Position-Based vs. Economics-Based PPC Bidding

This may shock you, but a large part of winning the pay-per-click marketing game has to do with how much you pay per click.

There are two schools of thought when it comes to setting pay-per-click bids: position-based and economics-based. This will be a quick summary of both models and an argument for why I believe you must follow one of the schools over the other if you want to truly maximize the performance of your Google Adwords and other PPC campaigns.

A common-sense approach

Let’s forget about pay-per-click marketing for a second and take a quick look at how we make decisions concerning prices in all other aspects of our life.

If I told you I was buying a used car for $4,500, then asked you if you thought it was a good deal, you would probably say something like, “What’s the Blue Book?” You would need to know what it’s actually worth before knowing if the price is right… right?

Similarly, if you’re looking to buy an investment propery and your realtor calls you and says “Hey, I’ve got this great house on the market for only $425,000,” would you be able to confidently buy it over the phone right then? Of course not. You would first need to estimate the actual value of the property as accurately as you could before you knew if the price made sense.

Now, pretend for a second you know nothing about pay-per-click marketing, Google Adwords, quality scores etc. and just answer this question: How much should you bid for any given click?

The correct response that a successful marketer should give is: “It depends… what’s the click worth?”

Makes sense, right?

Here’s the dirty little secret: a large majority of marketers do not ask that question. It’s not because they are lazy pay-per-click managers (although that’s definitely the case for some); but because they subscribe to the “position-based” school of bid management.

What is “position-based” bidding?

“Position” refers to the position that your ad appears relative to other ads on the search results page.

The general rule: the higher your ad is on the page, the more your ad will get clicked. It will have a higher click through rate and bring more traffic to your website, resulting in more leads/sales for your business.

With Google Adwords (Yahoo & MSN have similar systems), your ad’s position is determined by the following equation: CPC bid x Quality Score.

Quality score is Google’s somewhat-secret sauce that is a number 1-10 given to your ad based on it’s CTR and relevancy to the keyword and to your landing page. Getting a high quality score is an important topic, and one that an entire e-book could be written on (and a few have been). For now we’re talking about bid management, so the factor we’re interested in is the CPC bid.

Position-based bidders believe that there is a “sweet spot” position on the page for every keyword in their campaigns, and they will adjust their bids accordingly in an effort to keep their ads showing in that position consistently.

You’ll often hear position-based bidders say things like…

• “Positions 4 through 6 are the most profitable spots to be on the page. You’ll still get solid traffic without paying the premium for the 1 through 3 spots.”
• “Positions 1 through 3 drive a lot more conversions than lower positions, so we’re going to keep bidding high to keep our ads up there.”
• “If you’re ad isn’t showing on the first page then you need to raise your bids to make sure you’re getting traffic.”

Are these guys right? Do some positions lead to better conversions? Is one position truly better or worse than another?

Everything wrong with position-based bidding

Almost as if they were the ones managing your Adwords account, position-based bidding lets your competitors decide how much you bid.  When your competitors’ bids go up, yours have to go up to keep your ads in the same position.

This is a problem for two big reasons:

1. Your competitors have different economic models than you. Just because a lead may be worth $10 to one of your competitors doesn’t mean it’s worth $10 for you. If you have a better sales funnel than they do, that lead could be worth $15, 20, even $50 for your business…
2. There’s a good chance your competitors simply don’t know what the hell they’re doing, especially when it comes to pay-per-click bid management of all things. This makes bidding based on position often a true case of the “blind leading the blind.”

Additionally, let’s dispel a myth — different positions on the page do not have different conversion rates. Sure, you may get more conversions in position 1 vs. position 5, but that’s only because you get more clicks the higher you are on the page. The actual percentage of those clicks that convert into customers does not change. (Here’s a report on the subject released by Google in Aug. ‘09: Conversion Rates Don’t Vary Much with Ad Position)

A return to common sense: economics-based bidding

Bidding based on economics simply means determining your bids by asking the age-old question, “What’s it worth?”

Applied to PPC, that means looking at every keyword and asking, “How much is a click for this keyword worth to my business?”

Notice that this is a fundamentally different question than asking, “How much are my competitors paying for this click?” or “Where will I show up on the page for this keyword?”

None of these things matter when it comes to deciding how to set your CPC bids. Once you know click’s value to your business, figure out the price you’re willing to pay for that value and that’s your bid. It’s that simple.

A quick example

If you’re bidding on “widget,” and your data shows 15% of people who click on your ad after searching for “widget” end up buying your $50 product, and you’re willing to spend 10% of sales on advertising, then your numbers for keyword “widget” look like:

• Conversion rate: 15%
• Sale value: $50
• A/S (Advertising/Sales ratio): 10%

To get the value of the click, we multiply your product’s sale value by the keyword’s conversion rate.

Click value = Conv. Rate * Sale Value

In our example, the value of a click for keyword “widget” = $50 x 15%, or $7.50.

To determine how much you should bid per click, multiply the click’s value by your A/S ratio.

Your bid = Click Value * A/S

In our example, your max CPC bid for “widget” = $7.50 x 10%, or .75 cents.

Position is irrelevant

Once you have set your bids using the economic model, you don’t need to worry about position. If your ad’s in position 1, great!

What if your ad drops off the page to position 12? Oh well. That means the current economics of your business (sale price, profit margin) combined with effectiveness of your sales funnel (conversion rate) aren’t enough for your ad to profitably display on the first page.

Does this mean you should raise your bid? Nope.

Does it mean you’ll be off the first page forever? Not by a long shot.

Maybe a handful of your competitors for that keyword are operating at a loss (especially if they’re using the position-based method). Once their money runs out and/or they finally realize it’s unprofitable for them too, they’ll drop their bid. If enough competitors do this, then all of a sudden your bid is high enough to be appearing in position 8 or 9.

What’s important is not your position, but that you have a bid that makes economic sense for your unique business and sales funnel.

Use the economic-based method to set your bids and you can be sure that wherever your ad shows up is exactly where it’s supposed to.

Related posts:

1. How Adwords’ “Dynamic Keyword Insertion / DKI” Works