This article explains some basic concepts related to bidding on paid search keywords based on return on investment (ROI). Using ROI to make bidding decisions helps ensure that you are spending your advertising dollars in the most effective ways possible.
To explain these concepts, we will use paid search marketers Jane and Lisa as examples.
A few definitions to start things off:
Here’s an example scenario: Jane is paying $0.10 per click, 10% of clicks are converting to sales, and her average sale is $5. This means that on average she generates $5 in revenue for every $1 she spends to buy clicks. Therefore, her ROAS is $5.
If Jane is ok with a lower ROAS, she can generate more sales. Spending more per click will lower her ROAS, but the higher CPC will also drive more traffic. For example, if she can achieve her profit goals at a $2.50 ROAS, she can afford to pay $0.20 per click. Here is the math:
ROAS = Sales / Ad Spend
= (Average Sale X Conversion Rate X Clicks) / (Clicks X CPC)
= (Average Sale X Conversion Rate) / CPC
Solving for CPC, we get:
Target CPC = (Average Sale X Conversion Rate) / Target ROAS
Substituting Jane’s goal for ROAS, we get:
Target CPC = ($5 X 10% / $2.50) = $0.20
The process is similar for Lisa. Cost per acquisition is total cost divided by the number of acquisitions, or:
CPA = Ad Spend / Conversions
= (Clicks X CPC) / (Clicks X Conversion Rate)
= CPC / Conversion Rate
Solving for CPC, we get:
Target CPC = Target CPA X Conversion Rate
Substituting Lisa’s goal for CPA and assuming a conversion rate of 10%, we get:
Target CPC = $10 X 10% = $1.00
These calculations are pretty straightforward, and many paid search marketers use some variation of these methods. There are also a number of automated bidding systems that have formulas like these somewhere under the hood.
One assumption we’ve made is that we know Jane and Lisa’s conversion rates, but that is not necessarily a safe assumption. To learn more about the challenges of estimating conversion rates, have a look at this article: Paid Search: Bidding with Confidence.
And if you do not currently have the ability to track leads or sales to a keyword ad, Google Analytics is free and will do the job. If you would like help tracking performance or optimizing your paid search campaigns contact us.
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