Why Do Online Advertising? Part 3
Putting It All Together
So we’ve gone through the basics of online advertising, in particular with Google AdWords, and we’ve talked about some financial numbers to determine costs of acquiring a new client and the value of a new client. This article goes through tying it together – so you know if online advertising is worth it for you, the business owner.
What Is Return On Investment (ROI)?
Here’s the tricky part, but the most important part. I totally recommend going to an accountant or business consultant on this one, but if you have a good handle on your finances, you should be able to come up with a number that is in the ball park. Return On Investment, or ROI, is the net profit (or loss) after spending money on a particular item. It is the (gain from investment – cost of investment) / cost of investment.
You can get a proper definition at http://www.investopedia.com/terms/r/returnoninvestment.asp
- You send out coupons, which cost $100.
- Your increased business minus operating costs gets you $150,
- Then your ROI is $50 or ($150-$100)/$100 = 50%.
ROI For Online Advertising - Ecommerce
So how does this work for Google AdWords? If you have an e-commerce site, then this is fairly easy. You can track the AdWords clicks to your website all the way to completing a sale. Then from that you can determine how much profit you made on the item that was sold. So if you spent $300 on advertising during the month, and sold $1000 worth of goods and a profit of $500, then your net profit is $200 or ($1000-$200)/$1000 = 20%. Great! You are making money and should invest more money. Be sure to include the shipping costs, incremental costs for sending out the items (such as extra paid employee time, allowance for returns, taxes on net income, etc). Again, if you don’t have a good handle on this, I’d recommend speaking to a financial professional.
Determine your ROI – Non-ecommerce Sites
Now that you know how to determine your lifetime value of a client and the cost of acquisition, you can calculate the return on investment for a particular campaign. (you can also figure out ahead of time ball park numbers that you require for a new ad campaign to be successful).
As previously mentioned, to calculate your ROI, you take the net revenue and divide it by the incremental cost to get hopefully a positive number.
Using the number from Example 1 in the previous article. (15 new clients from your ad campaign)
You have determined the net lifetime value of a new client is $100.
Advertising costs for the month was $1000
Total revenue = $100 x 15 = $1500
Return On Investment (ROI) = ($1500 - $1000)/ $1000 = 50%
So your total return on investment is 50%. That is fabulous. For every $1000 you spend, you make an extra $500. Put more money into advertising! Well maybe…
What Budget Is Best?
So you find out you have a positive ROI for your advertising campaign – great! Now how much more do you put into it? Well here are my thoughts… If the sky is the limit for what you want to grow to be, then throw more money at it. With Google AdWords, you can bid more per click to move higher up in the advertisement position. Generally, the top 3 ads show up above the organic listings. So I like to be in the top 3. You can out bid everyone and beat out your competitors nearly all the time, however, you are paying more per click and therefore the percentage return on investment will be lower. But maybe you still make money at for example $6.00 per click at number 1 compared to $4.00 at number 2. At some point you will run out of potential clicks (if it’s not a competitive field), or the bid will be too high to make any money (for the more competitive fields). So this is where really knowing your lifetime value is. Then you can work with your marketing professional to determine where the sweet spot is. You may only want a certain amount of extra business before you have to expand or use up a salaried employee’s time. There may be other reasons to sit at a particular budget. Work with the numbers to determine what is best for you.
Cautions with Online Advertising
There are certain industries where online advertising may not be the best for you. In highly competitive fields such as carpet cleaning, residential plumbing, home security, there is a good chance of losing money. You need to be on top of what ads are profitable and which are not. In these industries and several more, there are people running ads that in actuality end up raising the ad prices to a point where it is very difficult to make money. This is where you need to work with someone who is good at AdWords and can steer you away from money-losing ads. Find what works and stick with it. Dump what ads you lose money on.
Online advertising can be your friend. It can make you tons of money. But it can also make you go broke pretty quick. I strongly recommend working with a professional marketing who will steer you in the right direction and make sure you are not throwing money into a bottomless pit. But you need to know your end of things as well. Know your cost of acquisition and the lifetime value of a new client.
It’s your business. If you don’t know those, how will you know what’s best for you?