You're About To Spend a Lot More on AdWords

Presented by David Deppner
Meet Magento Poland, September 19, 2016

This presentation explores the evolution of AdWords over the past decade and a half, diving into the key factors that are pushing up costs steadily over time. We'll discuss how Google's self interest and how they've structured the market lead to an inevitable rise in costs for everyone involved. But most importantly, we examine what ecommerce merchants can do to take advantage of these trends to thrive and grow.


I have to admit that when I first started working with AdWords a few years ago, I thought it was a complete waste of money.

My name is David Deppner, and I started working with AdWords primarily about six years ago at ClearBags, where I’ve been the Vice President of IT and ecommerce for about eight years now, working with Magento since the early versions of Magento 1.

When I first started working with AdWords, it had previously been managed by somebody from the marketing department and that person had left the company. I was asked to take over and try to figure out what was going on and whether we were actually making money or whether we were losing money. We didn’t really have good systems in place to figure that out and I became really obsessed with understanding the system and understanding how to work with the system to profitably generate results for the business. Since that time it has actually become one of the major sources of growth for the company.

I now have my own company working with other ecommerce merchants on managing their online advertising to generate the most profits they possibly can.

When I say it’s going to be worth it, that’s not entirely true for everybody. It’s going to be worth it if you understand the system, if you understand the game that Google has set up and the rules of that game, and if you can play that game successfully. There are a lot of companies that are not going to win.

When we talk about the game Google set up, you have to understand that back in the late ‘90s Google was the dominant search engine - everybody knows that. But they had a really big problem. The problem was they weren’t making any money. They had to figure out some way to monetize search and the advertising system they came up with is the way they did it. When they monetized search they set the rules of the game up in a way so they could extract the maximum revenue from the advertisers paying for the ads. But they also had to set up the game to keep relevant search results so users would keep coming back to the system and using it. They couldn’t lose all those users that loved the search results Google was giving them.

Google’s formula for doing this is pretty straightforward, and I’m going to illustrate this with some examples over the years from their search results. They had to make ads become as relevant as organic search results so users would click on those ads in order to find what they were looking for. They had to make successful ads dominate the screen and be more enticing than the organic search results. They had to shift people from clicking on organic to clicking on the ads so they could generate revenue, and then they have been steadily trying to drive up the cost per click so they make more revenue every time somebody clicks an ad.

If you’ve been using the internet for any amount of time you probably remember what Google looked like back around the year 2000. When ads first came out, they were over on the right-hand column and they were very small. They were very bad. If you clicked on them, you probably didn’t find anything that you wanted to find. And they steadily started innovating to improve that system.

One of the things that they did was implement a system using what’s called a Quality Score where all of the ads get rated and ads with higher quality scores tend to rise up to the top. They eventually set up a system where ads with higher quality scores could appear above the organic search results. They were no longer off to the side. And they started making changes to make the ads look more like the organic search results – these are no longer little boxes that look very different than the organic results. Just a little bit of a transition going on there.

Later on down the road, I’m sure most people that advertise in the ecommerce space are using product listing ads, so Google added these in, and that had the effect often times on many search result pages of pushing the organic results even further down on the screen. Now often times you’re only seeing one or two organic results at the bottom of the search result page and advertising is dominating the top of the screen.

This is what the search result pages have looked like over the last couple of years until the beginning of 2016. You still have the ads off to the right. They don’t look the same way they did before – they have improved the look a little bit. The ads up top look a lot more like organic results now. They no longer have a background color that’s any different. That just reflects that ongoing trend. The other thing that we started to see a lot more is extensions to the ads to make them larger and more enticing.

We have sitelinks here with some deep links into various parts of the site. We’ve got some callout extensions down here where people could tag the ad with some additional bullet point information. We have the seller ratings, of course, and we have phone numbers where people could just click on that when they’re on mobile in order to call the company. All these things make people interact with those ads more likely and they’re actually all part of Google’s strategy to make the ads bigger, enticing, more useful and shift people’s click from the organic results onto the ads so Google makes more money.

