It’s not uncommon for me to meet people who are interested in getting started with paid search, but have no idea how to get started.  That’s usually why they come to me in the first place.   More often than not, there is one question that trumps all others right out of the gate:  How much can I afford to pay?  It’s one of the toughest questions in search marketing, and it usually comes from a conversation that goes something like this:

I can spend $500 each month on advertising on Google and other search engines. But, what do I set my bids at? Where do I start?  How do I know what I can afford to pay for a sale?

If you’re like most people who have asked themselves this question, your answer is probably similar to theirs:  Less than what I’m paying now.

I’ve determined that the easiest way to answer this question from the beginning is to start at the end and consider how much profit we want from PPC, and using that to determine how much we’re willing to pay for a sale or conversion (typically referred to as a Cost Per Acquisition, or CPA).  So grab a pencil and some paper, or open an Excel window, and prepare to think about your goals.

Things to think about:

We need to consider a few things before figuring out what a reasonable CPA is:

• How much margin is gained from each sale?
• How often does your site convert visitors to buyers?
• Is your margin the same amount regardless of product or quantity, or does it vary per transaction?

Once you have considered this information–even in just ballpark terms–then you can begin working backwards to find out what you can afford to pay per sale and then determine your ideal cost per click.

First of all, how much of your margin are you willing to reinvest into the business in the form of future PPC advertising? This answer is based solely on your objectives and intentions, so there’s no way I–or anyone else–can tell you what this number should be.  As a starting point, you may want to consider this number in terms of a percentage. This will allow you to adjust your budgets over time so it’s easy to calculate modifications when you make changes in your pricing or cost structure. As an example, let’s assumes an advertiser is willing to invest 30% of her margin into PPC advertising to determine her ideal cost per conversion.  (I keep emphasizing PPC advertising because if you consider all advertising you will have a lot more volume from higher CPAs than you intentioned, and this will lead to a lot more money spent than you planned, and leave your original goals useless.)

EXAMPLE:  A website sells a product for $299.99, with a cost of goods sold of $194. This means the sale has a margin of $105.99. If she reinvests 30% of her margin, she would have $31.80, which would be your acceptable CPA.

Ta da! Now this advertiser knows how much she’s willing to spend for this $300 sale, roughly 10% of the sale total, or $30-32.

Determining Costs per Click

Once you know how much you can afford to pay on a sale, then you need to know how often you can sell a product to someone who comes to the site. This is where your site conversion rate comes in. If you don’t know this number already, simply take the number of sales (S) you receive on your site and divide it by the number if unique visitors (UV) over a given length of time, usually a month. Multiply this number by 100 and you have your conversion rate in percentage form.  As a formula, this would look like:

Conv Rate =(S / UV) * 100

To continue our example, we’ll assume that our advertiser has made 20 sales from 1000 visitors, which would be a conversion rate of 2% [2%=(20 / 1000)*100].  After you know your site’s conversion rate and your acceptable cost per conversion/sale, then you have the information to figure out what you can afford to pay per click to get those visitors to your site. Take your conversion rate in decimal form, (the conversion number you have prior to multiplying it by 100), and multiply it by your acceptable CPA.  In our case 2% is the same as 0.02, so the formula would look like this:

0.02*$31.80=Max CPC

Our advertiser has determined that her max CPC to meet her CPA is $0.64 per click. Voila!

WAIT! Don’t set bids to be $0.64! That would be too easy. Remember that your bidded CPC is rarely the same as your actual CPC, so you can go as much as 20-40% higher than your acceptable CPC to get close to $0.64 being your actual CPC.  In this case that would make the bidded CPC somewhere around $0.75-0.80.

DOUBLE WAIT!  There’s one other problem: This method doesn’t take into account competitive factors, ad copy changes, or landing page conversion rates, which all can have huge impacts on your costs per click AND your PPC conversion rates. So what do you do then?  Well, the honest answer is you test everything.  First of all, given the products/services you sell, is $0.64-0.80 a high CPC or a low CPC?  If you’re selling insurance you’re not going to be able to play ball with the big leaguers (unless you follow my advice on how to compete with bigger advertisers), and if you’re selling buggy whips, then your ads may be crammed in position 1, which is usually a good sign that you’re over-paying.  So test, and re-test again to see which of the variables, or combination of variables, gives you the best outcome.  You can always go lower and get cheaper CPCs and CPAs, but if you want to max out what you’re willing to pay to maximize volume, then this is how to get a good start.