Follow the Rules? Bid Management Strategies

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Paid search bid management may be the least understood – and most incorrectly applied – technique in search engine marketing today. Does that statement shock you? Worse yet, if you think I’m only talking about vanity bidders who bid to first position to keep the CEO happy, or folks not tracking at the keyword level at all who make mass bid changes across all keywords – you’re wrong! The truth is, 99% of all search engine marketers don’t understand – or properly apply – the science of bid management.

Rules-Based Bidding: The Most Popular Strategy

Most search marketers apply a rules-based bid management strategy for their paid search campaigns. In other words, they establish a business objective and then adjust bids up or down depending on whether or not they are hitting this objective.

For example, let’s assume an AdWords campaign with an objective of 20% margin, and a keyword with 1,000 clicks at $2.50 each, yielding an overall revenue from these clicks of $2,500. You run a quick calculation to figure out whether the keyword is currently bid at a level that will achieve a 20% margin, and if not, what the appropriate bid should be. Here’s how this math looks:

Total revenue from clicks = $2,500
Revenue per click (RPC) = $2.50 and Margin Goal (MG) = 20%
Bid = RPC(1-MG)

In other words, to achieve our optimal bid, we need to first figure out the revenue we make on every click (the revenue per click, or RPC) and then multiple the RPC by the inverse of our margin goal (one minus margin goal, or 1-MG). So if you want to get a 20% margin on a bid, you bid 80% of your revenue per click  – the result is a bid that is 20% below your revenue per click which gives you a 20% margin.

Adding in the numbers, the equation works out like this:

Bid = $2.50(1-.2)
Bid =$2.50(.8)
Bid = $2.00

According to this calculation, you were bidding $.50 too much per click to hit your margin goal, so by lowering your bid, you now expect to achieve your business objective. Some search marketers apply a nuance to this equation by attempting to factor in that you usually pay less per click than your actual max CPC (cost per click), so perhaps you will actually bid 15% below your revenue-per-click figure with the expectation that you will actually make a 20% margin.

Why Rules-Based Bidding Is Wrong

For the most part, this bidding strategy appears to work well. It is certainly better than vanity bidding or bidding without considering revenue or profit. But here’s the problem: it is mathematically wrong! To understand why, you need to consider the underlying AdWords algorithm.

First, let’s start with a little bid management history. Around the year 2000, GoTo (later Overture, and later still Yahoo! Search Marketing) was the only game in town. Whoever bid the highest CPC showed up as Position #1 – period. The system was completely transparent; as a bidder, I could easily see exactly how much it would cost me to get into a particular position on a search engine. Indeed, I could even purposely create a very poorly written ad to decrease clickthroughs and get a lot of impressions for little cost.

A couple of years later, Google launched AdWords and changed the GoTo model in two fundamental ways. First, they changed the equation for top position from “Max CPC only” to “Max CPC times Clickthrough Rate (CTR).” Second, they removed most of the bid transparency from the system, making it difficult to know how much you actually needed to bid to achieve a specific position.

What most advertisers fail to realize, however, is that the AdWords algorithm actually changed the game from a CPC bidding world to a CPM (cost per thousand impressions) bidding world, since CPC x CTR = CPM. In other words, Google optimizes the position of advertisers on their search result pages based on who is paying the most money per one thousand impressions, not on who is willing to pay the most per click (as with the GoTo model).

If you chart the CTR of a given keyword by position, usually there is an almost exponential drop in CTR as you drop in position. Most studies of CTR by position suggest that Positions #1 and #2 get the lion’s share of clicks and anything after Position #5 gets very little share. If you reduce your bid and move from a top position to a lower one, you will almost certainly see a much lower CTR and much fewer clicks. Remember this point – I’ll come back to it in a minute.

The other key observation is that conversion rates will vary by position. For some keywords, the conversion rate is very strong in the first few positions and drops precipitously as you move lower in the ranks. For others, the conversion rate is pretty consistent or even slightly better at lower positions. Anecdotally, I find positional conversion rate is often dependent on whether a particular keyword relates to a product or service that engenders a lot of research (conversion rate consistent across position) or one where the product is a commodity (conversion rate is high in top positions and drops at each lower position).

So we now know that both CTR and conversion rate vary by position. We also know that Google determines position based on a combination of CTR and CPC (CPM). Remember the rules-based bidding example from above, where you reduced a bid from $2.50 to $2.00 in order to hit your 20% margin goal? Let’s review this bidding decision again, but this time through the lens of Google’s bidding algorithm and our understanding of CTR and conversion rate by position.

Assume that for a bid of $2.50 you are in Position #2 on Google, with a CTR of 5% and a conversion rate of 3%. If you reduce your bid to $2.00, you will drop to Position #5, with a CTR of 1% and a conversion rate of 1%. The revenue per conversion is $100. Let’s see what happens to profit and margin by position based on this information.

Assume 1,000 impressions for each position and revenue per conversion of $100.

Position

Cost Per Click

CTR

Conversion Rate

# of Clicks Rec’d

Cost

# of Conversions

Revenue

Profit

Margin

2

$2.50

5%

3%

50

$125

1.5

$150

$25

16.6%

5

$2.00

1%

1%

10

$20

.1

$10

-$10

0%

Looking at the chart, it becomes clear that by reducing your bid to achieve a higher margin, you actually ended up reducing both your profit and margin.

Margin Testing – The Alternative to Rules-Based Bidding

The moral of the story? Don’t assume you should always bid to top position. In many cases the top bid is a bad option – the CPM may be astronomically higher than bids at lower positions or the conversion rate may be the same or lower than lower-placed ads. Your goal is to determine the “efficient frontier” (where you can maximize profit or margin) by figuring out the bid that will generate the greatest differential between the CPM you pay Google and the revenue per thousand impressions (RPM) you earn. The result is optimization based on maximum earning per thousand impressions (EPM).

In a perfect world, you would be able to quickly review the CPM and RPM by position in Google, as well as know what Maximum CPC you’d have to bid to get into a specific position, and then bid accordingly. However, because Google is so opaque, getting this sort of data is next to impossible. Unless you are willing to spend thousands of dollars testing every keyword you have in Positions #1 through #10, this is not a viable option.

The easiest proxy for optimizing positional EPM is to adjust your rules-based bidding for different margin goals and track your volume, conversion rate, and (ultimately) EPM. For example, if you are trying to achieve a 20% margin for your business, set up your bids to achieve a 10% margin one week, 20% the next week, and 30% the week after that. Calculate your total profit and your actual margin in each week, and you will quickly discover the bid level you should be targeting to achieve optimal performance.

Understanding the way Google determines position and understanding how position impacts volume and conversion rate gives you the ability to make smart bid adjustments that optimize your campaigns for your business objectives. Simply increasing or decreasing bids based on a margin or revenue objective is better than nothing, but ultimately will not guarantee optimal performance for your paid search campaigns.

About the Author

David Rodnitzky is CEO of PPC Associates, a leading SEM agency based in Silicon Valley. PPC Associates provides search, social, and display advertising management to growing, savvy companies. To learn more, visit ppcassociates.com, or contact David at david@ppcassociates.com.

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