How Much Should You Pay for a Click

by Andy Quick

You have a web site ready for action. Your product catalog, order tracking, credit card payment system, and fulfillment process are all in place. Now all you need is traffic! Many web entrepreneurs have learned that the magic nut to crack is attraction: get a steady flow of customers who explore your site and eventually purchase goods. The overhead costs of most web businesses are minimal relative to brick and mortar stores. However, the variable marketing costs can over shadow sales revenues by orders of magnitudes. Unfortunately, unlike the saying in the movie Field of Dreams, "If you build it, they will not come!" Luckily, the industry has learned this lesson; some the hard way, and others in spite of the losers. Dot-coms are clearly not the darlings of the capital markets any longer; however, there is still money to be made! If you plan to start a web business or already have one but are not sure how to increase traffic and make money at the same time, you should consider a science-driven approach. What does that mean? Read on…

How to Lose $500 in 12 Hours

One weekend, my business partner and I created an affiliate commerce site. The site comprised a list of links to other online retailers. People go to our site, pick a link to a jewelry store for example, buy something, and in turn we receive a commission from the sale. The process of creating the site, signing up the affiliate agreements, and turning it on was a cinch. The cost was virtually nothing. We, being new to this whole web business concept, thought we had an incredibly smart marketing idea: pay to have our site come up in an ad box on a major search engine (Google) every time someone searched on the word "gifts". The word gifts is searched for 49,000 times per day! We figured we would have a good flow of visitors and the money would start rolling in. For certain, we would at least break even. We sunk $500 in one day and let it rip. Here's what happened:

Our investment in Google - $ 500

Number of times our ad was displayed (impressions) - 36,964

Number of times people actually clicked on our ad when they saw it (click-throughs) - 429

Number of times a person visiting our site made a purchase - 10

Our total sales revenue- $ 77

Our total gross profit - $ (428)

The whole process took less than 12 hours. At least we learned a lesson quickly at a relatively low cost. Let's look at this event from a slightly different perspective, putting the costs in terms of number of visitors:

Our investment in Google - $ 500

Number of times our ad was displayed (impressions) - 36,964

Number of times people actually clicked on our ad when they saw it (click-throughs) - 429

Ad cost per visitor - $ 1.17

Number of times a person visiting our site made a purchase - 10

Average sale per purchase - $ 7.70

Average revenue per visitor - $ 0.18

Average gross profit per visitor - $ (0.99)

We were basically giving $1 away for each visitor that came to the site. Not a winning business model. However, taking this information, we can assess which marketing techniques can work best for the business. Let's add 2 additional critical data points to our table:

Our investment in Google - $ 500

Number of times our ad was displayed (impressions)- 36,964

Number of times people actually clicked on our ad when they saw it (click-throughs) - 429

Percentage people who clicked on our ad (click-through rate)- % 1.16

Ad cost per visitor - $ 1.17

Number of times a person visiting our site made a purchase - 10

Percentage of visitors who purchased something (conversion rate)-% 2.3

Average sale per purchase- $ 7.70

Average revenue per visitor- $ 0.18

Average gross profit per visitor- $ (0.99)

Running the Numbers

Putting this all together, you can create a formula for estimating the gross margin per visitor for a specific marketing campaign:

Average Gross Margin per Visitor=Average revenue per visitor - Advertising Cost per Visitor

Advertising Cost per Visitor=Campaign Costs /(Impressions x Click-through rate)

Average revenue per visitor=Conversion rate x Average sale per purchase

Putting it together:

Average Gross Margin per Visitor=(Conversion rate x Average sale per purchase) – (Campaign Costs / Impressions x Click-through rate)

Using our Google example, the average gross margin per visitor would be calculated as:

Average Gross Margin per Visitor=(0.023 x $ 7.7) - $500 / (36,964 x 016)=(0.99)

Remember, this formula can only be used for a single type of campaign. Depending upon your target audience and the type of campaign, all of the above variables can change. When we launched our Google campaign, we used impression-based advertising, that is, we paid Google a certain amount of money for every 1,000 impressions of our ad (about $15 per 1,000 impressions in our example). However, just because our ad was displayed inside someone's browser did not mean they would click on the ad itself.

