Why you should Never Cap your Adwords Budget

Most businesses using Google Adwords for their website will set a daily maximum budget for their PPC campaigns. Intuitively, this seems to make sense. Setting a daily budget ensures that you don’t exceed your desired level of spending and helps to keep your costs under control. In practice, however, setting a daily budget may be reducing the growth of your business or covering up a key flaw in your marketing strategy.

What is your Cost per Acquisition?
One of the most important pieces of information you need to know when planning any marketing strategy is your Cost per Acquisition. This is the amount of money it costs you to gain each new sale.

Example:
Let’s imagine that your Adwords campaign has been running for six months.

In that time, you received 2,000 clicks on your ads costing you a total of £3,700 (£1.85 per click).

Let’s imagine that those 2,000 clicks resulted in 50 sales which means that your conversion rate is 2.5% (2,000 clicks divided by 50 sales).

If we now divide the £3,700 that you have spent on the campaign so far by the number of sales it has generated, your cost per acquisition is £74 (£3,700 divided by 50). In other words, you are spending £74 on Adwords to produce each new sale from your website.

Now let’s assume that you are making an average of £120 profit from each new customer that this campaign generates. That leaves you a net profit of £46 (£120 minus £74) for each new customer you acquired from Adwords.

In reality, the figure may not be quite as simple as this to calculate for a number of reasons:

• Some of your customers may make repeat purchases without clicking on more of your ads.
• Some of these sales may later be refunded.
• Some of your customers may not make a purchase until several weeks or months after they first clicked on your ad.

Taking these factors into account you can then calculate a reasonable approximation of your Cost per Acquisition.

What is your Customer Lifetime Value?
By doing some simple analysis of your sales records you should be able to calculate your average Customer Lifetime Value (CLV). This will give you an understanding of how much each new customer is worth to your business over the course of your business relationship.
For example, several of the people who contact me to book a training course may go on to hire me for consultancy work or to perform an audit of their website. That means that the average Customer Lifetime Value of my clients is higher than the initial profit I make from the training course.

Once I know the true Customer Lifetime Value for my clients I can then calculate the maximum amount that I am able to spend to gain each new customer.

Cap your keyword bids, not your budget

When you cap your daily budget on Adwords you are effectively telling Google to stop showing your ads once they have reached your daily maximum.

This could mean that there are several prospects out there, searching for your products or services who would have clicked on your ad but didn’t have the opportunity to do so because you stopped your ads from showing.

Instead of setting an arbitrary budget for your campaign, you should instead be setting your keyword bids so that your Cost per Acquisition is below your Customer Lifetime Value.

As long as your Cost per Acquisition is comfortably below your Customer Lifetime Value it makes little sense to cap your daily spend. You are literally giving away your profit to your competitors.

Why do so many businesses cap their Adwords budget?
If you know that for every £100 you spend on Adwords you make a profit of £120, why would you want to cap this?

Businesses cap their Adwords budget for one or more of the following reasons:

a) They are mistakenly focused on their daily/monthly spend instead of their Cost per Acquisition.

b) They have never bothered to calculate their Cost per Acquisition or Customer Lifetime Value and so have no real idea whether or not their campaign is profitable.

c) Their business suffers from cash flow issues which means that the money is coming in slower than it goes out. 

d) The business has a limited capacity to produce the product or service. (There is little point paying to gain new customers if you can’t fulfil their orders).

If your customers pay you before you have to pay your suppliers and there is nothing restricting the supply of your product or service, your Adwords budget should be set at a level that is never likely to be reached in any single day.

I see many small businesses trying out Adwords after they struggled to get their website ranking in the organic Google results. When they don’t see the results they hoped for, they will then either stop the campaign running completely or apply some arbitrary daily cap on their campaign without ever really understanding how to use the platform to get the most for their business.

Conclusion

I do not work for Google and have no incentive to encourage you to spend more money on PPC advertising.

In many industries, you might be faced with a choice of bidding on high-volume, expensive keywords or affordable keywords that offer little or no search volume. 

All I am proposing is that if you do have keywords in your campaign producing conversions at an affordable level, it makes little sense to prevent these ads from showing just because your budget is set at the wrong level.

Addendum

I have received a few comments on Twitter from people telling me that this advice is not applicable to small businesses. I assume their argument is that a small business couldn’t afford to run a campaign with an unlimited budget. In most cases, I would completely disagree.

If your keyword bids are set at a level that makes your campaign profitable, your campaign will be automatically limited by the inventory of clicks available at your maximum bid.

Unless there are other factors limiting the growth of your business (as discussed above), why would you want to cap the number of new profitable customers visiting your site?

If I offered you a deal in which you received a  £1.50 guaranteed in return for every £1.00 you gave to me, why would not want to give me as much money as you had available?

Recommended steps:
1) Check your Adwords campaign to see whether your daily budget is preventing your ads from showing.

2) If it is, calculate your Cost per Acquisition by dividing your total Adwords spend in the last month or quarter by the number of conversions it has generated. (If you have not set up conversion tracking on your Adwords account, pause your campaign until this has been done)

3) Calculate your Customer Lifetime Value (see the infographic below for guidance).

4) Adjust your keyword bids to ensure that your Cost per Acquisition is lower than your Customer Lifetime Value.

5) Increase your Adwords budget to a level sufficient to show your ads to the maximum number of prospects per day.

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