Insofar as an account manager rules the keywords and ads of a pay-per-click (PPC) marketing campaign like a tormenting angel, so too must the bitterly pragmatic advice for a sovereign that Niccolo Machiavelli dispensed in The Prince and other works hold merit.
Though his name now is synonymous with malfeasance, many of Machiavelli’s dicta were fairly mundane: “Whosoever desires constant success must change his conduct with the times,” he wrote. And: “Entrepreneurs are simply those who understand that there is little difference between obstacle and opportunity, and are able to turn both to their advantage.” Who would argue with such sentiments?
Even his more-cynical observations, like “Of mankind we may say in general they are fickle, hypocritical, and greedy of gain” still find currency. In Small is the New Big, for example, Seth Godin said, “People are selfish, lazy, uninformed and impatient. Start with that and you’ll be pleasantly surprised by what you find.”
His philosophy can perhaps be summarized by what I call The Modified Golden Rule: “Do unto others as you fear they might do unto you.’ And it is apparent from even a cursory reading that Machiavelli’s most-renowned works hold much useful advice for the modern digital marketer.
In the opening scene of The Merchant of Venice, friends of Antonio (the title character) ask him why he seems distressed. Is he, perchance, worried about his ships at sea? No, Antonio demures: “My ventures are not in one bottom trusted, nor to one place; nor is my whole estate upon the fortune of this present year. Therefore my merchandise makes me not sad.”
Yet many digital marketers too often are needlessly made sad by their merchandise. Perhaps a word that yielded a few conversions last week gave none this week. Perhaps CPCs or Quality Scores have changed suddenly and without apparent reason.
In this respect, Google’s Bid Simulator (GBS) feature is intended to provide some guidance to help digital marketers maximize their profit. In ‘How to Calculate Profit-Maximizing ROI ‘ and ‘Optimal Bidding, Part 1: Behind the Scenes of ‘Google AdWords Bidding Tutorial ‘, I showed how the GBS’s estimates can be used to find the profit-maximizing bid for a given keyword. Let’s look at another example.
Consider a word that generates revenue of $5 per click, on average. (Say the ad gets $100 per conversion and the conversion rate is 5%, for example.) The Bid Simulator might provide estimates of the number of Clicks that ad can expect per week at several different possible bids. If so, then it might also give estimates of the weekly Cost expected for those clicks (from which the average cost-per-click can be calculated.) The numbers in the figure are fictitious, but realistic.
The expected weekly Revenue can be calculated from knowing that each click on average, for this particular example, brings in $5. The expected weekly Profit can then be found by subtracting the Cost (that is, Clicks times CPC) from the Revenue. (The numbers above are internally consistent, but might not appear so due to rounding.)
Form the table we can see that a bid of $4.60/click maximizes our profit. To bid lower gives up clicks at a profitable price, thus reducing our profit. To bid higher brings in clicks at too high a cost, which also reduces our profit. In fact, by modeling the relationships of ‘Clicks vs. bid’ and ‘CPC vs. bid’, we can calculate the expected weekly Profit at any individual bid, not just the limited options the GBS provides.
In the figure below, we can see the expected weekly Profit for any bid:
We see that a bid of $4.60 per click maximizes our profit. (This is why Hal Varian, Google’s chief economist, refers to the profit-maximizing bid as the ‘optimal’ bid.) To bid more reduces our expected weekly profit such that, at a little over $6.00 per click, we will make no profit at all (and to bid even higher will cause our expected profit to become negative).
But in a cutthroat bidding environment, it might sometimes be wise to settle for less profit for ourselves if it will hurt our competitors more. I call this concept ‘maximization of relative benefit‘.
Look closely again at the ‘Profit vs. bid’ graph. The profit-maximizing bid nets us, on average, $317.50 per week. But if we bid a little over $5 per click, we will still net a profit of around $300 per week. Our profit will be reduced by $17.50 (a bit over 5%), but the next-highest-positioned competitors will see their CPCs rise, in any auction in which we both participate, by $5.00/$4.60, or about 9%, regardless of their Quality Score.