Enter pay-per-click advertising. This advertising model allows you to pay for an ad only when a person actually clicks on it. In this model, you are guaranteed to get visitors. However, the cost per click is usually much higher. Let us assume we ran our same Google campaign except we used pay-per-click advertising. Pay-per-click also factors in position which will drive the amount you pay per click (the higher the ad position on the screen, the higher the price per click will be). Let's say we pay google $0.50 per click and based on Google's traffic for the word gifts, we receive 170 clicks per day (or visitors), or in total 1000 visitors over the life of the campaign (we still only put in $500, so $500/$0.50=1000). Using our same ratios, let us re-compute our Average Gross Margin per Visitor, modifying our formula slightly (notice the formula is simpler):

Average Gross Margin per Visitor=(Conversion rate x Average sale per purchase) – (Campaign Costs / Visitors)

Plugging in the numbers:

Average Gross Margin per Visitors=(.023 x $ 7.7) - ($500 / 1000)=(0.32)

If we used a pay-per-click advertising model, we could have saved $100. Either way, we would have lost money, but imagine if we had started with $5,000 instead of $500. The nice feature of pay-per-click is that you know ahead of time how many visitors you will receive. If you know your conversion rate and your average sale, you can modify the formula to determine the most you should pay for a pay-per-click campaign:

Max Pay-per-click=(Conversion rate x Average Sale per purchase)

In our Google example, our maximum pay-per-click should be $0.18. For every penny we pay less than our maximum pay-per-click, we're making money! Unfortunately, as of this writing, the minimum pay-per-click cost for the word "gifts" on Google is $0.37. The ultimate lesson is that for this particular site, the Google marketing campaign will not generate sales revenues. But is that really true? We could increase our conversion rate and our average sale per purchase. We could increase our conversion rate by optimizing the design of the web pages. We could increase our average sale per purchase by entering affiliate agreements that offer higher commissions. Let's say we used the $0.37 pay-per- click model on Google for our gift site. In order to make money we would have to get our average revenue per visitor to at least $0.38. If we just focused on our conversion rate, we would need to increase the percentage of visitors who make a purchase to 4.9%. If we left conversion rate alone, we would need to increase the average sale per purchase to $16.50. Alternatively, we could try and increase them both.

Not All Ad Models Are Created Equal

Using the same model, let's look at a different type of campaign: newsletter advertising. This form of advertising involves placing an ad embedded in a newsletter that is distributed to a subscriber base via email. The model for calculating average gross margin per visitor is exactly the same as impression based, except your target market is different. For example, let us say we spend $1,000 to place an ad in an email newsletter about shopping tips. And let's say the newsletter reaches 500,000 subscribers. If we used the same click-through rates and conversion rates, our average gross margin per visitor would be:

Average Gross Margin per Visitor=(.023 x $ 7.7) – $1000 / (500,000 x 0116)=$0.004

We're making money!! (not much, but the margin is positive). Translation: this campaign brings us under a half a penny per visitor. Another helpful ratio is to calculate the return on your advertising dollar:

Return of Advertising=[(Impressions x Click-through rate x Conversion rate x Average sale per purchase) – Campaign Cost] / Campaign Cost

Or in our case:

Return of Advertising=[(500,000 x .0116 x .023 x $ 7.7) – $1000] / $1000=2.7%. Translation: you're making 2.7 cents in gross revenue for every dollar of advertising you spend. Also keep in my mind that this newsletter reaches a different target audience. While people on Google may casually look for gifts, the recipients of a shopping newsletter may have a higher tendency to buy (i.e. your conversion rate may be higher). If your conversion rate were higher, let's say 3%, your new average gross margin per visitor becomes $0.05!! or a 34% return on our dollar.

The Bottom Line

Using formulas to compute the success of marketing plans is extremely helpful and reduces the risk of throwing away precious advertising dollars. However, understand that each marketing campaign will differ based on cost per click, conversion rates, target audience, and average sales per purchase. I encourage you to track all the data available about your marketing campaigns so you can realize profits instead of losses.

Marketing on the web can be difficult. Predicting the behavior of surfers is an art unto itself. Before you begin spending a lot of money on advertising, experiment with different types of campaigns, track all of the results, and make future marketing decisions based on real customer behavior. Also keep in mind that there are other, free forms of advertising. Writing articles, participating in newsgroups, print advertising, and email marketing are other examples. Remember that all of these marketing techniques will have different click-through rates, conversion rates, and revenues per visitor.