Paid Search: Bidding Based on ROI


This article explains some basic concepts related to bidding on paid search keywords based on return on investment (ROI). Using ROI to make bidding decisions helps ensure that you are spending your advertising dollars in the most effective ways possible.

To explain these concepts, we will use paid search marketers Jane and Lisa as examples.

  • Jane’s goal is to generate as much revenue as possible, but she doesn’t want to spend more than a dollar in advertising for every $5 in sales.
  • Lisa’s goal is to drive as many leads possible at a cost per acquisition (CPA) of $10.

A few definitions to start things off:

  • Click – a paid search click bought on Google, Yahoo or Bing
  • Conversion – a click-to-sale conversion. A conversion is when someone clicks through to your site, then completes a purchase. This could also be a click-to-lead conversion if your goal is to drive leads
  • Conversion Rate – the percentage of time clicks convert to sales. For example, a conversion rate of 5% means that 5 out of every 100 clicks result in sales.
  • Average Sale – the average value of a sale
  • ROAS – return on ad spend: the return in sales you are getting on your paid search investment. I will calculate this as $X in sales for every dollar spent
  • CPC – cost per click: what you are paying per click in Google, Yahoo or Bing
  • Target CPC – the cost per click you should be paying to achieve your target ROAS

Here’s an example scenario: Jane is paying $0.10 per click, 10% of clicks are converting to sales, and her average sale is $5. This means that on average she generates $5 in revenue for every $1 she spends to buy clicks. Therefore, her ROAS is $5.

If Jane is ok with a lower ROAS, she can generate more sales. Spending more per click will lower her ROAS, but the higher CPC will also drive more traffic. For example, if she can achieve her profit goals at a $2.50 ROAS, she can afford to pay $0.20 per click. Here is the math:

ROAS = Sales / Ad Spend
= (Average Sale X Conversion Rate X Clicks) / (Clicks X CPC)
= (Average Sale X Conversion Rate) / CPC

Solving for CPC, we get:

Target CPC = (Average Sale X Conversion Rate) / Target ROAS

Substituting Jane’s goal for ROAS, we get:

Target CPC = ($5 X 10% / $2.50) = $0.20

The process is similar for Lisa. Cost per acquisition is total cost divided by the number of acquisitions, or:

CPA = Ad Spend / Conversions
= (Clicks X CPC) / (Clicks X Conversion Rate)
= CPC / Conversion Rate

Solving for CPC, we get:

Target CPC = Target CPA X Conversion Rate

Substituting Lisa’s goal for CPA and assuming a conversion rate of 10%, we get:

Target CPC = $10 X 10% = $1.00

These calculations are pretty straightforward, and many paid search marketers use some variation of these methods. There are also a number of automated bidding systems that have formulas like these somewhere under the hood.

One assumption we’ve made is that we know Jane and Lisa’s conversion rates, but that is not necessarily a safe assumption. To learn more about the challenges of estimating conversion rates, have a look at this article: Paid Search: Bidding with Confidence.

And if you do not currently have the ability to track leads or sales to a keyword ad, Google Analytics is free and will do the job. If you would like help tracking performance or optimizing your paid search campaigns contact us.

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13 years ago

[…] One trick I sometimes do is to add both an exact match version and a broad match version of the same keyword to an ad group. This allows me to see the performance of the exact match version, which is often better than the broad match version. Over time, I will bid up the exact match version if it is getting better results. For more on keyword bidding based on performance, see our article Paid Search Bidding Based on ROI. […]

13 years ago

[…] Set initial bids – There are two ways to approach this. If you are on a tight budget, start by bidding low and collect some data before you start raising bids. The downside of this approach is that with low bids it may take a while to collect enough data to make a change. If you are not on a tight budget, bid keywords high enough to get a top 3 position and adjust bids up or down as you collect performance data. This approach will generate sales faster, but you will waste some budget on non-performers as you collect data. For more on setting bids based on ROI data, see this article: Paid Search Bidding Based on ROI […]

13 years ago

[…] across is that keyword bids are all over the place. It would be one thing if these bids were set based on return on investment (ROI), but they’re not. A PPC manager has set bids based on the minimum first page bid that […]

13 years ago

[…] while back, I wrote about setting paid search bids based on ROI. Since then, we’ve been working on a number of […]

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