Now that you’ve learnt how to track and measure conversions, you’ll know how many customers are taking meaningful actions on your website. You can optimise your ads for conversions and that’s great.
However, this information is does not yet help you make the most crucial business decision: How much should you spend on each ad? If you’re spending £2 per ad to make a sale of £50, that’s a fantastic ROI! It’s a different situation if each sale was only worth £5, in which case you shouldn’t be spending £2 per ad.
It’s time to calculate the next metric—your return on investment (ROI). The fundamental question is simple:
Are my AdWords ads helping me make a profit?
There are two textbook definitions of ROI:
- ROI = Net profit / Cost
- ROI = (Revenue – Cost of goods sold) / Cost of goods sold.
Example: Amy is a dressmaker and she sells dresses on her online blog. She sell dresses for £100 a pop. It costs £50 for her to produce one dress, including fabric, labour and postage cost. Amy ran an AdWords campaign for two weeks and sold eight of these dresses from those advertisements.
|Revenue||£100 per dress x 8 = £800|
|Cost of goods sold||Materials and Labour = £50 per dress x 8 = £400|
Advertising = £120 for whole campaign
Total = £400 + £100 = £500
|ROI of her entire dress business||(£800 – £520) / £520 = 54%|
In other words, for every £1 that Amy spends, she gets £1.54 back.
|ROI of Amy’s AdWords investment||(£800 – £400 ) / £120 = 333%|
For every £1 Amy spends on AdWords, she gets £3.33 back.
As an advertiser, you should focus on the second ROI number—the return on your AdWords advertisement.
A good rule of thumb is: the ROI number should always be greater than 100%. This means that, for every pound that you spend on AdWords, you make a profit. The greater the number, the greater the profit.
Your ROI matters more than number of clicks or number of ad views.
It matters more than your budget and how much you end up spending. There is so much data available on your AdWords and Analytics account and you’ll easily get sidelined (or borderline addicted) with tracking all those numbers daily.
However, it is more useful to translate those numbers into dollar-figures. You have to understand how your ads relate directly to the success of your business—you’re effectively seeing direct marketing in it’s purest form. Your ROI is the single most important number in your AdWords account.
How to calculate Return of Investment?
You will need to link your Google Analytics account with your AdWords account. You should’ve learnt all of this in the earlier pages of this chapter.
After you trigger conversion tracking on your account, Google shows you four new columns: Conv., Cost/Conv., Conv. Rate and View-through Conv. (where Conv. stands for conversions). Do note that none of these metrics show you your ROI yet. To see your ROI, you’ll need to:
- Run a Keyword Performance report from the “Reports” tab.
- Click on the “Add/Remove columns” menu and include the “Value/Cost” column.
- Save this report as a template, name it “ROI Report by Keyword” and schedule it to run periodically.
If the Value/Cost column happens to show more than 100%, you’re making money. The higher the number, the larger the profit.
You can export this table to Excel to give you even more meaningful data. Here are few more columns that you can add:
- Value = “Value / Click” x “Total Clicks”
- Cost = “Average Cost per Click” x “Total Clicks”
- Net Profit = Value – Cost
Now that you’ve calculated ROI, how can you use it to make better business decisions?
You’ll use ROI to determine your budget and bid amounts.
It doesn’t matter if you spend £1 million a month on advertising, as long as these ads are bringing in £5 million in sales!
Once you generate the report above, you’ll also understand which ads and keywords affect your profit the most. Maybe you’ll learn that some products sell better in your shop than others, and you’ll learn which product to advertise more often.
Of course, a sensible businessperson would then focus your budget on the most successful keywords research. Then, you can also scale back on keywords that cost too much. With this data, you can make better decisions than your competitors.
Here’s a cheat sheet of things to look out for in your report:
- If your ROI is less than 100%, this means that the advertising costs exceeds your profits. The bids for your keywords are set too high. In this case, you should lower the your bids so that you can at least break even.
- If your ROI is more than 100%, you can consider increasing your maximum bid. By increasing your bid, you might be able to get even more clicks. If you decide to run this experiment, remember to track its progress diligently for a couple of days.
- The ROI number on your report may drop because each click now costs more. You’ll need more clicks to make the same profit as before. If your ROI number declines, revert back to the original bid.
- If the ROI number increases, this means that you have gained enough extra clicks to cover the additional cost. In this case, you should keep the increased bid and consider experimenting with an even higher bid.
Other things to consider when calculating ROI
As we’ve discussed earlier in this chapter, there are five types of conversions that you can track: sales, leads, signups, page views and other. Different businesses may advertise for any one of these reasons. You must not use the blanket rule to calculate ROI. Instead there are different costs to think about before you can calculate ROI:
You’ll have to think about which types of conversions, and hence, which costs matter to you.
Let’s bring back the example of Amy’s online dress shop. We assumed that all of Amy’s customers would purchase the dress online. It made sense for Amy to track number of sales. The cost that she’s interested in is the cost to generate new sales.
Let’s consider other businesses.
- If you make most of your business offline, like a coffee shop or a car mechanic, you would use AdWords for lead generation. How many phone numbers of potential customers can you collect? In this case, you need to use cost per acquisition in your calculations.
- If you sell big-ticket items, like TVs or used cars, you’re tackling a whole different animal altogether. These customers spend more time searching and comparing different sites. The clickthrough-rate (CTR) for TV ads would be higher while the conversion ratio (CR) would be much lower. Sites selling TVs would also target leads, rather than number of sales.
- Another possibility to take into account when selling big-ticket items: If your customer returns after a spot of comparison shopping, he may find your site using another keyword. Perhaps he’s done his homework and now searches “65-inch quantum dot 4K UHD TV” instead of just “new TV”. The conversion tracking may then be assigned to the last keyword he used.
- Finally, some sites generate lots of repeat customers. Peppapig.com gets customers every Mother’s Day. If you think about the lifetime value of the customer, he may be worth far more than the profit you make on their first purchase.