Fun With Pay Per Click Math - How Much Can You Afford to Pay?

You really need to understand the goals of your pay per click campaigns. You need to know how many customers you want to try to gain and how much you can afford to pay to acquire each new customer. If you don't know what a new customer is worth, then that is something you really need to find out. Otherwise, you're shooting in the dark.

As professional search engine marketers, we have clients asking us to generate X sales per day or per month while spending Y dollars. This is a difficult situation because it often means we need to get clicks as cheaply as possible while maintaining a certain level of conversions. The thing that makes this a difficult situation is that as click bids go down, often conversion rates go down as well. One reason is that to generate low cost traffic, you often have to use content networks as well as search results, which are less targeted and convert at lower rates.

Nonetheless, to even tackle the problem we need to understand the numbers. Here is a very simple formula to calculate how much you can spend per click on your paid search campaign:

Cost Per Click = Amount You Can Afford to Pay Per Customer * Conversion Rate

OR

Cost Per Click = Average Sale * Profit Margin * Conversion Rate

For example, if you generate $50 revenue per customer, on average, with a 50% profit margin, then you can afford to pay up to $25 to acquire a new customer. You would only break even at that rate, but at least you would gain a new customer and would have the opportunity to sell more products or services to that customer in the future. Assuming a conversion rate of 1%, then the numbers work out like this:

Cost Per Click = $25.00 * .01 = $.25

OR

Cost Per Click = $50.00 * .50 * .01 = $.25

So you now know that you can afford to pay a quarter per click. If you can double your conversion rate, then you can double your profit or double your bids.

As you watch your pay per click campaign, you might find that certain products sell much better on-line than others. If this is the case, then you might want to re-work your numbers to emphasize the products that are selling. For example, let's say you have the following products, which are selling via Yahoo! in the following proportions:

Product A - $25 profit per sale - 50%
Product B - $10 profit per sale - 10%
Product C - $40 profit per sale - 40%

Then your average profit per sale is as follows:
($25 * .50) + ($10 * .10) + ($40 * .40) = $12.50 + $1 + $16 = $29.50

Based on these numbers, you know that you can now pay up to about $.30 for clicks.
Or if there is enough traffic related to Product C, you might want to start allocating more of your budget for it and less for the other products, since it generates the most profit per sale.

As mentioned earlier, it may even be worth taking a loss on the first sale just to get the customer. If you know the lifetime value of your customers, then you can make this call. If you generally only do business with your customers a single time, then that is another area of your business you need to investigate - how to sell more to people who have already done business with you. This is where you should use vehicles like email, newsletters, blogs, etc. to create a community of customers who come to rely on you for information. It all comes down to creating a holistic, integrated marketing plan, and it starts with knowing your numbers.