In This Section:
• Profit
• Cost per action (CPA)
• Return on advertising spend (ROAS)
• Return on investment (ROI)
• Bidding calculations example
Profit
Profit = Revenues - Costs
Profit is truly the “bottom line” number. Most businesses want to maximize profit, but profit can be hard to maximize when there are moving parts. Increasing advertising spend will bring in more customers, but you must ensure it will also increase profits.
Cost Per Action (CPA) or Cost Per Conversion
CPA = Advertising Costs / Number of Buyers
It’s helpful for you to know how much it costs to get a buyer, but it’s even better if you know what that buyer is worth. In order to do that, you need to know how much a buyer typically purchases and what you make on that purchase; knowing how many visitors actually become buyers is also important.
CPA is most useful when compared with the value of a customer. Useful measures include:
• Average Purchase Amount
• Margin
• Conversion Rate
Return on Advertising Spend (ROAS)
ROAS = Profit / Advertising Costs
ROAS measures how effective the advertising spend is at generating profits. Most businesses
prioritize their spending based on how much payback it will yield. Sometimes businesses will set
a hurdle rate, or a minimum threshold for that payback. Each business is different, so one person
may have a very different hurdle rate than another. But no matter what the hurdle rate, if there is
one, ROAS will show you what rate of return you are getting from your advertising spend.
Return on Investment (ROI)
ROI = Profit / Total Costs
Bidding Calculations Example
In the following example, the first four measures are based on the economics of the business. The fifth, conversion rate, is a measure of site performance.
Fixed Business Variables:
Average purchase amount: $100
Product cost: $40
Gross margin: $100 – $40 = $60
Value of a purchase: $60
Conversion rate: 2%
Marketing Variables You Control:
Clicks: 4,500
CPC (cost per click): $0.40
Definitions:
Average purchase amount: Product cost:
Gross margin:
Conversion rate: How much a buyer spends when he or she comes to the site. How much the product costs, excluding advertising costs.
How much you make on the product, excluding advertising costs.
The same as the gross margin, since that’s the profit from a buyer (again excluding what we paid in advertising costs to get the buyer).
Bidding Calculations Example: CPA
CPA measures how much advertising spend is required to get one action (in this case, one buyer).
Advertising costs:
4,500 clicks x $.40 per click = $1,800 in advertising costs
Number of buyers:
4,500 clicks = 4,500 visitors to the site
2% of them became buyers = 90 buyers
CPA:
Spend on Yahoo! Search Marketing = $1,800
Number of buyers = 90
$1,800 / 90 = $20 CPA
Compare CPA to Buyer Value:
• If CPA < Buyer value, you are making money and may be able to increase bids to get a higher position.
• If CPA > Buyer value, you are losing money and may have to reduce bids.
Bidding Calculations Example: CPA to Get Target Bid
Another way to view the CPA calculation is instead of starting with known advertising costs and bids, figure out where to set the company’s bids. If the value of a buyer is $60, how much are you willing to spend to acquire the buyer? It could be 5% or 95%; it depends on what other costs are involved and what your goals are. For XYZ Electronics, we arbitrarily set the amount at 33%.
1. Value of a Buyer: $100 average purchase x 60% gross margin = $60 value of a buyer 2. Maximum CPA: 3. Target Bid:
33% maximum acquisition x $60 value of a buyer = $20 maximum CPA $20 maximum CPA x 2% conversion rate = $0.40 CPC target bid
Profit is hard to maximize. You may have to experiment with moving bids up to see how much more revenue it creates and whether it offsets the rise in advertising cost, but it’s essential that you look at the bottom line when you are setting your bids.
Revenue: 4,500 clicks x 2% conversion rate = 90 buyers x $100 average purchase amount = $9,000 revenue
Costs: $9,000 revenue x 40% product cost = $3,600 product cost + $1,800 advertising cost = $5,400 costs
Assess Profit:
• If Profit > 0, you may be able to increase bids to get more buyers and increase profit.
• If Profit < 0, you may have to reduce bids.
• For XYZ Electronics, profit is $3,600, so there is room to increase bids.
ROI measures how effective your overall business spend, including advertising, is at generating profit.
Profit:
Advertising Costs: ROI:
$9,000 revenues - $5,400 costs = $3,600 profit 4,500 clicks x $0.40 CPC = $1,800 advertising costs $3,600 profit / $1,800 advertising costs = 200% ROI
The scenarios for ROI are the same as for profit.• If ROI is acceptable and profit is positive, you may be able to increase bids to get more buyers and increase profit.
• If ROI is unacceptable or profit is negative, you may have to reduce bids.
The calculations just reviewed apply particularly well to e-commerce sites, but the basic concepts apply to all types of sites. You should always strive to define at least one action that a visitor can take on your site that will denote that the visitor is worth more than average. Once you have defined one or more actions and monitor which visitors undertake the actions, your tracking system should tie it back to where the visitors came from. This will help you better gauge the value of various keywords, for example, so you can set bids with better regard for the economics of particular keywords.
