Hal Varian’s New Bid Management Tutorial For AdWords

Hal Varian’s New Bid Management Tutorial For AdWords

Hal Varian, the chief economist at Google, released another fascinating video tutorial on AdWords, and this time his subject is setting bids in AdWords.

Important New Metrics: Incremental Cost Per Click And Value Per Click

At the core of his well-reasoned bidding tutorial is Google’s new bid simulator, and two metrics that aren’t everyday terms in PPC analysis –  “Value Per Click” and “Incremental Cost Per Click”.

“Value Per Click” is the value on average per click through to your website and it is found by multiplying your maximum profitable CPA x your conversion rate.

Formula: Max Profitable CPA x Conversion Rate = Value Per Click

Example: $50.00 CPA  x  3.5% Conversion Rate =  $1.75 Value Per Click

“Incremental Cost Per Click” or “ICC” is a metric derived using Google’s new Bid Simulator, and is based on a new, higher target bid for a keyword.  That new higher target bid will increase what you pay for existing clicks and also enter you into new ad auctions.  The Bid Simulator tool will reveal to you  Google’s best guess as to what that the future cost  scenario with the higher bid would look like.  “Incremental Cost Per Click” is calculated by adding up the additional, “incremental” costs of both the new clicks you would get with the higher target keyword CPC bid and also the costs of the higher CPC’s you would pay for clicks you would have otherwise gotten (but will now probably get in higher positions), and divide that total incremental cost by the number of “incremental”, additional clicks you would receive with the target bid.

Sound complicated? To some extent that’s because it is complicated, but an example may help, and watching and re-watching  Hal Varian’s video certainly will.

Formula: Incremental Costs / Incremental Clicks = Incremental Cost Per Click (ICC)

Example: Target Bid of $1.65 instead of $1.50

Incremental Costs Per Simulator Tool $15.30 / Incremental Clicks Per Simulator Tool 9 = $1.70 ICC

How To Apply This Knowledge

The steps Google recommends that you take to maximize your profit from AdWords are simple:

  • Determine your maximum profitable CPA
  • Determine an average, reliable conversion rate
  • Calculate your value per click (which again is your conversion rate x your maximum profitable CPA)
  • Adjust your bids so your value per click = the incremental cost per click

The explanation, however, isn’t simple.  It’s involved, but it’s valuable.  I highly recommend viewing and reviewing this important video several times.

There are caveats to using this bid system, of course.  You’re relying on Google’s theoretical projections to determine what you’re going to pay them, and there’s an inherent skepticism when motives align that way, even if there’s no evidence of malevolence in their tools. Like I’ve heard Perry Marshall comment on Google Conversion Optimizer, keep your eyes open when you ask the dobermans to guard the ham sandwiches.

Also, it’s easy to forget that max profitable CPAs can vary widely by ad group, especially in retail where words represent different products with different margins.  Conversion rates often vary greatly by keyword and ad group as well.  Market seasonality is perhaps accounted for in Google’s tool in terms of impression volume and market CTR, but your own seasonality curves may not match that of your market, and even if they trend the same way they may not do so with the same intensity.

None the less, this is an excellent tutorial for making practical use of Google’s bid simulator, and it’s additional confirmation that anything Hal Varian issues is at least worth attention.

By Rob Sieracki

Director of Paid Search