Don’t Spend to a Budget – Spend to Your Economic Target!

David Kennedy / 11th May 2016 / Comment

paid search budgeting

The world of traditional marketing is one of fixed budgets, set well in advance, and post-campaign reporting. For understandable reasons, this same approach is often applied to digital marketing: set a fixed budget and assess the performance over time – but stick to the budget.

A performance marketer sees the world differently. While we understand the practical necessity of budgets, our primary focus is on achieving the maximum return possible for our clients. Depending on the client, we may assess performance based on Return on Ad Spend (ROAS), Cost Per Lead, or Ad Cost to Spend Ratio – all with an eye toward beating client return thresholds. One of the beautiful things about paid search is that we generally can predict our rate of return before we actually spend significant marketing dollars. Given our perspective, we tend to believe that budget should be determined by return available at or below client target metrics.

If someone were to come to you and propose that, for every dollar you invest with them, they would give you five dollars in return, and oh by the way, don’t worry about paying me until you get your money, exactly what is the right amount to budget for this deal?  A performance marketer would say, “when the economics of the deal shift to a less profitable metric than you desire”.  What’s great about digital advertising is that the advertiser gets to determine the value of the traffic they receive and express that value via their keyword bids. So, the amount spent is simply a function of the bid (the amount an advertiser is willing to pay for traffic), market demand in the audience targeted and the ability of a search marketer to attract engagement.

To take this explanation a step further, your bid determines how often the search engine shows your ad and where your ad is placed on the search engine results page (SERP). In short, each keyword bid affects impression share and click through rate. However, the bid does not affect conversion rate for a particular keyword nor do bid adjustments affect transaction size when a prospect ultimately consummates a sale. Let’s take a look at the chart below to explain why:

Widget Data

Because we increased our bid from $1 to $2 above, we were able to drive more Orders and Sales, but at a much lower ROAS. This is because we not only paid more for the additional 300 clicks we received, we also paid double for the first 400 clicks we would otherwise have received at the lower bid. Note though, that conversion rate and average order value remained constant. Think about searches you’ve done in the past. I can confidently say no one has ever said “I would have bought from that site if they only their ad were higher on the Google SERP page”.

So, in the two scenarios above, does it make more sense to bid $1 or $2 for traffic? The answer is, it all depends. As an advertiser, if you’re comfortable driving to a 2.3 ROAS, you should be bidding $2.  If you don’t, you stand the chance to leave plenty of growth on the table. However, if your economics suggest you should be driving to a 4.6 ROAS, you would need to keep your bid at $1. Remember, bidding more isn’t always the right answer. If you are budget constrained, you can bid less, which will reduce the traffic you generate (because your ad will appear lower on the page, but ensure that you maintain the conversion rate and ROAS your business needs).

Sound bidding strategy gives sophisticated paid search managers the powerful ability to both amplify revenue and finely tune ROI. Make sure that your account management approach properly uses bidding to ensure you get the most from your advertising budget.

By David Kennedy