Jakob Nielsen And The Search Engines

January 30, 2006

Jakob Nielsen is one of the big online usability experts. So I was surprised to read in his blog about pay per click extracting all the profits from a website. First, it seemed out of place and second — I think he’s wrong.

If you don’t want to click through to his blog, here are the basics. Companies pay up to the maximum that their margins permit for pay per click advertising. So, for example, if the product costs $100, the margin is 50%, and 2% of the people who click the ad make the purchase, the vendor can pay $1 per click — 100 clicks = $100, and he will have sold to two people, 2*$50=100. So he makes nothing and loses nothing. (So far, so good, but let’s remember that that is the most the vendor should pay — not the most that he actually does.)

Nielsen then goes on to say that, while you may increase your conversion rate and be able to make some money on the sale, your competition will get better too, ultimately driving up your price per keyword to the exact amount of your margin. He exhorts the audience to rely on alternative methods of driving traffic (and feels that organic search is not to be relied upon, since the engines can and do change the algorithms at any time.)

I was really shocked to read this. The notion that the bidding strategy on a PPC engine is perfect, i.e. your competition will force you up to exactly the price that pulls all the profit out of the sale, is as outdated as the idea that a company sells for a perfect price (the net present value of its future earnings.) Markets aren’t perfect and neither is competition.

Furthermore, Nielsen ignores the lifetime value of a customer. (Catalog companies pay way more than the expected marginal profit because they earn it back later.) If you are sitting there saying, “What lifetime value?” (online buyers are notoriously fickle), you should read this post I wrote last week about the loyalty program Travelocity created to create lifetime value (as heard at shop.org).