This post is mainly aimed at Google Adwords, but it equally applies to any PPC service where the cost per click is set by bidding. This includes both Microsoft's and Yahoo's programs as well.
So you've been using PPC advertising and after doing the numbers you realize that you are spending way more on advertising than you are making back in sales. You followed all of Googles optimization tips and even hired an outside consultant. Your click through rate (CTR) is great, so what the hell is wrong ?
You're being hoodwinked is whats wrong...
The main metric used by both Google and the SEM companies to rate their sucess is CTR, however for you, the website owner, CTR is very nearly completely irrelevant. Let me restate this a little more forcefully:
CLICK THROUGH RATE (CTR) is useless and even misleading as a metric.
A high click through rate is not necessarily indicative of a great ad - indeed it is more indicative of an ad designed to appeal to a mass audience. This means you will go through your advertising funds very rapidly and have very little to show for it, as the people who do click it and come to your website will not have been 'qualified'. They will in general bounce.
The metric that really is important to you is CONVERSION RATE. This is the number of people who come to the site that actually end up converting into a SALE. In general this is influenced by how your landing page is setup (a one click buy converts more than sending them to the home page and making them find the product) and how your product is placed against competitors in the marketplace, but it is also influenced by how 'qualified' the traffic is that is sent to the page in the first place. Badly qualified high click through rate traffic generally does not covert...
So whats a typical conversion rate ?
It varies from 0.5% at the low end (send badly qualified traffic to the home page) to 8% at the high end (very well qualifed traffic to a one click buy page). Typically the average is 2.5% - these figures come from research done by FireClick.
So how does this all relate to losing money at the PPC game ?
Because what you make on your advertising is absolutely dependant on your conversion rate. Google et als profits are absolutely dependant on you having a high CTR...
Here's a little formula that puts it better:
(Clicks per $100 of ad spend) x (Converstion Rate) x (Profit per sale) - 100 = (Profit from ad spend)
And this is where we get into the second part of why most people lose money when advertising through PPC - the first term of the formula (the number of clicks per $100 of ad spend) is dependant upon people bidding to be on the first page, so it can be pushed to the point where it would require unrealistic conversion rates to make back what you will spend on advertising.
Lets take a little example where we will assume the cost per click for the from page is $5 (which translates to 20 clicks per $100 of ad spend) - this is not unrealistic, popular terms are now ranging from $5 per click to $15 per click...
We will assume a standard 2.5% conversion rate and $80 profit per sale (again not unrealistic for an affiliate program sale).
(20 x 0.025 x 80) - 100 = -60
So in this average case, you will end up losing 60 dollars for every 100 you spend on advertising...
You can rearrange the formula to tell you how many clicks per $100 of ad spend you will need to break even:
(Clicks per $100 of ad spend) = 100 / ((Conversion Rate) x (Profit per sale))
So using this with our numbers :
100 / (0.025 x 80) = 50
So we would need 50 clicks per $100 of ad spend, or a maximum of $2 per click to break even...
Using this you can compare your keywords with what you need to be profitable.
Because of the bidding system for keywords, a lot of common keywords now fall into unprofitable territory (for the website owner)...
So to sum up, you are losing money on PPC advertising because:
1. The PPC companies and the SEM companies all promote CTR as a metric - it may be for them, but it is *very* misleading for the website owner.
2. The keyword bidding system has put many common keywords into territory that will require unreasonable conversion rates to be profitable.