Deciding on your budget
– [Instructor] At this point, it’s time to select our budget and big settings, and this is one of the more challenging aspects of starting up. Typically, you’ll be biding in AdWords on a cost-per-click basis, so you’ll set the maximum amount you wanna pay every time a person clicks on your ad. And this leads to two of the most common questions I get asked: what should I budget and how much should I bid per click? So, let’s work out how we arrive at these numbers. Say the Landon Hotel is trying to get people to book a stay at their hotel.First, we need to decide how much we’re willing to spend to achieve this goal, and for that,we need to understand our customer lifetime value, or LTV.
Now, I’m going to simplify this math. If you wanna understand the comprehensive methodby which to calculate LTV, check out my Marketing Tip on calculating customer lifetime value. Okay, so back to the Landon Hotel. Say they make $100 in profit for any one night’s stay. They also know the average customer stays for three nights, and those three nights could be all in the same stay or over the entire future relationship with that customer. And this is why we call it the LTV, it’s the value of the customer over their entire relationship with your business.
Could be one day, could be 10 years. It’s really dependent on your business and your customer. So, in this scenario, the LTV of a customer at the Landon Hotel is $300. That’s three purchases per customer at $100 profit per purchase. So, if a customer visits the website, clicks Book Now, we can expect to profit $300. From here, we need to calculate the maximum we’ll pay to acquire this customer, and this is our target CPA, or cost per acquisition.
A good rule of thumb is to target a CPA no more than a third of your LTV. So, with this knowledge, we’d be willing to pay a maximum of $100 to make that sale happen for the Landon Hotel. That means that our cost per acquisition can’t exceed a hundred bucks. Now, of course, our goal is always to lower our CPA. The cheaper we get the customer, the more money we make. However, when you start out with AdWords, target the maximum end of what you’re comfortable spending. From there, you can refine.
You wanna know that you can at least make your campaign work, so give yourself plenty of room to do that. Okay, so based on this, we know that we’re willing to pay $100 to get someone to book a stay at our hotel, and we’ll profit $200 on average. Now comes the second stage of our math. We need to figure out what we can spend per click. We can’t set our maximum cost-per-click to $100 because then we could pay $100 for every click, and we know that every click will not result in a sale.
That would be a 100% conversion rate and that’s definitely not realistic, so we need to figure out how many visitors it takes before one of those visitors makes a purchase. To start, look at your current conversion rate for your online traffic. Simply take the total number of sales, dividing that by the total number of visitors for that same period. So, let’s say the Landon Hotel converts 8% of the traffic that visit their site. Now, pay-per-click advertising conversion rates are typically lower than what you see from your typical traffic.
So, if your website converts at 8%, your ads are more likely to convert at, say, half that, 4%.Now, eventually, you’ll get real data on how your ads perform, but for now, you have to make assumptions. And these aren’t set in stone rules, they’re just a really good starting place. If you don’t know your store conversion data because you’re just starting out, that’s fine. You can use my assumptions. So, let’s start with an assumption that 4% of the people who click my ad will make a purchase. So, to arrive at our maximum CPC, we take our maximum CPA of $100 and multiply it by our conversion rate of 4%.
This gives us $4 for our maximum cost-per-click. Put differently, if our ad has 1,000 clicks,we would expect 40 sales and we’re willing to spend around $100 per sale. So, we would spend $4,000 to acquire 40 customers, and $4,000 divided by those 1,000 clicks is four bucks. I simply selected that 1,000 clicks number to make the math easier to follow. So, let’s recap all of this.
We start with your lifetime value, divide that by three to determine your starting max CPA.Now, if you have high margin sales, you might be willing to increase that CPA. If you have low margin sales, you might wanna decrease it. This is just a starting place. Take your maximum CPA and multiply that by your conversion rate, which’ll give you your maximum cost per click. Now, it’s always hard with the first ads. With future ads, you can look at your own performance data to determine how to modify your bids, and that’s gonna be based on your actual click-through and conversion rates.
Now, when it comes to determining your overall budget, you’ll have to evaluate how muchyou’re comfortable spending. Once you’re achieving results, it’s easy to increase your budget, but when you’re starting out, you need to pick a number that will drive enough traffic each day. If our max CPC is $4 and our conversion rate is 4%, we know we need at least 25 visitors to make a sale, but that’s assuming everything goes to plan. We’d really wanna aim for, say, 50 to 100 visitors, so we’ll need to target at least 200 to $400 per day for this budget.
Now, there’s still a flaw in this plan. You see, we’ve decided our max CPC should be $4, but what we really mean is that our maximum average CPC has to be $4. Because Google is auction-based, we might be willing to pay $6 or $8 for a click from time to time as long as the average maintains $4. So, don’t be afraid to bump up your CPC as you test your campaigns, but use this math and methodology as a great place to start.