One of the most common questions regarding PPC advertising is how much you should be paying for a click.

To calculate the maximum click costs you first need to know how much a customer is worth to you. Now there are two main calculations to look at:

• Long term or Lifetime Value
• Initial sale value

Lifetime Customer Calculation

This is simply the profit per customer over the period of the relationship which can be years or days. For example I have had a bank account with the same bank for over 30 years and it is likely that I will have one with the same bank for many more years.

Of course not all relationships last that long and in many instances it is very difficult to measure. See Wikipedia for the criteria.

However that aside most existing businesses can come up with an acceptable conservative current estimate. Lets take for example a DVD membership rental site.

Assume that the membership costs are £10 per month (profit is £5) and the average membership lasts 20 months. With a profit of £5 per month/customer (excluding acquisition costs) then the average customer is worth 5*20= £100.

Assuming that we are happy to make 40% or £40 per customer then we can afford to spend £60 in acquiring them (100-40).

 Now lets assume that we have a conversion rate of 5% meaning that for every 100 visits to our sales page we get 5 new customers.

This means that we get 1 customer per 20 clicks.

This customer can cost £60 to acquire hence we can afford to pay. 60/20 or £3 per click and still make a profit. Lets do the calculations based on the above:

Costs 100 clicks *£3 = £300 advertising costs Profit 5 customers * £100 = £500 profit before advertising actual profit =£500-£300= £200

So although the Initial figure of £3 per click may seem expensive at first it still results in a %40 profit.

Initial Sale

Were there is little chance of follow up sales then all the profit has to be made on the initial sale. Lets assume that the product sells for £100 and £50 is profit (excluding advertising/acquisition costs).

This means that a new customer is worth £50. Assuming that we want to make £20 per customer after acquisition costs then we can afford to spend £30 acquiring each one.

Again using our 5% conversion rate. 100 clicks give 5 sales so 20 clicks give 1 sale.
This one sale can cost £30 and so each click can cost £30/20= £1.50 Lets do the calculations based on the above:

Costs 100 clicks *£1.5 = £150 advertising costs Profit 5 customers * £50 = £250 profit before advertising actual profit =£250-£150= £100

So although the Initial figure of £1.5 per click may seem expensive at first it still results in a %40 profit.

Caution It Could Change

The above calculations have been simplified but are valid.

 However you should be aware of the danger variable and complete unknown.

That is the conversion rate otherwise everything else we know with reasonable accuracy.The conversion rate can vary considerably and can be disastrous when it does.

Let’s redo the last calculation with a conversion rate of 1%

Costs 100 clicks *£1.5 = £150 advertising costs Profit 1 customers * £50 = £50 profit before advertising actual profit =£50-£150= Minus £100

Now we are losing money, so to make this work we would need to reduce our average click costs or increase our conversion rate.

Related Articles:

• Google Adwords Guide
• Keywords For PPC Campaigns