The Economics of Online Marketing

From this article, you’ll learn how to determine the efficiency of your online advertising efforts and how to calculate the maximum cost per click for those campaigns.

The basic economics of online marketing are simple: Determine the advertising efficiency needed to make your profitability goals, then buy all the inventory you can get your hands on.

But how do you determine the advertising efficiency needed to achieve your profitability goals? This article offers some practical formulas and advice.

Defining Online Advertising Efficiency

Ad efficiency comes down to a cost vs. benefit ratio: “What did I spend on advertising?” vs. “What did I get in return?”

The “What did I spend on advertising?” side of the equation is straightforward. The ad venue sends invoices; your accounting department tallies the funds you paid during a period.

But make sure the cost figures you use to compute efficiency match actual invoices paid. Some agencies and advertisers estimate costs via their own in-house click counts and average cost-per-click (CPC). These click and CPC estimates can differ from the authoritative costs provided by the search venue. Conduct occasional audits to ensure that the cost side of your online reports ties to your online ad bills.

The “What did I get in return?” side of the equation is more complex. Most marketers seek profit as their ultimate online marketing goal. Yet accurate profit numbers may be too hard to obtain or may be generated too far in the future. When this is the case, employ meaningful proxies such as cost per lead, cost per registration, cost per order, cost per new buyer, advertising-to-sales ratio, and margin-to-cost ratio as surrogates for actual profit.

Establish an A/S Target

Let’s continue using the advertising-to-sales ratio (A/S) as our profit surrogate. What’s the right A/S efficiency for your online business? Rule of thumb: Catalogers typically spend 80 percent of sales on cost of goods and marketing combined. The profit and loss statement logic here is that if marketing and cost of goods sold consumes 80 percent of sales, and variable selling expense and overhead each consume another 7 percent or 8 percent, then about 5 percent is left as pretax profit.