can be a difficult game. You have to learn how to play it.

You need to create better campaigns and raise your bids in order to get paid search results. This will increase costs.

But, raising your bids will not always result in more clicks. You’ll eventually reach a point when increased bids won’t return much to you.

This is the law that diminishing returns plays. This concept is a factor in managing PPC campaigns.

This article will discuss the law of diminishing return and other factors that make paid search more difficult today. This will allow you to set higher expectations for your PPC performance.

The law of diminishing returns

The law of diminishing return is a principle in economics that states that if an organization invests more in a particular area, its rate of profit will eventually stop rising. This assumes that all other variables are constant.

Additional investment in this area will result is a lower rate of return. After a certain point of expansion, the marginal ROI (return on investment) that applies to additional units is negative.

The total outcome will begin to decline beyond this point. It is still positive but not as high as the maximum.

This principle emphasizes the importance of choosing the right level of investment to maximize overall profit. The “sweet spot”, or the area where marginal ROI changes from negative to positive, is the place where marginal return equals zero.

We observe that every resource is limited. As such, the supply is less responsive to price changes. It eventually doesn’t matter how high the price. The supply will not be greater. This phenomenon is known as the law of diminishing elasticity.

Price elasticity (E) is a measure of how responsive the demand or supply is to changes in price. It is the percentage change in quantity of a service or good that is demanded in response to a price change.

The price elasticity greater than one means that the demand or supply are elastic. This is because a small change in price can lead to a larger change in demand or supply. The demand or supply will be inelastic if the price elasticity is lower than 1.

Why is the CPC so high?

Advertising is subject to the laws of diminishing returns as well as elasticity.

You must be more aggressive and competitive to generate more traffic through PPC. This will allow you to accept higher conversion costs and increase your bids.

However, increasing the cost per click (CPC) leads to smaller and less traffic increases. You will eventually reach a point where there is no way to get more traffic for a particular keyword (i.e. if the ad ranks #1 in all searches with 100% impression shares).

The total budget also includes the law of diminishing returns. As you can see, these costs can change in Google Ads Performance Planner.

Campaigns that do not overinvest or aren’t underinvested will usually have a straightforward relationship. You will need to pay a 10% higher conversion cost and a 10% lower return on your ad spend (ROAS) in order to get 10% more traffic.

Google’s average price elasticity of supply, or the ratio of traffic growth to CPC rise, is therefore 1.

This is why? This operation can lead to a loss of 20% customers and a 10% increase in margin for a vendor. Prices will likely go up.

A 10% margin increase will only cause 5% of customers leave the seller’s store. The previous prices were too low.

The price at which the seller can make the most of a 10% margin increase is the point where the sales volume drops 10%. This is the optimal price. The price elasticity of the demand is 1 to increase sales profits.

Google’s sales margin is almost equal to advertising revenue, as variable costs such as click and impression are negligible.

They should ensure that their price elasticity is 1 in order to maximize their profits. This explains the way the auction algorithm works, and the reason why the market has this regularity.

It is expensive.

PPC is characterised by a non-linear rise in campaign budget.

The market’s elasticity E=1 means that doubling traffic and sales volume will result in doubling CPC. This results in a fourfold increase in budget.

These proportions may be different at other levels of elasticity. It is not realistic to assume that double the budget will result in double sales in a channel.

These expectations are often reflected in marketing and business plans, which then fail. Expansion can be costly and even more painful.

Google and Meta are here for business

The marginal cost per click, or CPC _m, is almost always more expensive than the actual CPC. By definition:

The elasticity is also defined as:

Therefore:

This means that buying clicks more than once at E=1 is twice as expensive as the current cost per click. These same calculations are applicable to Effective Revenue Share (ERS = Cost/Revenue).

Advertising is a profitable investment for advertisers as long as their marginal cost is less than their profit margin. Advertisers get more profit from advertising.

Advertising costs will consume all revenue when the marginal effective revenue share exceeds ERS =1 Additionally, expansion will result in a decrease of marginal revenue and a reduction in total revenue. The campaign will generate maximum total profit when it:

This is:

This formula is ROAS = 1.ERS = ROI + 1. It can also be written ROAS = 1 + 0.1/E or ROI = 1-1/E.

One simple formula can help you determine the optimal level and areas for under- and overinvestment.

E = 1, the typical market elasticity, means that advertising can generate maximum profits when ROI = 100% and ERS = 0.

This means that advertisers spend on average 50% of their profits on PPC ads, without considering fixed costs.

Advertisers who advertise more aggressively than others may have a higher elasticity than E=1. Advertiser profits that maximize ERS/ROAS/ROI will therefore be higher or lower.

For every $1 invested in Google search, U.S. companies earn $2. Google sees it this way, but it also means companies will give half of their profits to tech giants.

It’s impossible to ignore it

Businesses are in a position where Google, Meta and other advertising platforms can get half of their sales margins before fixed costs because of the laws and economics.

These are the rules of advertising, regardless of whether we like them or not. It is easier to understand the system and create realistic expansion plans.

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