Google AdWords is quite plainly, the most effective and popular advertising platform ever created. It accounts for the bulk of Google’s earnings, and it operates on principles that resemble both auctions and stock exchanges

 

Google is a Stock Exchange …

In Google AdWords ecosystem advertisers bid for search-terms much like investors bid for stocks in an exchange, and just as a stock’s price is driven by investors’ demand, so demand by advertisers for a specific search term, will push up it’s cost-per-click (CPC).

 

… And it isn’t

A primary difference between Google AdWords and any stock exchange is that whereas the stock exchange serves to regulate trading on offers made by others, Google is both the regulator and the exclusive offer in the market. Clearly that’s a very lucrative position to be in…

 

The Lingo

Before we jump into how it all works, it’s best we clarify a few of the terms used:

 

Click-Through-Rate (CTR)

The percentage of the audience who clicked on your ad, out of the total audience exposed to it. CTR = (# of people who clicked the ad / # of people who were exposed to the ad) * 100

 

Ad Position

The position your ad will be displayed on Google’s Search Engine Results Page (SERP).

 

Quality Score

A scoring system that reflects expected CTR, Ad & Keywords relevance, and the experience on the target landing page.

 

Ad Rank

This value determines your ad’s position.

Google determines Ad Rank by multiplying your Quality Score by your CPC bid for the search-term.

Ad Rank = Quality Score * Bid Price

 

 

How Cost Per Click is Calculated

With the basics now clear, it’s time to explain how the actual Cost Per Click you’ll pay, is calculated:

Actual CPC price = (the Ad Rank of the bidder below you / your Quality Score) + $0.01.

Confused?

Here are a few examples, to make things clearer:

VIMI Are You Selling Enough

There are many discussions on the web (many tedious and tiring), about the factors that determine actual CPC rate – classic questions are “How can Google calculate ‘expected CTR’ for my campaign, before I launched it?” or “How exactly does Google measure a landing page’s relevance?” and plenty more.

After running a fair amount of campaigns, and managing budgets that ran into millions of dollars a month my feeling is that Google isn’t fundamentally different from any other business – It puts out the red carpet for VIP clients and embraces big spenders.

 

A parting insight About Google AdWords

My experience has been that the more you spend, the higher your score rank is, and the higher the score rank, the higher the CTR. A higher CTR leads to better ad position and a better ad position yields higher CTR. Higher CTR gives a better quality score. Better quality score yields a lower actual CPC, and so on… What a loop eh?