But SEO – well, one more point. Early 2016 we had a shift where the ads on the right-hand side were eliminated – this was about February of this year – instead of just three ads at the top, they added a fourth ad. Any of you who are advertisers have probably noticed that change. The thing to understand is, the ads on the side weren’t getting very many clicks, they weren’t generating a lot of revenue, and the cost per click on those was a lot lower. So even this is a strategy to shift another ad into one of those top positions where Google is able to make more money for it, and now there are fewer ads at the top of the search result pages so people are competing a lot more intensely for those top slots.

One of the final changes that I’m going to illustrate here is something called Expanded Text Ads, and that’s what’s going on right here. This ad now has a longer line of descriptive text relative to the standard ads that you’re seeing in the positions down below that have these smaller lines that are more like the traditional ads. One more very minor tweak. Google continues to make these minor tweaks, one little change at a time, but it’s really driving the ads to look a lot more like organic search results.

So here we go – SEO isn’t dead yet. The reason I say SEO isn’t dead, even though it’s declining... Obviously people still get a lot of results from organic links. A lot of benefit can come out of activity to try to get to the top of the rankings. But we have to face the fact that the number one organic link is now typically the fifth link on the page. On a lot of searches, ecommerce merchants have found that if they can place in the top text ad slot, and place in the top organic slot, and have several of the product listing ads, they totally dominant that search results page. And it turns out that actually when you’re in multiple places like this on the search results page, all of them get more clicks than if they were in isolation. It’s not always true, but in most cases that I’ve looked at, it has been. A lot of other people have looked at this as well. What’s really going on is that when you’re dominating the search results page, you’re clearly the authoritative source; you’re a good result, and you have more credibility. People are just more likely to click on any of those links.

I want to get into a discussion about why the costs are going up. The fundamental answer to the question of why the costs are going up is because of how Google has structured the ad auction. Auctions have been around for a long time, and the fundamental characteristic of an auction is it’s a marketplace where the highest bidder is the one that’s going to get the sale. So the seller is going to make the most money possible because whoever is willing to pay the absolute top dollar is going to engage in the exchange. The Google auction is a little bit different because it’s not actually the highest bidder that wins the auction. It’s the advertiser with the highest ad rank, and we’re going to get into what that is in a minute. But the other characteristic that’s interesting about the Google auction is they’re not actually selling you the click at that point – what you’re bidding on is the position on the screen, whether you’re going to get into one of those top slots or not.

There are a lot of factors that go into the ad rank – there’s the amount you bid, there’s the quality score of your advertisement, and then there’s something called the format impact. I’m going to go into all of these in a little bit of detail in just a minute. There’s an interesting video that if you haven’t seen it, I think you should. This is Hal Varian. Hal Varian is the Chief Economist for Google. I didn’t know a few years ago that Google employed teams of economists, much less a Chief Economist, but these are the people that laid out the rules to the game we’re playing, and this gives you some insight into how they structured it and why they structured it the way they did. This is a video that’s just short, 8 minutes long, and you can find it by just Googling Insights on the AdWords Auction. That’s the title of the video. In this video Hal explains several things, just the nuances of how different people bid for ad rank. It’s just a function of the bids, the quality score, and the format impact.

Let’s dive into each of those. Format impact really means all of those ad extensions and types of ads that you can implement. Google knows that when the ad is bigger and more enticing to users, people are more likely to click on it. So they’re going to reward you for implementing all these features like Seller Reviews and Sitelinks, while shifting your ad into a higher position where it’s going to get more clicks. So you can see very clearly on a search result page like this, that this ad is going to dominate. Nobody is going to read all this, but just at a glance they’re more likely to skim this and click on it. The U-Line ad here is also big. Both of these implement quite a few of the AdWords extensions.

What you might not realize is that the ads down here at the bottom also implement those extensions. But since those ads are performing a little bit poorer, Google has rated them lower and isn’t bothering to show those extensions and take up the screen real estate. This is one of the techniques that Google uses to shift clicks that might have gone to an ad that was going to make less money, a lower cost per click, because they’re bidding lower probably. Google is shifting those results up here by adding on those extensions optionally onto the ads in certain situations, making it more likely that the ads that are paying more are going to get additional clicks.

So when we talk about the actual bids, there’s a fundamental conflict involved, and that is that you, as a business owner, want to maximize your profit but you also want to get at the top of the search results. Getting at the top of the search results means you have to increase your bids, which increases your cost, which drops your profit. So which of these two things do you pursue? And I’m going to lay out a simple strategy that I think is the right way to approach this, and it starts with maximizing your business’s profit. If you’re not maximizing your profit, you’re not staying in business and you can’t be in this game for the long haul.

A lot of advertisers use bidding techniques like bidding based on the target cost per acquisition they want to achieve or bidding based on a target return on ad spend (ROAS), but ultimately Google translates all of the bidding methods down into a cost-per-click bid. The best way to actually bid is to deal with cost-per-click. I can’t get into that in a great deal in this presentation, but what you really need to get down to is what is the value of a click so you know what you can bid for that click in order to gain it profitably.

If you’ve ever gone through the AdWords interface and clicked around on the actual bids, there’s a little icon there that you can open up that’s the bid simulator. This shows you what your current bid is, and what results you’re getting from it, but it’s also giving you some information that’s a projection of, if you changed your bid, what would happen. This by itself doesn’t give you enough information to really decide how to set your bids profitably, because Google doesn’t know anything about your business’s cost structure or business model. But you have that information, so you can do that with a little bit of simple math, really.

You can get a lot more complicated with this, but here’s a simple example to illustrate. If you’ve got a gross profit of $100 per conversion, then you can very easily see the projections for the various conversion levels of, based on whatever bid you’re going to set, what your gross profit would be. You also know what the cost is going to be approximately for that bid level in a weekly period, which is what this bid simulator is showing, and you can start to get an idea of an estimation of what your net profit would be at each of these bid levels. In this example the bid is set at $2. This is pretty typical – people just throw an arbitrary bid up there and they don’t really know what’s the most profitable. But in this example it’s saying that a bid closer to the $3.32 level would be the most profitable.

If you go through your entire account and set bids based on what would be the most profitable, all the way down at the level of every individual keyword and every individual product in your account, you’re going to find that some bids go up and some bids go down. We have this system where we want to get to the top of the Google listings so we can profitably make a lot of money, get a lot of clicks and keep going, but initially just bidding based on profit maximization drops a lot of your bids and you lose those top positions. The thing to understand about that, though, is that if you’re in the top position losing money or making less money than you could, maybe it’s not the best use of your cash. It makes more sense to focus on the ads that can rise.

Let’s get into talking about how you can increase all of your bids after an initial round of profit maximization. The thing is, that quality score was that third component of how ad rank gets determined and who wins the auction. So improvements in the quality score are also going to bring your ad rank up. I’m going to show you how that can turn into a method where you can increase your bids profitably. So quality score has a lot of factors.

There are three major components. So you’ve got your ad relevance, your click-through rate and your landing page experience. Just think about this as that user journey – what’s going on as somebody does a search, sees your ad, decides whether to click on it, and then interacts with your webpage, your website on the back end, and maybe makes a purchase or not. There are a lot of other minor factors as well, and so this gives you a lot of opportunities for improving your quality score. But the click-through rate is the most important one of these factors and again, it makes sense why. If you just think about it for a minute, Google only makes money when somebody clicks on your ad. So it’s the most important factor to them in determining quality. It’s really the probability that they’re going to earn revenue.

The easiest way to get started with improving your quality score is to do things that impact that click-through rate. Typically where people really get started is in doing things like restructuring their account so it’s more tightly focused and they can implement a lot of negative keywords to eliminate impressions that don’t result in clicks. Taking that a step further, you can really work to eliminate having your ad show up for search terms that would generate clicks that aren’t generating conversions.

The impact of that – there’s a lot of impacts of that – but a couple of the key impacts is that you’re spending less money on irrelevant clicks – that’s a profitability win right there – also the average conversion value for the clicks that you are paying for goes up.

So this leads to an interesting cycle, and this is the fundamental cycle that’s driving bids up. People do things to improve the quality scores in their AdWords account, the value per click goes up, the click is now worth more to them so now they can bid more to buy more clicks. Profits rise, they go back to it, they keep working on improving the quality, expand out the account, add more negative keywords, do other things that are improving quality as well since there’s so many factors that impact that. This sort of constant improvement cycle is basically what’s going on throughout the market right now and what all the ecommerce companies are dealing with.

Not everybody is actively pursuing it; some people are just sort of stumbling into improvements that are making them more profitability, but some are really aggressively following the math, following the numbers, and engaging in this continuous improvement. And as they’re bidding up and they’re eliminating the wasteful spend, they’re able to bid up more on their top converting keywords and it’s basically making the costs for everybody else go up as well.

So the danger and the opportunity is simply this: costs are going to continue to rise as other people continue to implement these sorts of optimizations. If you want to become more profitable and grow the converting clicks that you are buying from Google, you actually have to essentially just improve faster than your competitors. But this is also one of those things where if you improve a little bit faster than your competitors, and you keep at it, you get better and better and better and continue to take more share away from them and increase their costs and decrease their results.

So who wins? I think it’s very clear that users win from this. Google rigged the game. Google set this up to keep people coming back to Google. They need users to keep coming to Google, typing their problems, the things they’re trying to find, what they want to buy, and finding those things. So they’re clearly winning from this, because bad ads or poorly converting ecommerce sites – they fall out. They can’t afford to continue in this game. Google is clearly winning. Google’s ad revenue from 2001 through 2015 has a spectacular rise and it’s 67 billion dollars in revenue last year – that’s quite a bit of money. That’s actually 90 per cent of Google’s revenue now. So most of their revenue – almost all of it – comes from advertising.

This next graph is the same data but instead of looking at the raw numbers, we’re looking at year over year growth. I think this starts to get at why there’s been so many additional changes and so many more efforts to monetize search over the years. The growth rate of this advertising revenue has clearly been declining. Obviously in the beginning the numbers are skewed, but the long-term trend is the growth is declining. There’s a limit to how far you can go when you just continue doing the same things. Google needs to continue to shift people away from organic search to clicking on ads. Look at even during the 2009 recession, they still had 9% growth rate, which was great. But that 9% growth rate during the recession also led to their stock price falling. And for the most part, their stock’s been on a steady rise ever since. But right now they’re back down into the teens in growth rate, and they’ve had a steady drop. What’s 2016 going to look like? What’s 2017 going to look like? This is what’s driving all of these changes in Google AdWords. This is what is putting the pressure on. They need to keep their stock price up and they’re going to keep doing whatever they can to continue monetizing search and pushing all those bids up.

So what does the future hold? Because of the way this game is structured, ad relevance is going to continue getting better, and you have to keep up with that. Your competitors are definitely pushing their ad relevance up. It’s going to cost more to rank at the top, and if you’re not ranking at the top, you’re no longer going to rank at all. Organic results are going to continue to be marginalized. It’s not something that anybody really publicly talks about at Google but that’s the trend, that is what is occurring. That is what has gone on for fifteen years now and it’s certainly going to continue. Ultimately, there are going to be more changes that drive clicks to advertising.

So just a quick recap of the key points about how you can win.

  • You need to dominate with bigger and better ads. That means if you’re not implementing all those extensions right now, that’s an easy win, you just need to go and do it.

  • Organic, text, and product ads all on the same keywords just get you better results on all of those. I’ve talked to a lot of people that are a little bit shy about advertising when they’re getting that number one result, but the way things are going now, if you aren’t advertising at the top you’re just continuing to get pushed down. And there’s a lot of data to say that when you advertise, you can do so very profitably on those top converting keywords.

  • Set your bids to maximize profits. I think that this is one of the most important things to take away. Most people don’t do the profitability analysis on their advertising. They have people that don’t understand the cost structure of the business making the decisions and maybe they have a budget to spend and they spend it all. But if you really get into this you can have tremendous results.

  • Constantly work to improve your quality scores, and recalculate those bids regularly. It’s not just your actions that change the point where you should be bidding for maximum profitability. Your competitors are always making changes. If you’re not actively in there managing those bids and changing them very regularly, you’re losing money.

So if you want some more information on Psyberware, I’ve written a number of blog posts about some things like the issue I talked about before about bidding based on acquisitions or target return on ad spend, instead of bidding based on clicks. Also some things about what happens when you’re trying to target a certain ROI and why that might not be the best-case scenario - maybe you should focus on profit instead. Feel free to reach out to me on Twitter or email, and I’ll be here for the rest of the event. I look forward to talking to you. Thank you.

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