Calculating the Maximum You Should Pay Per Click

While it can be very exciting to see new visitors coming to your website and increased online sales you should be aware that the pay per click advertising campaigns that are bringing you this boost may be killing your business.

The problem is as simple as it is timeless:

If you pay more in costs than you make in profits you are losing money!

While this is obvious to (almost) everyone, they way this problem can emerge via pay per click campaigns is not so clear.

Calculating the Maximum You Can Afford to Pay Per Click

First let me introduce the basic calculations you should perform to arrive at the answer particular to you. Then I'll present a video by Google's Chief Economist, Hal Varian, to see it explained visually which includes afvice on how to implement effectively it in Google Adwords to maximise your expenditure.

The method is from the video which I have also bookmarked at AuspireVideos on YouTube.

In a nutshell, here are the three steps:

1. Determine your Maximum Profitable Cost Per Aquisition (CPA).
2. Determine your Conversion Rate.
3. Calculate your Value Per Click (this is what we want - the maximum you should pay for a click).

Stepping through this list is easy so stick with me for a few minutes and you'll have it mastered.

Step 1. Determine your Maximum Profitable Cost Per Aquisition (CPA)

Price - Cost = Maximum CPA

For example: if you sell a camera for $300 to your customers. You purchased the camera from the wholesaler for $200. So:

$300 - $200 = $100 (This is your Maximum CPA for this product). Easy right!

Step 2. Determine your Conversion Rate.

This step requires you to be tracking your conversions (each sale on your website) using tracking software such as the free Google Analytics or by using the conversion tracking code found in your Google Adwords account.

Software such as Analytics and Adwords will show you your conversion rate once installed however here is how it is calculated:

(Conversions / Clicks) x 100 = Conversion Rate

For example: if you have 50 conversions (sales of our camera mentioned above for example) from 1000 clicks then:

(50 / 1000) x 100 = 5% (This is your conversion rate for this product).

Step 3. Calculate your Value Per Click

This is what we are after - the maximum amount you can afford to pay per click before you start to lose money.

Here is the calculation using our results from the previous two steps:

Maximum Profitable CPA / Conversion Rate = Cost Per Click

So in our camera example:

$100 x 0.05 (5% as a decimal) = $5

There it is! We have now determined that based on the profit we make from this camera and our current conversion rate we can afford to pay no more than $5 per click. If we do, we are guaranteed to be losing money!

NOTE: If at any time our profit margin on this camera or our conversion rate change (check it regularly) then we must redo this calculation all over again.

Without further ado, here is the video: