The Pitfalls Of Budget-Constrained Bidding

The downsides to overbidding on keywords are both plain and painful: low-quality traffic at a high cost-per-click (CPC) and a limited budget quickly blown away with little to show for it. But bidding too little, or just not properly accounting for budget constraints, also has consequences, some subtle and some more obvious. Here we will consider some lessons that will help you to avoid the pitfalls of budget-constrained bidding.

Lesson 1: Being timid is like sending your competitors a fruit basket

Since each ad position, as a rule of thumb, tends to get about 40% more traffic than the position below it, dropping several positions in the rankings, or dropping out of bidding entirely, results in multiple competitors getting substantial increases in traffic at the rate they were paying for their lower position. You wouldn’t send your competitors a fruit basket, so why give them higher ad positions at a discounted rate? One reason that might spring to mind for many account managers is “Because it saves me money,too!” An account manager I will call “Mike” once asked me something like, “If a word can get 100 clicks a week for $2 each, why not instead reduce its bid and get those same 100 clicks spread out over a month for $1 each?”

It’s a very good question, since Mike’s method sounds like it would get the same click volume for less cost, but there are two key times when it can be problematic: (1) when you don’t have a monthly budget limit, and (2) when you do. Let’s consider the first case first.

Lesson 2: There is only one “bidding strategy”

Some PPC marketers talk about “bidding strategies” the way they talk about market strategies and business models, as though there are many of them available and the marketer’s job is choose which is most appropriate and most likely to succeed in a given situation. In their book Search Engine Marketing, Inc., Moran and Hunt provide a table of what they claim are many different strategies, but as Google’s chief economist Dr. Hal Varian’s YouTube video “Google AdWords Bidding Tutorial” shows us, there is only one: For each keyword at each time, bid optimally.

Consider a keyword (called “A”) which has a 5% conversion rate and makes $300 in revenue per conversion. A second keyword, “B” is identical to A except that it has only a 2% conversion rate. The monthly performance figures shown in the table below for these keywords are fictitious, but realistic.

We can see from the table what a striking difference the lower conversion rate makes in both the monthly profitability of the words and in the range of bids over which a word is profitable, which is why people like Tim Ash, author of Landing Page Optimization: The Definitive Guide To Testing and Tuning for Conversions, are such vocal advocates of conversion optimization. According to Dr. Varian’s method, if we had no budget limit, we could find our best bid for each keyword by just selecting from the table the bid with the highest profit (which for keyword A would be $7.20, bringing a profit of $2,443 per month and for keyword B would be $2.40, bringing $719 per month). These are the only optimal bids for these words, since our economic goal as advertisers is to maximize the amount of profit we make per heartbeat.

In that rare utopia where an advertiser has an essentially unlimited budget, AdWords acts as what I call “the bank of Google.” I have one client in particular who, despite the economic downturn of the past year, can’t spend money on pay-per-click (PPC) advertising fast enough, because for each dollar they spend they ultimately generate on average $2 in profit. For them, AdWords is like a bank where for every $1 deposited, their account is credited $2 by the end of the day. In fact, in “Online Ad Auctions” (The American Economic Review, Jan. 2009) Dr. Varian has shown that the ratio of value delivered to advertisers divided by the revenue to the auctioneer (that is, Google) should be about 2 to 1, at minimum.

So when the budget is essentially unlimited, for Mike the account manager to overbid on any keyword reduces profit by wasting money and to underbid reduces profit by wasting time. He has only one optimal bid for each word and should use that bid until the performance estimates on the table change.

Lesson 3: Sometimes a pawn is your strongest piece

Done properly, PPC marketing is a measurable profit center, even though some see advertising as just an expense and therefore put artificial limits on spending levels. So, if we were not permitted to spend more than, say, $500 per month, we could put it all into keyword A (the more-profitable keyword), bidding $4.60 per click for a profit per month of $2,380, which is far more than we could make on keyword B. The question is: How much of our $500 budget should we consider shifting from the more-profitable keyword (A) to the less-profitable keyword (B)?

At first glance that question sounds absurd. If we have a limited budget, why not spend it all on keyword A, which has a higher conversion rate and generates two to five times as much profit at any bid as keyword B? Well, because it so happens that there is a better way to spend $500 than by putting it all into keyword A. If we were to bid $3.20 on keyword A and $1.70 on keyword B, then we will make $2263.34 + $706.80 = $2,970.14 (which is far more than bidding solely on keyword A) and still meet our budget limit. You can check the math for yourself.

The lesson for online marketers is that bidding optimally on multiple keywords simultaneously under a constrained budget is not simply a matter of reducing our bids until some desired spending level is attained, as Mike suggests, nor just selecting the largest profit from a table, as Dr. Varian suggests for the case of an unlimited budget. It requires rigorous calculation to avoid missing available profit, and there is no simple shortcut except to be aware of the pitfalls of budget-constrained bidding and to avoid them.