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Budget Wisely…if you must

As we’ve written about in the past, we find it irrational to artificially restrict the size of an efficient paid search program with hard budgets.

However, we’re aware that plenty of paid search managers are constrained by budgets, whether they like it or not, and so they have two objectives to meet: don’t spend more than allowed and hit a certain ROI goal.  In this scenario, a subtle danger needs to be avoided: if you’re hitting your efficiency target but your budgets are limiting the display of your ads — for example, you have your ads set to serve evenly over the course of a day up to a certain budget — you’re spending money unwisely.

You should not use a budget to limit your spend; instead, you should aim for a higher ROI.  Here’s why.

An Example

Let’s take a fictional keyword, “widgets”, and assume you’re aiming for a 30% cost-to-sales ratio.  Imagine that, due to the bidding landscape on the page for this keyword, a $3 bid will place you in position 1, and will gather 1,000 clicks per day; a $1 bid will land you in position 5, with 500 clicks.

For that “widgets” keyword, the advertiser sees that they have a 10% conversion rate and a $100 average order value, meaning that for every 1,000 clicks they gather, they will generate 100 orders and $10,000 in sales.  They decide to bid $3 for that keyword, and their click costs are therefore $3,000.  With $10,000 in sales, they achieve their 30% cost-to-sales ratio.  Hooray!

Let’s imagine, now, that the client can only afford to spend $1,500 per day due to budget constraints.  They set a budget on their campaign and have the engine serve their ads evenly over the course of the day, up to that $1,500.  With $1,500 now available to spend, they will generate 500 clicks ($1,500 budget / $3 CPC).  On those 500 clicks, they will generate $5,000 in sales, which — with $1,500 in cost – yields the same 30% cost-to-sales ratio.  So we’re good, right?

No.  Hitting that 30% target obscures a hidden inefficiency.  We saw earlier that we could generate 500 clicks by bidding $1 and accepting a lower position on the page.  Now we’ll only pay $500 (rather than $1,500), but we’ll generate the same amount of sales, $5,000, for a cost-to-sales ratio of 10%.

Since our budget isn’t depleted — we have $1,000 left to spend — we should therefore slowly increase our bids so that, on average, we spend as close to our budget as possible without having to resort to turning our ads off or having them scattered throughout the day.  So in this example, we might bid $2, and discover this will gather 750 clicks per day.  Now we’re generating $7,500 in sales on $1,500 in cost, for a ratio of 20%.  This is “below” our target of 30%, but due to the budget, we actually generate more sales this way.

In General Terms

It may seem reasonable to think, “Sure, the numbers work out rather perfectly in your example here, but what about with real keywords?”  It is true that it is very difficult, if not impossible, to know with certainty how many clicks will be gathered at a certain position on the page, let alone multiple positions.  And of course, each $1 increment in bids will probably not yield an even increase of 250 clicks.  Traffic may not increase so sharply, and CPCs may not increase so quickly.

But while these numbers are fictional, they capture two important essences of paid search: higher bids for higher positions, and a decreasing marginal efficiency.  Clicks do not increase as quickly as click costs, and as you move up the page, costs rise faster than sales. The reason for this, as we’ve blogged about and as Google’s Chief Economist has confirmed, is that conversion rates don’t vary much with position.  Knowing this, we can safely assume that higher positions will generate the same number of orders per click, but because of the higher bids, those orders will necessarily be more expensive.

Therefore, if budgets are limiting the display of your ads in any fashion, it will always be true that you could pay less for the same amount of traffic that you’re currently getting, and, by extension, you could gather more sales through a bid somewhere in the middle.

What that middle ground is, however, will take some experimentation.  Bid progressively less on your keywords until your budget is not being depleted (if your ads are set to serve evenly over the course of a day, you may have to turn off that setting).  What you’ll find is that your ads are in a lower position on the page, but you’ll spend the same amount of money and gather more clicks.  At some point, your costs will just equal your old budget, and you’ll have found that “sweet spot”, which both limits your costs and gets you as many clicks — and sales — as possible.

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  • Andrew Morgan
    Andrew Morgan is the Director of Product Development at RKG.
  • Comments
    3 Responses to “Budget Wisely…if you must”
    1. Hi Andrew,

      You’re completely right – hitting campaign budgets is very inefficient, and is something I recently wrote about on my blog http://www.alanmitchell.com.au/techniques/budget-time-for-budget-checks/ .

      When daily budgets are being hit, reducing bids will almost always lead to more clicks for the same (or less) spend, so it makes complete sense that CPC bids, rather than daily budgets, should be used as a means to control daily spending. Campaign budgets, instead, should only be used as a failsafe.

      Cheers,
      Alan

    2. Andrew Morgan Andrew Morgan says:

      Very cool Alan! Great minds think alike! I’m pretty sure you said it more eloquently and clearly than I, as well. :)

    3. Bob says:

      Would your call center stop answering sales calls because they’ve reached their budgeted labor for the month? This is considered variable labor. SEM, if managed properly, should be considered variable marketing expense.

      The only legitimate reason for hard dollar budgets should be cash flow. If you can’t pay your marketing expense due to cash constraints or it isn’t financially feasible or prudent to finance those expenditures, then it’s necessary.