Google Lower Cost Per Click Doesn’t Matter

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Google just reported its quarterly earnings. They did very well, beating pretty much every analyst’s numbers. Those who want to nitpick will complain that the price per click has gone down. However, that isn’t really surprising considering that the number of clicks went up. There are some issues coming with Google’s stock, but this isn’t one of them.

Google Cost Per Click Down

Google earnings graphicGoogle’s advertising model is based on advertisers paying either “per click” or “per impression.” Actually, advertisers pay per every thousand impressions, but that isn’t the point. Advertisers who pay using the per click model pay a certain amount each time someone clicks on their ad, but nothing if the ad goes unclicked.

A smart online advertiser using the per click model will determine how much each click is worth. There can be many ways of determining this, and numerous intangibles are considered by some advertisers. However, the most simple concept would be something like this.

Maximum payable cost per click = Amount of revenue generated per click / Number of clicks necessary to generate revenue.

In other words, if you generate $1 per transaction (this is called a conversion) and it takes you 10 clicks to generate one transaction, you can pay no more than 10 cents per click, which break even. You’d have to pay nine cents per click to generate a profit.

Google chooses which ads to display using an algorithm that takes into account several factors including the quality of the ads, how often they are clicked, how often they convert, and so on. However, all other things being equal, the highest paying ad is placed first. Furthermore, each advertiser can set various limits on the way their ad dollars are spent. When an advertiser’s limit is reached, his ads no longer display, regardless of their offering price.

With this in mind, we can see that if the number of clicks go up, the cost per click will go down, assuming all other factors are unchanged.

Here is how it looks.

  • Advertiser A offers 50 cents per click, up to 1,000 clicks per some time period.
  • Advertiser B offers 25 cents per click, up to 1,000 clicks per some time period.

That means that:

  • The CPC will be 50 cents so long as there are 1,000 or less clicks.
  • The CPC will be less than 50 cents if there are more than 1,000 clicks.
  • The more clicks there are beyond 1,000, the further the CPC will drop.

As you can see, if advertisers make no changes to their advertising budgets and limits, the CPC will always drop when the number of clicks increases.

In fact, if the number of clicks and the the CPC increase at the same time, then that is an indicator that advertisers have dramatically increased their ad spending on Google. Because, in order for both the CPC and the number of clicks to increase, the additional CPC must offset the lowering power of an increasing number of clicks.

The other big news out of Google’s earnings today was the so-called stock split being used to shore up the founder’s control of the company. This isn’t really necessary, and we’ll explore why tomorrow.

 

 

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