ELROI, My Favorite PPC Metric

When practiced intelligently, Internet advertising is driven by numbers. Get the right metrics, make sure they’re accurate, and manage your PPC accounts patiently and wisely, and you can scale some significant heights, in terms of traffic, revenue, and profitability.

Every company in every market is different, of course. Metrics which are readily obtained in one company may be prohibitively difficult to measure in another. And depending on whether your goal is brand awareness, lead generation, or direct sales, different metrics are preeminent.

Introductions

With those disclaimers out of the way, allow me to introduce my favorite metric. It works for most sites that are selling something, as long as they have good metrics and have some way to identify and measure the value of return customers. It is Estimated Lifetime ROI.

You already know that ROI is Return On Investment. I’m not kidding when I say that the first time I thought of calling my favorite metric ELROI was as I was writing this post. Now that I think about it, it could just as easily have been LEROI — and far as I can tell, neither acronym is in use already. Eeny, meeny, miney . . . ELROI.

The concept is simple, even if the calculation often is not: in the long run we want to get more money out of our PPC advertising than we put into it. Cash flow issues — or caution, or the temporary lack of adequate metrics for ELROI — may cause us to focus in immediate ROI, but faster growth is generally possible if we can take a longer view.

Short Term: ROI

The shortest route to today’s destination leads through a brief discussion of simple ROI. Here’s the equation:

ROI = (Gains – Cost) / Cost

Gains are the total revenue from selling our widgets through our PPC ads — we’ll assume we’re an e-commerce company — and Cost is the total cost of our PPC advertising. This includes our PPC ad spend, the fee we pay for PPC management (or salary, benefits, office space, and other expenses for our in-house PPC analyst or team), and any other relevant costs, such as our graphic designer’s fee for making those image ads we use on the display networks.

Here’s a simple, made-up example:

ROI sample

As you see, in November 2014 our revenue was almost $132K, and our total costs were almost $73K. (By the way, a PPC management fee of 20% of ad spend is not unusual — and if the manager is good, she’s likely worth it.) Simple division tells us that the revenue is 80.8% greater than the costs, so the ROI — which I like to call the immediate or up-front ROI — is a tidy 80.8%.

Some notes, and then we’ll move on:

  • Cost calculations can get complex, to the point of including not only the cost of office space and other infrastructure for the people who manage your PPC, if they’re in-house, but also the cost of equipment and personnel to answer calls or other leads generated by PPC. Small companies which need to be making sales while they figure out the finer points of these metrics may wish simply to ballpark some of these things. For example, if we’re confident that the break-even point is somewhere below 140% of ad spend, we can work to keep the ROI at or above 40%, and refine our calculations later.
  • As I’ve defined ROI here, 0% is losing your money with no return; 100% is breaking even; and 200% is getting back twice what you put in. I have seen executives who preferred in their reporting to define the break-even point as 0% (where you get back your investment with zero increase), so 100% would be doubling your investment in paid search. As long we all know which definition of ROI we’re using, either can work.

Before we get all the way to ELROI, I should mention one other very useful metric. This one can be tracked directly in the AdWords web interface.

Return on Ad Spend (ROAS)

The best, most profitable accounts I manage for e-commerce sites are the ones which tell Google AdWords the value of each conversion (sale). How to set that up is a discussion for another day, but the concept is simple.

Look at the numbers in my ROI example. We only need two of them: ad spend and revenue. The ratio of revenue to ad spend in the example is 2.19 to 1, which the AdWords web interface would helpful round to 2.2.

One more example. If our revenue from PPC-induced sales is $200,000 and our ad spend is $40,000, our ROAS is 5.0.

All a client has to do is tell me that his break-even point is an ROAS of 4.0, and I don’t need to know anything about his other costs. I’ll keep his ROAS above that — as much above it as possible — and his PPC advertising will be profitable. I may try to maximize ROAS at a fixed level of conversions (sales), or I may try to maximize conversions (sales) while maintaining a profitable ROAS. That’s a business decision.

If a client has the inventory, infrastructure, and cash flow to allow it, and if there is sufficient unexploited search traffic to allow growth, we begin to see the power of ROAS. If we can keep the ROAS high enough that new sales are profitable, we can pump money into ads indefinitely — and the more we spend at a profitable ROAS, the more profit we will accrue.

That’s when PPC advertising turns into a money machine.

Think about it: If I would give you $5.00 — or even $1.25 — for every dollar you gave me, no matter how many dollars you gave me, wouldn’t you give me every dollar you could?

ELROI is only a slight refinement on ROI and ROAS.

ELROI

If I can come up with a way of measuring the lifetime value of a customer, and if I have enough cash flow, I can run a negative (up-front, immediate) ROI, as long as my Estimated Lifetime ROI is positive.

This possibility exists in at least two places: conventional e-commerce and online subscriptions.

Suppose I offer a subscription service — it doesn’t really matter to what — and I can measure the average number of renewal payments I’ll receive from my customers. I may offer a monthly subscription and an annual subscription. If the average monthly subscriber pays me for 5 months, I may be willing to pay as much as two or three times the monthly subscription price to get that subscriber. If the average annual subscriber is a paid subscriber for 1.8 years, I may be willing to pay somewhat more than the annual price for that subscriber. My ROI up front will be negative, but in the long term I’ll make money. Running a negative initial ROI may allow me to grow much faster in the meantime.

Assuming I measure everything correctly, that is. I’ll want to be taking new measurements often, to refine my estimates and to track changes in the average customer’s lifetime, and therefore also ELROI.

I cultivated ELROI for several years as an in-house Internet marketing manager, selling online genealogy data subscriptions. We had two slightly different products with different pricing, and you could subscribe to them for either a month or a year. The more new subscribers we could pull in with PPC and through other channels, the better, but we also paid careful attention to renewals. Our retention rate wasn’t the Holy Grail, but it got us a long way toward calculating the lifetime value (LTV) of a customer, and that got us most of the way to ELROI.

In that situation, we calculated ELROI separately for monthly and annual subscribers to each product, then combined the results in weighted averages to guide each product’s advertising. We recalculated ELROI regularly, and continually worked to test and refine our calculations.

All this is relatively easy, if all you have is a few subscription products. It’s harder for e-commerce sites with many products. But if they can track the purchases of return customers who first arrived through PPC, similar calculations are possible — and again, a company may be willing to accept negative initial ROI to attract more customers with a positive (estimated) lifetime ROI.

By the way, some people leave off the word “estimated” in situations like this, but I like having it there to remind ourselves — and especially to remind management — that this is an estimate, not a guarantee, and needs to be continually reevaluated.

Let’s Be Crass

Money is why we do this. Making more money is why we attend to ROI, ROAS, and ELROI. Advertisers ignore them at the peril of their pocketbooks.

To recap, if we can estimate the lifetime value of a customer acquired by PPC — whether that’s the sum of the average’s customer’s original subscription price and the average number of renewal payments, or some other measure of initial and returning purchases — and assuming our inventory and infrastructure can support the growth — we can turn PPC advertising into a money machine. The more we pump into it at a positive ELROI, the more we can take out of it.

With the right tracking — which I don’t see as often as I’d like — ELROI can even be used when the task is lead generation. Again, the concept is simple, even if the execution is not. If you can measure the value of customers obtained by PPC leads, among other metrics, you can use ELROI to drive profits.

Posted in Metrics, PPC