The New Imperative for Search Engine Advertising: ROI
Introduction
The highly publicized results of Google’s IPO (NASDAQ:GOOG) confirmed that search advertising is big business. According to analysts at eMarketer, search advertising will exceed $3 billion in 2005, growing over 25% from 2004. More significantly, search advertising will comprise nearly 35% of online advertising spending in 2005.
While Search Engine Marketing has been a boon for many companies, its increasing popularity is adversely affecting companies that spend heavily on search ads. What is alarming is that most companies do not yet know this. As the popularity of search engine advertising increases, the relative benefits diminish. Unless companies understand the factors that influence Return on Investment, they are most likely wasting money on unprofitable search ads.
Compelling Advertising Medium
Search ads, known as “sponsored links” on search engines such as Google, Yahoo, MSN and AOL, offer several compelling advantages over traditional advertising channels. Unlike print, television, and even online banner ads, search ads deliver a targeted message to a prospective customer at the very moment they are looking for your product or service.
In addition, online advertisers charge companies for search ads on a cost-per-click basis. So a company pays only when a prospect clicks on the ad, not when the ad is served. The CPC pricing model is unique to online advertising and is favored by those who prefer to pay for results, not just impressions.
Moreover, the price of a search ad is based on auction-like bidding (similar to pricing on eBay). The more popular the search phrase, the higher the cost. As one might expect, the cost for search terms varies substantially, ranging from $0.10 per click for a relatively obscure term like “glass carrier” to $100 (yes, one hundred dollars) per click for terms that are very popular and potentially profitable such as “mesothelioma attorney” (mesothelioma is a cancer linked to asbestos; personal injury lawyers compete aggressively to attract these clients).
Search Ad Price Increases
Market researcher Nielsen/NetRatings reported that the growth of Web search traffic will slow in the coming years. At the same time, search ad spending will continue to grow rapidly.
Increasing demand for search terms, combined with a limited supply of ads and a competitive bid price structure, can only have one result: rising cost of search ads.
Online publisher ZDNet confirmed this recently, reporting that on average, search Ad costs have increased 50% since late 2002. In competitive markets, prices have increased 300-400% in the last 12 months. Given that search advertising is still in its infancy, it’s a safe bet that search ad prices will continue to rise.
Reduced Conversion Rates
What is less obvious but of equal concern is that increased competition also impacts customer conversion rates. As prospects have more and more options from which to choose, they are more likely to browse back and forth, seeing what each advertiser has to offer. For example, when a search results in two sponsored links, each site has a 50% chance of making a sale. But when five or six sponsored links are presented, prospects are more likely to browse back and forth to compare prices, features, etc. The more competitors, the lower the chance of making the sale. So while the advertiser may pay for the same number of clicks, they will see fewer sales. The net result is that while search ads make sense where prices are low and competition is limited, they become less attractive when prices rise and competition increases. A small change in cost and conversion rate can make a search ad unprofitable. Consider the following example: ABC Co sells $30 tools that have a $6 gross margin. When ABC began placing search ads, the cost was $0.40 per click and the conversion rate was 10% (1 in 10 visitors bought a tool). So ABC spent $4.00 (10 x $0.40) to earn $6.00 (1 x $6) for an ROI of 150% ($6 ÷ $4). But as competition increased, Ad costs increased to $0.60 and its conversion rate fell to 8%. ABC now spends $7.20 (12 x $0.60) to make $6.00, resulting in a loss of $1.20 per sale. At $.60 per click, this ad is no longer profitable.
The Need for Proactive Search Ad Management
Because small changes in cost and conversion rates have a dramatic impact on profits, companies must track and measure ROI from search ads. While this may seem obvious, very few companies are able to do it, as it requires technical resources and web marketing expertise that few companies have. Consequently, most continue to spend heavily on search ads, unaware that they are often losing money on unprofitable ads.
Net, net: ROI measurement is a must. If companies know which ads are profitable and which are not, they can boost profits by re-directing ad spending. Early adopters do this today, but they are a very small segment of the market. Over the next 18 months, we believe more and more companies will implement ROI measurement systems. Those that do will continue to reap value from search advertising. Those that don’t will learn a very expensive lesson: you can’t manage what you can’t measure.