How Google AdWords Works [Infographic]

Google AdWords

In this AdWords auction market, advertisers compete to show their ads to potential customers. If you’re following so far, you should wonder: “So if it’s like an auction, the sale goes to the highest bidder, right?” Not so fast. This is where AdWords really sets itself apart: How often an ad shows, its position on the page, and how much the ad costs all depend on two factors: the advertiser’s bid AND the projected quality of the ads.

Google.com is the most used internet tool and website in the history of ever! “Googling” did not become a universal verb because Google sold search results to the highest bidder. Google became Google because they show people exactly what they want to see: quality results that answer questions with reliable information, up-to-date resources, and a wide variety of websites. Google will not jeopardize their core user base by providing a bad experience, so it incentivizes quality ads by essentially giving a discount to the best ads in the form of a quality score.

If your ads are crap (low-quality score), you have to pay a lot more (super high bids) to Google for them to make it worthwhile to show the ad to their users.

Okay, let’s break this down one step at a time.

Whenever someone Googles something, Google’s algorithm checks to see if advertisers are bidding on the major keywords of that search query.

Google starts an auction if the keywords are relevant and identifies which advertisers qualify for the auction. If you thought auctioneers move their lips fast, just wait. In just a fraction of a second, Google takes all the qualifying ads and their respective bids to instantly determine which ads show and in what order on the search engine results page (SERP).

What Ads Qualify for the Auction?

Advertisers identify groups of keywords to bid on for every ad they create. Google uses that to determine which one is the single most relevant keyword to enter the auction. Ads that have poor relevancy, are unapproved, or irrelevant to the query (like targeting a different country), are not shown.

How Are Ads Ranked?

When partaking in the auction process, Google determines your rank by using this formula:

AD RANK = MAX CPC BID x QUALITY SCORE

Max CPC Bid: When creating an ad, advertisers bid on specific keywords by indicating the maximum amount they’re willing to pay in order for the ad to show.

Quality Score: Google’s 1-10 rating of the quality and relevance of your keywords and search ads, determined by these factors:

  • Google’s Expected Click Through Rate (CTR)
  • Historical AdWords Performance
  • The Quality and Relevance of Your Keywords
  • The Quality and Relevance of Your Landing Page
  • The Quality and Relevance of Your Ad TextThe auction system is set up so that advertisers only need to bid 1 cent higher than the advertiser below them. However, advertisers with a lower bid can rank higher than a higher bidder if they have an ad that has a higher quality score.

If you look at the chart above, “XYZ” brands bid $1 more than PPC Agency, but ranked lower because their quality score was 2 points lower.

Moral of the story: The more time you spend on optimizing your ad and your landing pages, the more money you’ll save!

How Much Do Ads Cost?

As we mentioned before, the auction system is set up so that you pay the minimum amount to retain your ad position, because you only have to pay 1 cent more than the ad placed under you. This is determined by this formula:

ACTUAL COST PER CLICK (CPC) = AD RANK OF AD BELOW YOU / YOUR QUALITY SCORE + $0.01

Let’s revisit the chart above.

As you can see, fighting for a higher rank fancies the opportunity to save money on your ads. However, it’s important to note that highly competitive keywords effectively increase the overall cost of the keyword for everybody competing for it.

How much should I pay for a click?

We will expand on this in future articles, but it is important to take a step back from the formulas and think about the basic question: how much am I willing to pay for a click? This is the fundamental question for AdWords success.

Let’s walk through a 1-minute exercise to help you determine your optimal CPC.

First, take the product or service you are trying to sell. What is the price?

Then, understand the cost to produce, ship and sell that product. What are your costs?

Subtracting costs from price gives you your Profit or Profit margin! This is how much money you make from a sale.

Now that we have that profit margin number, we can work backwards to determine how much you should bid for someone to click on your ad.

If you know the conversion rate of your website, you can figure out how many clicks you need to generate one sale.

Let’s use an example of a $150 pair of headphones that cost $50 to make. Your profit on each headphone sale is $100. If you know that 5% of people who make it to your website buy a pair of headphones (a 5% conversion rate), you make one sale for every 20 people. If you’re using ads to get those people to your site, you need 20 clicks to generate 1 sale worth $100 to your business. If you divide $100 by 20, you get $5. This is the maximum amount of money you should pay for a click if you want to run a break-even advertising campaign. This is your maximum cost per click that you are willing to pay. In other words, this is the highest you should set your bids for an advertisement for your headphones.

If our headphone business can generate a CPC below $5, you’re making money off your ads.

The next step is maximizing the amount of money you make from AdWords ads. Using this example, what if we found an audience online or set of keywords that not only cost $0.50 per click, but also convert 50% of the time because your headphone were EXACTLY what they were looking for. 20 clicks at a $5.00 CPC costs you $100 in AdWords spend which cancels out the profit margin of a single headphone sale. 20 clicks at a $0.50 CPC with our 50% conversion rate costs $10 in AdWords spend, which equals 10 sales (conversions) resulting in $990 profit for your headphone business. Tweaking (or “optimizing”) that audience took your business from break-even, to $990 in the green from just $10 spent on AdWords.

There are victories like this big and small everywhere in AdWords, and that’s what this blog and AdHawk are for: giving you the tools and know-how to find and tackle these opportunities.


Bidding You Farewell

So that’s how the auction system works. If you have any questions, don’t hesitate to email us hello@etrend.com or call us at (800) 420-1053.

I’d be more than happy to answer any questions you have! Until next time.