Imagine going to the store to buy 100 widgets. They cost $1.00 each. But then you notice exactly the same widgets with ever so slightly different packaging for $0.50 each. Which widgets do you buy?

Now imagine that your autocratic boss sends you to the store every day with the instructions “buy the best widgets you can buy, but spend no more than $1.00 per widget.” Which ones would you buy? Would you buy 100 widgets for $50 or 100 widgets for $100? What if your boss added “I will increase your salary by 10% of the amount you spend”?

Search marketers sometimes find themselves in exactly this situation, able to buy a certain number of clicks for a particular price, or buy exactly the same clicks for a fraction of the price. Let me provide an example. For one of our customers recently, we reduced our maximum cost-per-click (CPC) bids to about half of our previous actual CPC cost for two exact match keywords on Google. The charts below show the CPC and click performance over time for these keywords.

  • Green Line — Keyword 1: The traffic for one of the keywords responded in the stereotypical way – Google’s auction moved the ad to a lower rank, and fewer searchers clicked on it.
  • Blue Line – Keyword 2: The traffic for this ad did not change at all. We received about the same number of impressions, the same click-through rate (CTR), the same number of clicks, and the same number of conversions as before. Thus, in some cases, you can get exactly the same traffic for half the cost.Screen shot 2010-01-19 at 12.07.07 PM

We found this behavior on about half of the keywords we tested that are:

  • branded terms,
  • in the #1 paid search position, and
  • $1.00 CPC or higher.

Such keywords often account for a substantial fraction of a brand-name company’s paid search traffic and conversions, and they typically already provide excellent return on investment (ROI), even without reducing the cost. Furthermore, these are terms that the CMO might just type in to their favorite search engine and then complain “Why aren’t we in the #1 ad position?” Consequently, both agency staff and in-house search marketers are reluctant to take any risks on these keywords. But, because the spend on these keywords is also high, the potential cost savings are substantial.
There are three reasons this may happen.

  1. Google sometimes promotes an ad with a high “quality score” to the top of the SERP, putting it ahead of competitors with higher Ad Rank. You can pay to stay ahead of your competitors, but you may not have to!
  2. Sometimes dropping from 1st position to 2nd or 3rd position does not reduce the CTR or quality of visitor. This is especially true when the top ads appeal to different segments of searchers, e.g. if United Airlines and United Van Lines ads appear for the query “United”.
  3. If you reduce your bid and end up behind your nearest competitor on the SERP, that competitor’s CPC typically goes up (sometimes very significantly), and the competitor may reduce its bid in response to your change.

So a great way to sabotage your SEM is to spend more and receive no marketing benefit. This is a special case of high marginal CPC, which is a concern for every paid search keyword.

To understand marginal CPC, imagine that your autocratic boss sends you to the store every day with the instruction to “buy as many widgets as you can, but spend no more than $5.00 per widget.” The shopkeeper informs you that the more widgets you want to buy, the more expensive each one is. You can buy 100 widgets for $100, which is $1 each. Or buy 150 widgets for $300 or an average of $2 each. But if you wanted to buy 200 widgets, that would cost $800, or an average of $4 each. Remember, your instruction was to buy as many widgets as possible for less than $5 each. What should you do? Buy the 200 widgets? No! In all reality, the last 50 widgets, of the 200, cost $10 each (i.e.: [$800-$300]/50 = $10 each). If the widgets are worth $5.00 each to your company, your company’s interests would be best served by buying only 150 widgets.

Marginal CPC has also been called incremental cost per click (ICC). Based on the incremental cost, one can calculate an incremental ROI. Taking the marginal CPC into consideration in maximizing the return on paid search advertising spend has been termed positional optimization, though that is somewhat a misnomer since what matters is the amount of additional traffic gained per extra dollar spent, regardless of the absolute position.

Why does this matter? In principle, if you are not considering marginal CPC, you are not optimizing your paid search campaigns in the sense of maximizing the benefit that your advertising dollars can produce. And if you aren’t optimizing, you cannot determine whether a performance improvement is due to a strategic change or due to a tactical change, such as a bid adjustment. Thus, continuous improvement begins with an optimization methodology. In practice, it is typically possible to improve campaign performance by 20% by optimizing (considering marginal CPC) vs. just adhering to ROI constraints. Using a generic model of CTR vs. ad rank in the optimization provides some improvement. In order to obtain the full improvement, it is necessary to continuously test the marginal CPCs of high-volume keywords. This, by the way, also protects you against bid jamming.

Actionable Insight #1: If you are shopping for a bid automation system, find one that can optimize based on marginal CPC.

Actionable Insight #2: If you use a bid automation system that does not optimize based on marginal CPC, take your top 10 keywords by spend out of the bid management system and manage them by hand. You can increase their performance while simultaneously reducing your bid management fees.

Actionable Insight #3: If you set bids manually, get someone on your staff with an operations research (or similar) interest involved. This quantitative optimization perspective can substantially improve your process and campaign results.

Actionable Insight #4: In the process of writing this post, we searched for written information on which bid management systems optimize based on marginal cost per click, and only found one white paper. If you are a bid management vendor, please comment below with a link or high-level description of how you manage marginal cost per click and we will publish it here – free marketing and SEO link juice!