This week I had an interesting moment with a client who likes Google AdWords but was on the fence about shutting down her campaigns. This client knows that many of her phone calls and leads come from Google AdWords, but she gets discouraged by the cost of AdWords and seeing her card charged on a weekly basis.
Instead of just saying “yes, there is a cost to AdWords and you will get billed regularly,” I took the time to explain AdWords profitability to her. She had an aha moment and the beauty of AdWords finally clicked for her, and I could tell from that point on she’s going to be a successful and long-time advertiser on AdWords. Understanding the how and why of AdWords profitability changed everything for this client, and understanding AdWords profit is a must for any successful advertiser. So let’s take a minute to break it down.
To understand AdWords profitability, you need to know the following metrics:
- Average lifetime value of a new customer
- Cost per lead
- How many leads it takes to acquire a new customer
- Cost per acquisition
Average Lifetime Value Of A New Customer
What is one new customer worth to you, on average, over the course of your entire business lifetime?
AdWords gets you new customers, so it’s important to understand how much those new customers are worth to you. And you want to know how much they’re worth to you on the first interaction, and also over the lifetime of your business.
In this example the client runs an estate sale company. Her average profit from an estate sale client is $3,000. Given the nature of estate sales, there is not much repeat business from that customer, but there is a small lifetime benefit from every customer because of word of mouth referrals.
This is a gray area where you just have to make a judgement call, but we decided to add 7% to the average estate sale client’s value in order to account for the word of mouth referral benefit the estate sales company receives every time they put on an estate sale.
The average lifetime value of a new customer in this example = $3,000 initial average profit from an estate sale + 7% additional value from word of mouth marketing = $3,210
The average value of one new estate sale customer for this business is $3,210.
Cost Per Lead
In the AdWords account, we’re defining a lead as a phone call that lasts at least 60 seconds or a lead form being submitted. Cost per lead is very straight forward, as it is the cost per conversion column in AdWords.
You just have to make sure all your conversion settings are in place.
Are you tracking website phone calls?
Are you tracking calls from ads?
Are you tracking all lead forms?
For more on lead tracking, watch this video.
And you also want to make sure your conversions are set to track unique conversions and not every conversion if you’re tracking leads. It doesn’t matter if the same prospect calls twice in one day, that should still be one lead, one conversion.
For this estate sales company, the cost per conversion (the cost per lead) is $63. It is costing us $63 to get someone on the phone for over a minute or to get someone to complete the lead form.
How Many Leads It Takes To Acquire A New Customer
The next step to defining AdWords profitability is to determine cost per acquisition, which is the cost to acquire not just a lead, but an actually paying customer.
In order to be able to find the cost per acquisition, you have to know how many leads from AdWords it takes to acquire a new customer.
In our example of this estate sales company, we didn’t have hard numbers on this. The client did not have any data on how many leads it takes to get a customer.
After talking it through with the client and getting her feel for how many leads she thinks it takes to acquire a paying customer, we decided to go with two estimates, a liberal estimate and a more conservative one.
Our more liberal, optimistic estimate is that is takes 10 leads to acquire a customer.
Our more conservative estimate is that is takes 20 leads to acquire a customer.
Cost Per Acquisition
Now that we have numbers on how many leads it takes to acquire a new customer, we can calculate our cost per acquisition.
In our liberal estimate, we estimated that it takes 10 leads to acquire a customer, so our cost per acquisition would be:
Cost per acquisition = $63 cost per lead x 10 leads to acquire a customer = $630 cost per acquisition (CPA)
In our conservative estimate, we estimated that it takes 20 leads to acquire a customer, so our cost per acquisition would be:
Cost per acquisition = $63 cost per lead x 20 leads to acquire a customer = $1,260 CPA
So in our more liberal estimate it costs $630 to acquire a customer from AdWords, and in our more conservative estimate it costs $1,260 to acquire a customer from AdWords.
Calculating AdWords Profitability
Here we put it all together and find out if AdWords is profitable for this estate sales client.
To calculate AdWords profitability, we subtract our cost per acquisition from the average lifetime value of a customer.
In our liberal estimate:
AdWords profitability = $3,210 average lifetime value of a customer – $630 CPA = $2,580 profit
In this scenario, every customer the client is getting from AdWords has a profit of $2,580.
In our conservative estimate:
AdWords profitability = $3,210 average lifetime value of a customer – $1,260 CPA = $1,950 profit
In this scenario, every customer the client is getting from AdWords has a profit of $1,950.
Putting It All Together
So that’s it. That’s how you determine if the customers you’re getting from AdWords are profitable.
In this scenario, whether the estate sales company is making $2,580 from each AdWords customer or $1,950 from each AdWords customer, it’s less than their normal $3,000 profit from a customer. But that makes sense. The reason the profit is lower is because of the advertising cost from AdWords to acquire those new customers they would not have gotten otherwise.
But the customers the client is getting from AdWords for her estates sales company are still profitable. In the worst case scenario, this client is making a $,1950 profit from each new estate sale she gets from AdWords and that is still a large enough profit to motivate her to get these leads and customers and perform the estate sales.
When the client worked through these numbers and saw that AdWords really is profitable for her business, she instantly got it. Things finally started to click. And she stopped worrying about the weekly costs associated with AdWords and instead, she started focusing on how we could grow her budget and get her more of these profitable estates sales.
Advertising on AdWords can be tough psychologically. It hurts seeing that money charged to your credit card every week for any businessperson, but it especially hurts if you aren’t certain that the advertising money is being spent profitably. It’s a lot easier to part with your marketing dollars if you know that it’s bringing in customers at a profitable rate.
The above AdWords profitability calculation isn’t perfect. It took some judgement calls and estimates, but we are confident that we are being accurate-enough and that the AdWords campaign is bringing in customers at a profitable rate.
It’d be nice to have harder data about the lead close ratio, in terms of how many leads become paying customers, but in this case we just don’t have those numbers so we had to make our own estimates.
However, incomplete data is still better than no data, and calculating AdWords profitability helped this client understand how AdWords was benefiting her on a deeper level than she understood before, and that’s made her a better, more confident advertiser.
Every AdWords advertiser should run a calculation like this example and figure out where their bids and cost per conversion need to be in order to make AdWords profitable for them. Good luck out there.
PS – We created a Rothman PPC AdWords profit calculator you can use here.