I used to do consulting work in the past, and most of my clients had trouble understanding the mathematics behind Internet advertising models. I figured it could be useful to explain some of the basic formulas around.
Calculating The CPM
CPM stands for cost-per-mille. Mille is the latin word for thousand, so CPM means cost per thousand. In this case we are talking about thousands of impressions on a website (also called page views). This is one of the most used metrics on the web. Under this model you’ll have an advertiser who is willing to play a certain price for each lot of one thousand impressions his banner will get on the publisher’s website. CPM numbers vary from $0.1 up to $20 or more, depending on the size of the banner, placement, authority of the website displaying the banner and so on.
Basic formula: Let’s suppose that you created an account with an ad network that offers a $3 CPM for 300×250 banners displayed above the fold. If you put that banner on your site, and it generates 120,000 page views during that month, the ad network will pay you $3 x 120,000 / 1,000.
We must divide the total number of impressions by 1,000 because the CPM puts a price on lots of thousand impressions. So we are basically doing $3 x 120, which is equal to $360.
Reversing the formula: It is also useful to be able to reverse that formula. Let’s suppose that you sell 125×125 banners on your sidebar, and that you charge a flat fee of $150 monthly for each. Your blog generates 200,000 impressions monthly. Then one day a potential advertiser asks what CPM your advertising spots cost more or less. What would you reply?
It is simple, just remember that CPM stands for “cost-per-mille” (or “cost-per-thousand”), so you need to divide the cost ($150) by the number of thousand impressions you get (200). That would be $150 divided by 200, so the effective CPM on your 125×125 banners would be $0.75.
Calculating the CPC
CPC stands for cost-per-click. This is another very popular advertising model around the web, especially because that is what Google uses on its AdWords/AdSense platform. Under this model the advertiser will pay a certain amount for each click he will receive from the publisher (or from search portals). The actual cost per click can vary from $0.01 up to $50 or more, depending on the keyword in question, the niche, and on where the click is coming from.
The basic formula: Calculating how much you should get as a publisher is very easy.
If the average CPC you are getting on your website is $0.09, and you generate 1,300 clicks per month, you’ll be making $0.09 x 1,300 monthly, which is equal to $117.
Reversing the formula: Reversing the CPC formula is almost as simple. Again let’s suppose that you sell banners directly on your website. The 728×90 leaderboard on the header costs $1,000, and usually that banner spot gets 3,700 clicks per month. One day an advertiser asks you the average CPC of your 728×90 banner. What would you tell him?
Again, remember it is “cost-per-click.” You’ll just need to divide the cost ($1,000) by the average number of clicks (3,700). That would be $1,000 divided by 3,700, so the average CPC on that spot is $0.27.
Notice that calculating the numbers for advertising models such as CPA (cost-per-action), CPL (cost-per-lead) and CPS (cost-per-sale) is pretty much the same thing. You’ll just need to substitute the number of clicks by the number of actions, leads or sales.
Calculating the Conversion Rate
Conversion rate is another very important metric, because it is directly related with the bottom line. It basically tells you what percentage of the people clicking through an ad ended up taking the desired action (which could be to purchase the product, or simply to sign-up for a newsletter). You can also track the conversion rate of a landing page, disregarding the source of the visitors. In other words, what percentage of the people visiting that page are taking the desired action there?
The basic formula: Calculating the conversion rate is not difficult. You just need to divide the number of people who took the desired action by the total number of people who clicked on the ad.
For example, let’s suppose that your purchased 1,000 clicks on Google AdWords, and out of those 35 people ended up purchasing your ebook. Your conversion rate on that campaign was 35 divided by 1,000, which is 0.035. After that we need to multiply the result by 100 to find the percentage. So 0.035 x 100 equals 3,5%.
Reversing the formula: Reversing the conversion rate formula is particular useful for people who sell products online or for affiliate markets. Let’s suppose that you sell an ebook for $17, and that you want to drive traffic to your sales page using Google AdWords. How much should you pay for each click, however? The answer to that is what I call “the average value per visitor.”
You’ll basically need to multiply the conversion rate by the price of your book. Let’s suppose your conversion rate is 4%. So 4 / 100 equals 0.04, times $17 it is equal to $0.68. This is your average value per visitor. If you pay $0.68 per click, therefore, you’ll break even. If you manage to pay less than that, you’ll make a profit.
For example, if you managed to purchase 2,000 clicks for $0.50 you’ll make a profit of 2,000 x $0.18, which equals to $360. $0.18 is the difference between the average value per visitor on your site ($0.68) and the price you are paying to get each visitor there ($0.50).
Another way to calculate the profits is by finding out the total revenues and total costs. Since your conversion rate is 4%, out of the 2,000 clicks you bought 80 people ended up purchasing your ebook. So total revenues equal to 80 times $17, or $1,360. Now total costs were 2,000 clicks times $0.50 per click, which is equal to $1,000. Finally, if we subtract costs from revenues we get $1,360 minus $1,000, so profits equal to $360.
Making these calculations if you are an affiliate marketer instead of a product seller is exactly the same thing. You’ll just need to change the price of the product with the commission you get per sale. The interesting thing here is that affiliate networks will tell you the average conversion rate for each product, so you start with all the numbers on your hand.
Let’s suppose that a particular affiliate offer converts at 7%. The cost for that product is $39, and your commission is 20% per sale. This means that on each sale you deliver to the merchant you’ll get paid $7.8 ($39 x 0.2) by the affiliate network. With this numbers you already know how much you can spend per click that you’ll send to the product sales page. That is the conversion rate multiplied by your commission, so 0.07 x $7.8, which is equal to $0.54. As long as you can send visitors there for less than $0.54, therefore, you’ll be making a profit on that campaign.
Obviously conversion rates may vary with different traffic sources, time of the day and the like, so the formula is not perfect. Despite that, it is the best framework you have to take an analytical approach to Internet advertising.