variety of factors and measures how relevant your keyword is to your ad group and to a user's search query. The higher a keyword's Quality Score, the lower its cost-per-clicks (CPCs) and the better its ad position. Which page we direct the user to in our website affects the keyword’s quality score as well. For instance if the end-user were to click on an ad specifically for dog toys and you send them to the pet store homepage, that might lower the quality score. That’s one of the reasons people use landing pages – to ensure the content is directly relevant to the AdWords.

Conclusion

Keep in mind that conversion rates and costs are variables and will change depending on current economic climates, seasons, keyword popularity, bidding rates and other financial and cultural factors. It's a good idea to go in and run simulations on a regular basis to consistently maximize your profits.