Even in the worst case (that is, an ad which never converts for us and therefore brings us no revenue) our ad still occupies space, robbing your competitors of precious clicks. Thus, for one who values the pain caused to competitors more than the price paid to get that traffic, it is worthwhile to bid even for a non-performing term.
For ads that do generate business, the economics are even more compelling. Bidding slightly above the profit-maximizing level:
- increases the CPC for the next-highest competitor (for a single ad auction)
- reduces the number of clicks competitors are likely to accrue (for a collection of ad auctions), and
- nets you more clicks (even though they are at an incremental price above which you should be willing to pay if you were a strict profit-maximizing bidder).
Regarding the second point, of course, there might not be a one-to-one relationship between the number of additional clicks you receive and the number your competitors lose, since your change in bid might, for example, make Google alter the number of ads they show and therefore the total number of clicks the paid listings receive. (I explained this effect in ‘Pay Attention to the Man Behind the Curtain .’)
In the graph below I have calculated the effect of small increases in one’s bid over one’s profit-maximizing level for the cases where each additional click we gain takes 0.00, 0.10 or 0.25 clicks from the next-highest-positioned competitor. (This analysis assumes that there is a next-highest-positioned competitor and that that competitor get the same amount in revenue per click, on average, as we do.)
Even when our higher bid takes no clicks from the next-highest competitor, it still drives up their CPC. For a bid only 5% above our profit-maximizing bid (in this case, $4.83), our expected weekly profit drops to $314.65, a loss of less than $3 per week to us. However, it costs our next-highest-positioned competitor about $11 per week (an extra loss of about $8 above our loss). If we increase our bid by 10%, we will sacrifice about $10 per week, but cost our competitor about $18. These amounts might not seem large, but if our competitor loses 0.25 clicks for each additional click we gain, then his loss should average about $30 per week, for a word that, if his economics are similar to ours, would otherwise generate over $300 in profit. That’s a nice chunk of his profit and perhaps sufficient to harm his overall marketing efforts if done on a wide enough array of words or on waves of carefully selected terms.
(This concept differs from so-called ‘vindictive bidding’ in that being vindictive involves bidding the highest amount possible to achieve our profit-maximizing CPC. But ‘relative benefit maximization’ involves aiming for a target CPC above our own profit-maximizing level simply because, for small bid increases, doing so hurts our competitors significantly more than it hurts us.)
In The Merchant of Venice when Antonio fails to pay his debt, Shylock demands a pound of flesh as compensation (and for this Shylock is regarded as one of Shakespeare’s cruelest villains). But we can see that for the example above, exceeding our profit-maximizing bid (up to a certain level) can hurt the next-highest advertiser’s profit worse than ours.
Even bidding just $0.05 (about 1%) over our ‘optimal’ bid cuts his profit noticeably while hardly affecting ours at all. So, while Shakespeare wished for his audience to hold Shylock in contempt, judging from the particular circumstances in this case by seeking only one pound of flesh, in my opinion, Shylock underbid.
Done properly, bidding to maximize one’s relative benefit can be a useful part of driving competitors out of a given set of keywords (or, with luck, out of a given market completely). Perhaps Machiavelli put it best: “If an injury has to be done to a man it should be so severe that his vengeance need not be feared.”
- AdWords Position Preference is Dying. Good Riddance.  - April 7, 2011
- Is Google Exploiting Neuromarketing in Reporting Quality Scores?  - March 21, 2011
- Does Google Reward High Quality Scores with More Impressions?  - February 14, 2011
- Like a Rock: The ‘Bid-CPC’ Relationship  - January 19, 2011
- From Business Intelligence to Bathtub Insights  - December 30, 2010
- Google’s New “Automated Rules”  - December 9, 2010
- Braking the Rules  - December 6, 2010
- Google Rich Snippets for Shopping Sites: A New Dilemma  - November 4, 2010
- Quality Score Never Shined My Shoes  - October 19, 2010
- Ad Auctions are Not Auctions  - August 24, 2010