Imagine that your job is to stand outside a barber shop and bring in new customers. If a businessman with shaggy hair comes walking by, you give him a big wave and a hello. If a bald man walks by, not so much.
This analogy is used by Google AdWords to describe its Enhanced cost-per-click (ECPC) feature. The feature is intended to identify auctions that are more likely to lead to conversions — and to automatically raise bids to “work harder” for those sales. It’s a powerful concept, and one that has understandably gained traction in the SEM community.
Imagine if you could take this logic a step further. Imagine that you could identify those Ad Groups (or even keywords) that are likely to attract great customers — shoppers who are likely to turn into loyal, long-term, repeat buyers and develop a relationship with your site far beyond their initial conversion.
Wouldn’t you be willing to spend more to acquire those customers? Odds are, you would.
While PPC accounted for 15% of conversions this January — up from 14% in January 2013 — the growth of paid search was eclipsed by the explosion in other channels, like organic (26% in 2013 to 30% in 2014) and email (12% in 2013 to 15% in 2014). These figures come from The Custora Pulse, a free US e-commerce industry benchmark, aggregating transaction and customer data from over 100 US e-commerce retailers, developed and updated by e-commerce marketing analytics company Custora (disclosure: my employer).
In other words, while PPC is still growing, the channel won’t always provide a boundless stream of prospective new customers — so, it’s important to focus on the long-term value of the customers that your paid search program is helping you acquire.
The Opportunity For Search Marketers
The traditional approach to SEM management has been to optimize return on a particular Ad Group or keyword by tracking the value of a conversion against the cost to acquire that conversion. We can think of this as managing for immediate payback. Here’s a simple numerical example:
- Average cost-per-click (CPC): $3.00
- Conversion rate: 20%
- Cost/conversion (transaction): $3.00/20% = $15.00
- Value/conversion (=transaction amount): $30.00
Return: $30.00/$15.00 = 2x
But let’s say that the conversion in question belongs to a brand new customer. That initial purchase may capture only a fraction of their long-term value to the business. And, where a retailer may only want to pay up to $30 to get that initial conversion, that might go up to $45 or $50 when the customer’s long-term value is considered.
Enter Customer Lifetime Value (CLV)
Savvy digital marketers have long recognized the importance of aligning a customer acquisition strategy around customer lifetime value (CLV). CLV represents all of the profit that we expect to make from a particular customer over his or her “lifetime” in our store. It includes the profit from the initial conversion, as well as any subsequent purchases that he or she may go on to make in the future.
The key insight, as any marketer can tell you, is that not all customers are equal. Some make a single purchase and then vanish forever. Others turn into loyal, repeat shoppers. And, if you could identify the channel, affiliates and ad networks that were attracting high-value customers, you’d want to invest more in them. This isn’t just a thought experiment. Customers acquired across different paid search terms frequently differ in long-term value by as much as 30% or more.
Furthermore, most of this difference is driven by your customers’ likelihood of making repeat purchases down the line — not by initial order value. In other words, if you’re optimizing your SEM program solely on immediate payback, you’re leaving money on the table. If you could identify the Ad Groups that are bringing in your highest-value customers, you could invest more, knowing that you’re still driving a robust return on new customer acquisition.
Optimizing Paid Search For CLV
So, how can search marketers actually leverage CLV to boost the profitability of their acquisition marketing programs? The key is to gain visibility into the customers that you’re acquiring across campaigns, Ad Groups and keywords, and to use those insights to guide your SEM strategy. Here’s how to do it:
Step 1: Move From Transactional Metrics To Customer-Centric Metrics
Google Analytics’ e-commerce tagging lets you pull data associated with unique order IDs. Matching this data up with the order IDs in your database enables you to associate orders with customers. So, you can move from questions like, “How much revenue did I earn from keyword x?” to questions like, “Who were the customers acquired through keyword x?” Match each customer acquired via paid search to the campaign, Ad group and keyword through which he or she was acquired.
Step 2: Identify The Lifetime Value Of Your Customers
Tools like a cohort analysis can give you visibility into the historic spend of different customer segments: for example, the average one-year spend of customers acquired from one Ad Group compared to another. Alternately, some marketing analytics software platforms can offer predictive lifetime value scoring. This enables you to quickly and accurately identify the CLV of new customers acquired across your search program — even if you’ve just recently launched a particular campaign or keyword. (To learn more about Customer Lifetime Value and how to calculate it, see the Customer Lifetime Value course on Custora U.)
Step 3: Bring In Cost Per Acquisition (CPA)
Once you’ve identified the CLV of customers across different Ad Groups, the next step is to understand how much you’re currently paying to acquire each customer. Take your spend on campaigns, Ad Groups and keywords in a given time period (e.g., last quarter) and divide it by the total number of new customers acquired via those vehicles. For example, if you spent $2,500 on an Ad Group last quarter and that Ad Group brought in 100 new customers, your CPA would be $25.
Step 4: Search Out Favorable Ratios
Identify Ad Groups or keywords offering a higher-than-average CLV-to-CPA ratio — that is, those Ad Groups where the lifetime value of a new customer far exceeds the cost of acquisition. This could be because a particular Ad Group is attracting unusually high-value customers. It could also be because there’s limited competition for a particular Ad Group, leading to a lower average cost-per-click, or because most of the conversions through a particular Ad Group are new customers — meaning that you’re not paying as much “overhead” on returning customers to support new customer acquisition. Whatever the case, a high CLV-to-CPA ratio signals a potential opportunity to invest more of your paid search dollars.
Step 5: Identify True Opportunities
Once a group of Ad Groups have been identified with a high CLV-to-CPC ratio, confirm that investing more in them will actually move the needle. Remember, the goal is to acquire more customers from high-return campaigns, Ad Groups and keywords. If a particular Ad Group is already in the top position 100% of the time, raising the bid won’t actually help acquire more customers. (Branded search terms often come up as illusory “opportunities” for this reason.) A true opportunity is one where increasing the bid actually has the potential to bump up the average position — for example, where your average bid position is 1.5 or lower.
Step 6: Test & Learn
Start by laddering up your investment in opportunity Ad Groups incrementally, increasing the max CPA (or max CPC) by 10% at a time, and measuring the impact on average position, CPA and CLV. The final step — of testing and measuring results — is critical to establishing the success of a CLV-driven paid search strategy. By tracking the overall ROI of your SEM spend over time, you can continue progressively refine your bidding approach, discover new opportunity Ad Groups and ensure the overall effectiveness of your strategy.
Optimizing your paid search strategy around CLV isn’t a cakewalk: there aren’t currently any commercially-available solutions that automatically set and manage bids based on lifetime value, out of the box (although some can accommodate up to a 30-day cookie window). But ultimately, using CLV to guide your SEM program can boost the profitability of your customer acquisition efforts. It can make every SEM dollar work harder for you by ensuring that you’re investing in the highest-return campaigns, Ad Groups and keywords — and driving long-term value to your business.
Image courtesy of Custora.
Opinions expressed in the article are those of the guest author and not necessarily Search Engine Land.