Working the Math of Online Advertising

Ever struggled to figure out whether it makes sense to make a specific online ad buy? There's really only one way to figure it out, and that's to run the math on it.

Expect your "best guesses" to be way out of whack the first time you try this excercise. That said, doing an estimate and then a report after the campaign is the only way to get the insight and learning required to make better and better ad buying decisions.

More importantly, if you have ad buys that you do on a recurring basis, you MUST do this kind of analysis to figure out if they are making you money or not.

So, in a nutshell, here are the rows you will put in your excel spreadsheet:

1. CPM (the amount you pay per thousand for your banner ads).
2. Cost per impression (1/1000 of the above - somewhat redundant but it helps with our formulas and to illustrate a couple of points).
3. Click % (the percentage of people who click on the ad - this ranges from almost nothing to a couple percent for a highly targeted vertical ad).
4. Cost per click (cost per impression divided by click %) *Note: for Google Adwords, where you are paying based on cost per click, this is where your spreadsheet starts.
5. Landing page conversion % (this is the percentage of people who arrive at the landing page from the ad and take your desired action).
6. Cost per conversion (Cost per click divided by landing page conversion %).
   
7. Value of conversion (this is your net profit if you are selling something or an assigned value if you are undertaking lead generation or other activities).
8. ROI (Value per conversion divided by cost of conversion)

Once you arrive at ROI, there are a few factors to consider. For instance, if there is branding and/or residual value in your campaign, you will want to factor this in. Don't expect to achieve positive ROI in all your campaigns, but be prepared to aggressively test and optimize the ones that are close to positive ROI.

Once you successfully found an activity that generates clear ROI, you have uncovered a beautiful opportunity and need to explore how you can duplicate and/or scale up your efforts. This is the key customer acquisition strategy of most of the biggest companies on the Internet: Find a few ROI-positive acquisition methods and scale them up like crazy.

There are a million variable factors in this model, but keep it simple to start and then expand on it as you get comfortable. For instance, you may want to assign the "value" of the action as your average LCV (lifetime customer value) instead of the value of a one time sale.

The beauty of using the model is that as time passes and you get real results to enter in the spreadsheet, you'll get more and more accurate in your projections. Some of my clients keep a tracking document that stores both their original projections as well as the post-campaign actual results for each campaign they run. While this requires that you put your ego in check (a lot of the projections will be very, very wrong), it eventually becomes possibly the most important and accurate decision making tool in your business.

So, while it will take you a few minutes to set up the first time, this exercise is very straightforward and becomes incredibly valuable if you do it for each campaign you run. Also, as you can see, it is an excellent tool for and "apples to apples" comparison of different types of advertising (AdWords vs CPM for instance).

If you get really creative, you can even find ways of incorporating contests, trade shows and sponsorships into this model of ROI comparison (this gets tricky but is definitely valuable as you get comfortable with this kind of model).

BTW I actually thought this was going to be a quick and easy post before I started, but as I got further in it became clear that this is an area that will require some more digging.

More to come (including an example)...