# How much should you pay for a click?

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Recently, someone wrote me and explained that he was launching a new site, and all the advertisers that he was interested in using (except Google) had pay per impression plans. Old fashion advertising, you might call it. That’s the way magazines charge for their ads, and they audit their circulation to prove that they are faithful to their rates.

He did a comparison of pay per impression to pay per click, and then wrote me back:

Let’s say I pay \$25 per 1,000 impressions. If spend \$500K, I should get 20 million impressions. If I get 4% click through, that is 800,000 users on my site that I may or may not convert to purchasers. If I pay \$1.5 per click, I get 333,333 users that may or may not convert. Now, I believe all number to be within the industry standards but as you can see, pay per click looks terrible unattractive. What am I missing?

Since he kept the 4% click through the same for both scenarios, it’s not worth quibbling over what the actual CTR will be (and I mislaid my crystal ball, anyway.) The real issue, I wrote in my reply, was that he was paying too much for the click. At \$.625 for a click, the two models are financial identical. (So, I suggested a few ways to decrease his cost per click.)

This leads right into the question, how much do you pay for a click? It’s an easy calculation, but to do it well, you need to understand your profitability, your average order size, and your conversion rate.

Let’s say your widget sells for \$100 and has a gross margin of 45%. (I use the word “widget” loosely – you can use this for a service too. Or, scale it up by adding zeros and use the same equations to value PPC bids for your million dollar enterprise software license.) 1.5% of all visits to the site turn into customers, and they purchase, on average, 1.2 widgets when they convert (so the average order size is 1.2*\$100 = \$120)

To figure your maximum price per click:

Average Order Size x Gross Margin x Conversion Rate = Maximum Price/Click
\$120 x 45% x 1.5% = \$.81

Explanation: Average order size times gross margin percentage gives you the average gross margin per customer. When you multiply that by the conversion rate, you now have average gross margin per visitor (instead of, per customer). When your average gross margin per visitor is the same as the amount you are paying for each click, you break even. But just.

Robbin Steif
LunaMetrics

Our owner and CEO, Robbin Steif, started LunaMetrics twelve years ago. She is a graduate of Harvard College and the Harvard Business School, and has served on the Board of Directors for the Digital Analytics Association. Robbin is a winner of a BusinessWomen First award, as well as a recent Diamond Award for business leadership. You should read her letter before you decide to work with us.

I like to compare contextual ads to ads you might find in a magazine. Pick up any special niche magazine and you’ll see ads for products or services related to the subject matter of the magazine as well as ads on subjects that might be of interest to readers in the magazine’s subscriber demographics.

Want a good reason to try contextual advertising? Think volume and exposure. Consider all the sites you visit each day on the Web. Most of these are candidates for contextual advertising. Cpxclick.com claims to have partnerships with over 500 search engine sites in the system already. For a company wanting widespread exposure on the web, I can’t think of another medium that has the potential reach of contextual advertising.

• CPC can be great for sites that have high profit margins and are actually selling products effectively to consumers.
However that is the google way of selling anything online which is quite expensive, with a 500,000 dollar budget anyone could sell.

I prefer experimenting with social media sites like twitter and lead generation sites which can do better work through API’s.

With the growth in real time search and twitters inclusion onto google, the dynamics of shopping and marketing online are changing, it looks promising for small business owners who want to market their brands and service without the 500k price tag.

• The problem I have with this formula is that because I sell a service, which is usually confirmed by telephone, it’s not always possible to accurately calculate the conversion rate. Once you’ve secured the business you can always ask where a customer found you, but often they’ll simply say “on the internet” or something similar. The last thing you want to do is to push them for specifics and perhaps risk losing the sale.

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