E-Commerce: Lead Generation:Content: Use CPA, profit and ROI if possible
Define action and how to track over time online or offline. Use CPA and value per lead (= customer value x % of leads that become customers) Estimate visitor value based on actions (e.g., newsletter subscription that could lead to affiliate earnings) or ad revenue per page view. Use CPA, profit and ROI if possible.
Once you have mastered the bidding strategies, tactics and techniques described in the previous sections, you can push your bidding success to the next level by pursuing more advanced concepts. We recommend that you add one advanced topic at a time, rather than tackling the whole set at once.
In This Section:
• Lifetime value (LTV)
• Deferred or latent buyers
• Per-product metrics
• Influencing the metrics
• Third-party tools
Lifetime Value (LTV)
Thinking in terms of lifetime value recognizes that buyers may not have only one transaction with your business. Rather, they may be repeat customers, with transactions occurring over the course of a month, year or longer.
If you understand the value of buyers over their lifetime, you will have a more accurate estimate of the value of those buyers. Since the average lifetime will likely be more than one transaction, the lifetime value of a buyer will be higher than a single-transaction value. This enables you to bid more accurately — and higher — because you can account for the higher value. To calculate lifetime value, you must estimate:
• How long the average buyer has a relationship with your business
• How much the buyer purchases during the lifetime
Deferred or Latent Buyers
Deferred buyers are customers who do not purchase on the first visit, but subsequently return to your site and make a purchase at a later time. While the buyer might have used advertising (such as your search listing) to reach your site the first time, often the buyer returns to your site via a bookmark or by typing in your URL.
If you can associate prospects with the buyers they become, you’ll get a more accurate understanding of how your advertising is performing. Since it’s common to not count these prospects, most businesses are underestimating the effectiveness of their advertising spend. By accounting for deferred buyers, you will have a more accurate picture of your business, and you will be able to justify higher bids, thereby getting even more customers. Tracking deferred buyers typically requires assigning cookies to each visitor so you can see the original source of each buyer.
Per-Product MetricsCompanies with multiple products or services can improve profits by tailoring bids to how each product line performs. The examples we have reviewed so far assume a single purchase amount, margin and conversion rate. For businesses with multiple product lines, or even multiple products or services within the same line, it can make sense to analyze the economics and site performance for each in order to bid smarter.
Evaluate each product line by its:
• Conversion rate
• Average purchase amount
• Margin
• Lifecycle
One of the best ways to bid smarter is to change the rules of the game by influencing the metrics. Your bids are not your competitive advantage — your site, products and service are.
Rather than simply accepting the economic and site performance metrics that guide your bidding, you should strive to improve them. Anyone can post a higher bid, but only a successful business and web site can make money from that bid. By improving the underlying economics of the business, you will be able to profitably bid higher, and get more customers from whom you will make even more money.
Within the context of your sponsored search advertising, you can improve your metrics. For example, writing search listings that accurately describe your products and services can filter out searchers looking for something slightly different, thereby increasing the quality of your visitors and your conversion rate.
XYZ Electronics Conversion Rate Example
Baseline conversion rate = 2%
If conversion rate increases to 3%:
• Revenue grows from $9,000 to $13,500
• Profit grows from $3,600 to $6,300
• CPA drops from $20 to $13.33
• ROI increases from 200% to 300%
Third-Party Tools
There are software programs and service bureaus that can help you manage your bids. Yahoo! Search Marketing has approved several services that automate bid-setting and ongoing bid management. Additionally, many of these services have modules that aid in identifying additional targeted keywords, or even writing search listings.
Fees may be monthly or one-time, and typically vary based on the number of keywords you wish to manage, and sometimes the frequency with which you would like to re-set bids.For the most current list of approved services, visit the Third-Party Bidding Tools section of the Sponsored Search FAQs, which you can find in the Resource Center at http://searchmarketing.yahoo.com/rc/srch/index.php.
ExerciseApply these calculations to your business’s marketing metrics to determine your CPA, ROI and target Maximum Bid.
1. Calculate Your CPA
Advertising costs:
(#) _______ clicks x $ _______ per click = $ _______ in advertising costs
Number of buyers:
(#) _______ clicks = _______ visitors to the site
______% of them became buyers
(buyers, as a ______% of visitors) x (______# of visitors) = _______ buyers (for example, if you had 100 visitors and 5% became buyers, .05 x 100 = 5 buyers)
Advertising costs ÷ Number of buyers = $ _______
2. Calculate Your ROAS
_______ Profit ÷ _______ Advertising costs = _______ ROAS
3. Calculate Your ROI
_______ Profit ÷ _______ Total cost = _______ ROI
4. Calculate Your Maximum Bid
Value of a Buyer: $_____ average purchase x _____% gross margin = $_____ value of a buyer
Action Steps
Define what conversions are for your business by identifying one or more actions you want customers to perform on your site (i.e., purchase, subscribe to newsletter, etc.). Based on your business model, select metrics for performance measurement. Set bids based on the economics of your business:
• Analyze site performance and financial metrics.
• Start with desired CPA.
• Apply this knowledge to “back into” your bids.
• Look at profit and ROI if possible.
Once you have done the above, add one advanced strategy at a time to bid even smarter.