Ecommerce store owners are always asking me… Should I be using Google Adwords? How do I know if it’s worth the cost?
Here’s the simple 2 minute Traffic Light Test to determine if you should invest in Google Adwords:
Photo Credit: Horia Varian
First Find Out The Average Cost-Per-Clicks of Your Top 3 Keywords In Adwords
Open up the Google Adwords Keyword Tool. You will need to be logged in to Adwords to see actual cost-per-clicks.
Set To “Exact Match”
Click Columns and check “Approximate CPC”
If you don’t yet have an Adwords account you can use other services like http://spyfu.com to estimate cost-per-clicks.
Next, Determine The Value Of Your Visitors
There are two ways to look at it – Short Term and Long Term.
Short Term Visitor Value = Average Order Value * Margin * Conversion Rate
You need to know these numbers. If you have ecommerce tracking set up you can see them in Google Analytics. If you don’t know your conversion rate you can estimate 1% for anything under $200 and 0.5% for more expensive products. Margin is what % of your product revenue you keep as profit. For example if you sell a widget for $100 and $50 of that is profit – your margin is 50%.
Long Term Visitor Value = Lifetime Value of Customer * Margin * Conversion Rate
Which one is right? Well it depends on your business and your risk tolerance. I’ve found that the right answer is usualy somewhere in the middle.
And that’s where the Traffic Light Test comes in…
If your Short Term Visitor Value > Adwords Cost-Per-Click then go full speed ahead.
Example: You sell widgets for $100 with a 50% margin and 1% conversion rate. Cost-per-clicks in Adwords are $0.40
Short Term Visitor Value = $100 * 0.50 * 0.01 = $0.50
$0.50 short term value per visitor > $0.40 cost per visitor so you have the Green Light
You should be running an Adwords campaign yesterday as the numbers are in your favor and you will likely make a solid profit from your paid traffic. Feel free to hire me right now.
If Short Term Visitor Value < Adwords Cost-Per-Clicks < Long Term Visitor Value then proceed with caution.
With many Adwords keywords high competition will push cost-per-clicks higher than your Short Term Visitor Value but less than your Long Term Visitor Value. How you proceed will really depend on your risk tolerance.
Let’s say you run a subscription company and retain customers on average for 12 months and charge an average of $500 per month. Your margins are 50% and you know that 0.5% of site visitors become customers. The Adwords Cost-Per-Clicks on your top keywords average $10.00 per click.
Short Term Visitor Value = $500 * 0.5 * 0.005 = $1.25
Long Term Visitor Value = $6000 * 0.5 * 0.005 = $15.00
So the Long Term Value of your visitor is $15 and Adwords clicks only cost $10… that’s a slam dunk right? Well not necessarily.
In this example you would be spending $2000 in Adwords expecting to get $3000 of lifetime profit from your customer over 12 months. But that means that it would take 8 months until you break-even and earned back the $2000 you spent on Adwords.
If the example business has a solid balance sheet and could take the outlay of 8 months, then Adwords could still be really profitable in the long run. But there is a significant risk that the customer would not be retained for the full 12 months and then the company loses money.
In general, the longer time it takes you to get your full payoff, the more you should discount the long term value of the visitor. If it takes you 12 days to get paid then you don’t need to discount much for risk, but if it takes you 12 months to get fully paid then you might discount the long term visitor value by 30% or more. Like I said it depends on your risk tolerance so proceed with caution.
If Long Term Visitor Value < Adwords Cost-Per-Clicks then stop immediately.
Example: You sell widgets for $100 with a 50% margin and 1% conversion rate. Over lifetime your customers on average purchase 3 times from you for $300 total lifetime value. Adwords Cost-Per-Clicks average $2.00
Short Term Visitor Value = $100 * 0.5 * 0.01 = $0.50
Long Term Visitor Value = $300 * 0.5 * 0.01 = $1.50
$1.50 long term value per visitor < $2.00 cost per visitor so you have the Red Light
Before using Adwords you need to find a way to either:
- increase your lifetime customer value (new products, upsells, etc)
- use conversion optimization to increase your conversion rate
- bid on less expensive keywords
Then come back and try the Traffic Light Test again – maybe your Red LIght will turn Yellow or even Green.
How did you do on the Traffic Light Test? Green, Yellow, or Red?
Feel free to leave a comment and I will answer any questions.