Or, Can I really Afford This?

The last few years have seen dramatic changes in the way Google Search works, with new algorithm enhancements such as Penguin and Panda, many good websites found their entire business hanging in the balance either through their own actions or through those of less reputable SEO companies. This has led a lot of site owners to look at Pay per Click (PPC) for the first time. The problem is that many of them are making the same bad decisions that led them to trouble in search. The worst is not really understanding how much they can really afford to pay for each click.

If you hire an agency this should be one of the very first things that they discuss with you, how to determine how much they can spend on your ads and still turn a profit, or at the very least, not lose a lot of money. I should note here that you will almost always lose money to start with. This is normal and to be expected while the ads and audiences are experimented with to find the right fit. But you should always have a goal set when starting any PPC campaign.

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How Do I Calculate My Ad Spend?

For this part of the discussion which PPC outlet you choose to go with doesn’t matter. We are interested in figuring out how much you can afford to spend, later we will discuss where to spend it.

The first task in the process is determining what your profit margin is. If you are selling a purely digital product you created yourself, the profit margin could be 90%! BTW, never say 100%, at 100% you have no money left to pay yourself. If you are selling a $7 eBook then at the most you want to spend $5.60 on advertising “per sale” unless this is a lead in product to a much higher priced product which makes this discussion become very complex real fast.

However, if you are selling a physical product you should know what your profit margin is on that product if you are advertising just that one product. Or, you should know your overall company profit margin on all sales over time, along with the total of all sales. This number could be as little as 20% or as high as 200%.

What is your Profit (P) per sale?

For this example let’s assume that you are a general eCommerce retailer with an average profit margin of 35% and and average sale price of $75.00. This makes your average profit per sale $26.25

$75 * 35% = $26.25

What is your Conversion Rate (CR)?

This number is not always as easy to come up with. If you are not running analytics on your website you will never be able to figure this out. Conversion Rate itself is easy to figure out. It is simply the number of sales (S) you make divided by the number of visitors (V) to your website. S / V= CR%

47 / 3000 = 1.56% CR

If you have had 3000 (V)isitors to your website and have made 47 (S)ales your CR is 1.56% or 64 clicks per conversion V / S = Clicks Per Sale (CPS).

3000 / 47 = 64 CPS

So what is my MAX PCC?

Now it’s time to figure out how much you can spend for each click that you pay for, on average.

We know that we earn $26.25 per sale (P) and we know that it takes 64 clicks (CPS) [on average] to make a sale. P / CPS = Max PPC.

$26.25 / 64 = $0.41 cents

This assumes that you are willing to spend 100% of your profit to make that sale. As I said before, in some cases this is acceptable, in others not so much. Perhaps this is a lead in product to future sales, in that case we want to calculate the profit (P) based on the life time value of that customer. Or maybe this is a loss leader to get people to your online store. In many cases though you will want your ads to turn a profit so you want your ad spend to be less than your Max PPC.

More Scenarios

Another level that might apply to your business is one where your website is used to generate leads for your sales team. This ads yet another level to the math. The first two steps remain the same, what is your profit per sale (P) and what is your conversion rate (CR)? The new level is your lead conversion rate.

If we assume that 10% of all the leads you get are really just marketing companies using your lead gen form to try to sell you their services we throw those out right away. Then we can assume that your sales team is able to convert 25% of the leads that your website generates in to actual sales.

This gives us (P) $1000, (CR) 2%, and ((LeadCR) 25% – (J)unk 10%)

The website generates 50 leads every 2500 visits. We lose 10% to junk and convert 25% of the remaining leads.

(50 * 90%) * 25% = 11 Sales per 2500 visits

This now gives us a Max PPC of $4.40

$1000 / (2500 / 11) = $4.40 Max PPC

As you can see it can be very easy to get lost in the numbers. This is why it is so important to have someone on your team that lives for numbers like these. More importantly though, these are the numbers that actually matter. When you PPC team tells you that their ads reached 100,000 people for just $5,000 that’s great, but did those people buy? Did they buy enough for you to turn a profit? Or is the PPC team using numbers that make them look good at the expense of your budget?

To help you with these calculations we have made a Google Drive Spreadsheet for you to copy and use for your own easy calculations. You can get it by clicking here – MAX PPC Spreadsheet.

Wrapping it up

When spending hard cash money on PPC it is incredibly easy to find yourself spending far more money that you ever expected very quickly. It’s important to understand your profit margins overall and for each product. This is even more important when you are running ads for specific items on your website. 40 cents per click might be great on one product ad, but it might ruin you on another product. So it is incredibly important to understand exactly how your money is being spent. And even more important, that your PPC Team understands these numbers and not some random metric that makes them look good while you go broke.

Steve Gerencser

I've been a lot of things over the years, restauranteur, comic book store owner, architect, jeweler, graphic designer, software developer and more. Through them all marketing has been a large part of every step of the way. I built my first website in late '96 or early '97 and started marketing online shortly after that. Since then I've seen almost all of it and try to bring real world business needs to our search marketing and PPC campaigns always with ROI first and foremost in our goals.

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