The Magic Formula
If you’ve been to school, you’ve heard about the theory of relativity. E=mc2 and all that jazz… well in pay per click, there’s a special equation too. Every time you look at your AdWords or adCenter or YSM performance, you see the results of this equation. But a funny thing happens when you pull all the numbers out of the picture and discuss the equation itself – you get what I call “the magic formula.”
CPA * ConvRate = CPC
This is the basis for every important statistic in your paid ad account but most people never think about how powerful this formula is for things like calculating what you can afford to pay per click when you know the maximum cost per conversion you can afford. Or figuring out what your target conversion rate needs to be in order to achieve a certain cost per conversion without paying more than a certain cost per click.
Here’s an example of the magic formula in action:
I have a client who wants 100 conversions a day with a target cost per acquisition/conversion of no more than $8. He only wants to spend $8000 a month. Right off the bat there’s something amiss with this client’s math (3000 conversions at $8 a conversion would cost $24,000, for example). Unfortunately, just telling a client that their math is wrong won’t win you any contracts – so I want to find out if any of the numbers he is requesting are even doable, then go back to him with some supporting numbers and maybe even an alternate plan. Here’s what I do.
His average CPC on the account is about .50 and he’s fine with that. His current conversion rate is about 5% (.05) and while they’d like to improve, it’s never been above 7%, so I use 5% for my current figures. If his budget for 30 days is $8000, he can afford 16,000 clicks in a month. This averages out to about 533 clicks a day without exceeding his monthly budget.
But before we even get that far, we know we have a problem – take the numbers we know from the existing metrics and plug them into the magic formula:
CPA * ConvRate = CPC
$8 * .05 = .50 <<< um, this doesn’t add up… Let’s review this from a different direction so we can see what the problem is – we know we ARE paying 50 cents a click and we know we HAVE a 5% conversion rate, so let’s see what that gives us in terms of the current cost per conversion:
CPC / ConvRate = CPA
.50 / .05 = 10 — so we’re currently paying too much for our conversions. The metric we have the most direct control over is CPC – we can manually change that to whatever we want. What do we need in order to hit $8 per conversion at the current conversion rate? Go back to the original formula of CPA ($8) * ConvRate (.05) = CPC
The math for that is >>> 8 * .05 = .40
So we know that in order to hit the target CPA of $8, we have to drop the average cost per click to 40 cents instead of 50 cents at the client’s current conversion rate of 5% (or .05, as we’ve written it in the formula).
Now, what sort of activity can we expect, given the budget limitation? Let’s see how many clicks can we afford if they cost 40 cents each?
$8000 / .40 = 20,000 clicks a month
Over a thirty day period that means we can afford about 666 clicks a day with the $8000 budget and forty cent clicks. But we only have a 5% conversion rate – let’s do that math to find out how many conversions we can expect if we maintain a 5% conversion rate against 666 clicks a day:
666 * .05 = 33.3
That means this conversion rate will only bring in about 33.3 conversions a day, which is WAY short of the client’s desired 100 conversions a day over 30 days for $8000 a month. We actually need a 15% conversion rate to hit 100 conversions a day on this budget or else we need to drop the CPC more.
This is when reality needs to set in. To drop CPC you can lower bids and aim for position 5 or 6 but what if that’s where you already are? To improve conversion rate you can either filter out more low quality clicks (which will likely reduce total conversions by a few too) or make improvements to the landing page/web site to ensure better converting pages. Or perhaps it’s time to perform some market re-evaluation and reassess our expectations.
- How far down the sidebar can you bid and still expect to maintain the original 5% conversion rate?
- How much improvement on the conversion rate would new landing page elements provide?
- Can you really expect a 300% increase in conversion rate based on the current conversion funnel and page design?
- Is this budget limitation realistic in light of the cost per click for this market?
This is the power that the magic formula gives you over unrealistic expectations (or numbers that some VP just pulled out of thin air.) You can demonstrate mathematically exactly what can be expected if everything stays the same and you can predict what will change and by how much when any of those values are modified.
Here are the common permutations on the magic formula:
CPA * ConvRate = CPC
CPC / ConvRate = CPA
CPC / CPA = ConvRate
Now, go forth and conquer those busy-body bean counters who think they can just spit a number at you and you can make it happen!
Sorry, ouija has no special extra insight.
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