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Justify your Search Engine Marketing Investment

Why spend money on marketing? To achieve a positive return on investment. If I put $1 in, how much do I get out? Does the return justify the risk? This is why Google Advertising or PPC is so powerful. You can estimate your return or ROI before you get involved in a campaign. And you can track and tweak as you go.

Even though search engine marketing is results oriented and completely measurable, many sites and tools given an inaccurate analysis of profit and ROI. I have seen tools that consider new revenue to be profit, many of which do not even consider the cost of the cost of goods. If you are not going to offer an appropriate measurement mechanism, then you should not have one at all. It is deceptive.

Let me walk you through how I run the numbers step by step...

First, download the spreadsheet that I use for this.

Know your revenue per customer (Rev). This is easy if you are a mortgage broker, a consumer software firm or anyone that has a product or service with a 1 time fee. This is a bit more work if you bring in a certain stream of revenues per customer. Then you need to know churn, average time of a customer, what typically a customer buys. The best is if you understand the notion of Lifetime Value of a Customer (LTV).

Know your average gross margins (GM%). GM% = Rev - COGS.

  • Average Gross Margins are expressed as a percentage and is Revenue minus Cost of Goods Sold (COGS). For a services company, COGs is the cost of producing or providing a service. This is the key missing item in most analyses. Not listing this is the difference between investing in your business and putting your money into slots. For example if someone tells you that for an average $12 cost of acquisition (CPL), you get $8 in "profit." This is fool's gold if the cost of producing the product (COGS) is $10 or a gross margin of 50%. You lose $2 for every product sold through this medium. That can add up to the thousands or millions fo dollars in losses.

Estimate your cost per click (CPC). CPC = Average bid price over all clicks.

  • There are many tools to estimate this number - some are on the search engines themselves. Generally a less competitive arena is less than $0.50. More competitive is around $1. Highly competitive areas like mortgages can be over $2.

Estimate your conversion rate (CR%). CR% = Lead/Clicks

  • This is your conversion rate to a lead. That is, what percentage of people who click, do something that you want them to do? This is typically filling out a form to be contacted, downloading software or a white paper, or purchasing something directly. This number varies substantially from 1% all the way up to 25%. I would be conservative in this number. The output this number will cost per lead or CPL.

Estimate your quality lead rate (QLR%). QLR% = Quality Leads/Leads

  • Not every lead is quality. Many filled forms are garbage info, duplicates, tests, etc. Some forms are not filled out at all. Numbers vary widely here as well. We've seen as high as 90% and as low as 30%. Having a quality keywords, ad copy, and landing pages make all the difference in the world here. Now if someone is purchasing something directly, neither conversion rate nor quality leads count.

Estimate your close rate (CloseR%). Close R% = Sales/Quality Leads

  • Every company with a different business has a number here. Some are 3-5%, others are 30-50%. As they would say in The Holy Grail, "100% is right out."

Estimate your search engine budget (Ad Spend) and your campaign management fees (Fee).

  • If you are doing this yourself, then only your monthly search engine ad budget matters. If you are paying a firm to manage this, enter this data in - typically its a percentage of ad spend or a lead based fee.

Now it is time to make some calculations:

Clicks per Month (ClickMonth) = Ad Spend/CPC
Leads per Month (LPM) = ClickMonth * Conversion Rate (CR%)
Quality Leads per Month (QLM) = LPM * Quality Lead Rate (QLR%)
Closed Sales per Month (CSM) = QLM * Close Rate (CloseR%)

Gross Margin per Customer (GMC) = Revenue per Customer (Rev) * Gross Margin (GM%)
Monthly Lead Cost (MLC) = Ad Spend + Fees
Cost per Lead (CPL) = MLC/LPM
Cost per Quality Lead (CPQL) = MLC/QLM

Now for what really matters:

New Sales per Month (RevM) = Rev * CSM
Cost per Sale or Action (CPA) = MLC/CSM

New Profit per Sale (PS) = GMC - CPA
New Profit per Month (PM) = PS * RevM

ROI% = PS/CPA * 100

Now this is something a businessperson can work with because it includes real cost per sale including your cost of good and your cost of sales. With search engine marketing these types of metrics are completely understandable and trackable. It's why I got into this business.

Having this data in detail is very helpful to you and your search engine marketing agency, because they can control for certain steps in the process to help you arrive at your projections. Soumya (from our firm) has done a nice job defining the terms you should know about PPC or Search Advertising.

Different businesses will have to make some adjustments to fit their situation. If you need some help, please let me know.

Check out the spreadsheet I use with clients.

This is a work in progress, so comments are appreciated.

November 03, 2006
By Rajiv Parikh