How Much Should You Pay For A Click?

May 14, 2006
By Robbin Steif

Recently, someone wrote me and explained that he was launching a new site, and all the advertisers that he was interested in using (except Google) had pay per impression plans. Old fashion advertising, you might call it. That’s the way magazines charge for their ads, and they audit their circulation to prove that they are faithful to their rates.

He did a comparison of pay per impression to pay per click, and then wrote me back:

Let’s say I pay $25 per 1,000 impressions. If spend $500K, I should get 20 million impressions. If I get 4% click through, that is 800,000 users on my site that I may or may not convert to purchasers. If I pay $1.5 per click, I get 333,333 users that may or may not convert. Now, I believe all number to be within the industry standards but as you can see, pay per click looks terrible unattractive. What am I missing?

Since he kept the 4% click through the same for both scenarios, it’s not worth quibbling over what the actual CTR will be (and I mislaid my crystal ball, anyway.) The real issue, I wrote in my reply, was that he was paying too much for the click. At $.625 for a click, the two models are financial identical. (So, I suggested a few ways to decrease his cost per click.)

This leads right into the question, how much do you pay for a click? It’s an easy calculation, but to do it well, you need to understand your profitability, your average order size, and your conversion rate.

Let’s say your widget sells for $100 and has a gross margin of 45%. (I use the word “widget” loosely – you can use this for a service too. Or, scale it up by adding zeros and use the same equations to value PPC bids for your million dollar enterprise software license.) 1.5% of all visits to the site turn into customers, and they purchase, on average, 1.2 widgets when they convert (so the average order size is 1.2*$100 = $120)

To figure your maximum price per click:

Average Order Size x Gross Margin x Conversion Rate = Maximum Price/Click
$120 x 45% x 1.5% = $.81

Explanation: Average order size times gross margin percentage gives you the average gross margin per customer. When you multiply that by the conversion rate, you now have average gross margin per visitor (instead of, per customer). When your average gross margin per visitor is the same as the amount you are paying for each click, you break even. But just.

Robbin Steif
LunaMetrics