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How does online advertising ACTUALLY work ?

May 3rd, 2019

How do you, the business owner, actually make money, in what seems like a crowded atmosphere of ads, ads, ADS ?

The Four Percent Rule

The very first thing you need to know is the four percent rule:

Simply put: Roughly 4% of the viewers who see a well designed and well targeted ad will convert to a “customer”. But wait: In the days of newspaper and television ads, that was where this ad ended: Their purpose was to show you a product or service and ask for a direct sale, then or there, whether you called it in or went to the store (if a customer goes to the effort of remembering the ad and getting up to visit a physical store, the likelihood of an actual sale is very high) – In modern advertising, the most common goal of ads is to first get you to visit the vendors’ website, where that 4% rule applies yet again:

So: If a website containing your ads receives, say, 10,000 unique visitors per month and your ad is well designed and well targeted to those visitors AND is seen by all of them; you can expect roughly 4% of them, or 400 people to “click through” to your website.

Once they get to your website, that same percentage holds true: Of those 400 people, if your site is well designed (the targeting should be assumed, since you are attracting people specifically interested in your wares), you should be able to convert roughly 4%, or 16 people into new sales.

Should your profit per sale dictate your monthly ad budget ?

As with many things in life, the quick answer is “it depends”:

It depends if the nature of your business tends to be non-repeating, one-off sales; i.e.: A sale to a customer that you rarely expect to see again, or if you are hoping for repeat sales (which, obviously, is always more profitable) – It changes again when what you are selling has a subscription or repeating invoice component.
Keep reading for actual profit dollar examples and suggestions for your spend.

Let us use three examples of businesses running online ads and what they should expect to spend and make:

  • Company A, who sells bouncy rubber balls
  • Company B, who sells boxes of garbage bags
  • Company C, who sells monthly subscriptions for Internet service (an ISP)

For the sake of simplicity: Each company sale is ten dollars:

  • A bouncy rubber ball is $10
  • A bag of garbage bags is $10
  • A subscription to an ISP $10

Let us assume, as well, that in each case, they are looking at advertising on a website that receives 10,000 unique visitors per month (More on those visitors, later: And it is equally important!)

Again, for the sake of simplicity for comparison: We will assume a profit of $5 per sale (you can plug your own numbers into this, for personalized understanding)

Using the 4% rule, above, and assuming the ads are well designed and targets AND each companies’ website is equally well designed, we could assume 16 sales per month (4% of 10,000 and 4% of 400):

Company A, who sells bouncy rubber balls, can fairly expect most of their sales to be one-offs: Repeat customers, while not impossible, are uncommon: Their profit per month, from their advertising is $5 x 16, or $80 per month or $960 for the entire year.

Company B, who sells garbage bags, sees the same numbers per month, except, they have and desire a repeat customer effect – People need garbage bags on a regular basis. While repeat customer rates vary from industry to industry and depend on a number of factors (is the product any good ? Is the price fair ? Does the store provide good service ? ) a “good” or average number is around 30%. This makes those ad numbers and profits a little different. In one year:

Month

New Customers

Return customers

Total customers

Monthly profit

Total profit to date

1 16

16 $80 $80
2 16 5 21 $105 $185
3 16 10 26 $130 $315
4 16 15 31 $155 $470
5 16 20 36 $180 $650
6 16 25 41 $205 $855
7 16 30 46 $230 $1,085
8 16 35 51 $255 $1,340
9 16 40 66 $280 $1,620
10 16 45 71 $305 $1,925
11 16 50 76 $330 $2,255
12 16 55 81 $355 $2,610

The ad for the garbage bag company, with an expected 30% return customer rate, generates a growing profit each month, from the steadily growing customer base and a first-year profit of $2,610. In truly long-term planning, that profit value carries forward into the next year’s calculations, because in the first month of the second year, those initial 81 returning customers would not have been customers in the first place, if it had not been for the advertising in the year before.

In Company C, the ISP, selling a monthly subscription, the sales and profit look like this:

Month New Customers Total customers Monthly profit Total profit to date
1 16 16 $80 $80
2 16 32 $160 $240
3 16 48 $240 $560
4 16 80 $320 $880
5 16 96 $400 $1,280
6 16 112 $480 $1,760
7 16 128 $560 $2,320
8 16 144 $640 $2,960
9 16 160 $720 $3,680
10 16 176 $800 $4,480
11 16 192 $880 $5,360
12 16 208 $960 $6,320

The ad for the ISP generates an accumulating $80 per month in profit, for a first year, year-end profit of $6,320. With monthly subscription services, there is an attrition rate, but that varies so widely per industry, it is hard to come up with a business-wide average: You should know yours and be able to adjust accordingly.
(For the record: I happen to know that the average independent ISP profit per line, per month is actually closer to $2 - $5 per customer, per month, for basic services: The above is simply to fit with the example)

So: Now we have three yearly profit totals, which should give us an idea on the affordability of our advertising budget:

  • Company A is $960 per year
  • Company B is $2,610 per year
  • Company C is $6,320 per year

Company A is the easiest to calculate: Anything over $80 per month in advertising will result in a net loss of money; Obviously: They need to diversify their products and services, because finding a website willing to expose their ads to 10,000 people per month for $840 for the whole year (to allow for a $10/month profit) is nigh impossible.

Company B is looking at $217.50 per month in available profit to dedicate to advertising: Using this rate, for the first year, their actual profit will be neutral, since it is eaten up by the advertising, but the following year will double, then increase each year. Of course, the option to advertise for less than $217.50 per month exists, in order to allow for some profit throughout the year. As with anything: Lower expenditure = lower exposure, which means the new customer rate may be lower, as well: Long term planning always ends up in higher returns, in advertising.

Company C has the highest option for advertising out of the three: $526.67 per month to be revenue neutral in the first year, with 208 new customers in the first year and the profit increasing substantially the following year.

In ALL cases, above, one of the other benefits of acquiring new customers from advertising is not just to sell them what was displayed in your ad, but to expose them to additional products and services you offer – the upsell. This is true not just at the point of sale, but over the course of your relationship: As they discover that you sell or provide quality products and service, so grows their trust in you and likelihood to purchase additionally from you, further increasing the profit per customer – and, again: All of this became possible from that very first ten dollar sale that was because they saw and responded to your ad.

Targeting your ads

“Great!” says you, “I’m going to go spend five hundred a month on new advertising!”

Hold on: It is critically important to point out that the four percent rule applies to a well designed and well targeted advertisement. I will not get into the design of an ad, because that is not my area of expertise, except to say that the imagery and wording used must be applicable to BOTH your product and your target customer: An ad with a scantily clad woman and blaring, hard-rock music will most likely not resound well if you are selling walkers to senior citizens, for example.

We used the 10,000 unique visitors as our example, above and we will stick with that number:
What is important to know, first is this: WHY are those 10,000 visitors at the site on which you wish your ad to appear ?

Is it a website for customizing hot-rod muscle cars ? Then your ad for gardening tools will not do so well.

It is a website for cooking and baking tips ? Then your ad for torque wrenches will not do so well.

These are two specialized websites, or, in other words: Their audience is highly targeted: This means that your torque wrench ad will do quite well on the hot-rod site: Their audience is, after all, exactly who would likely buy your product – Just as the baking tips website is the exact audience to show your cookie tray ad to.

But what about a general audience website like, say, a local newspapers’ online portal ?
Suddenly, those 10,000 unique visitors are no where near who is going to either see or be interested in your ad: This is where you, the advertiser, MUST be discerning in asking for detailed traffic numbers:

If your ad is selling athletic support gear, you do not want your ad in the gardening tips or social section of the website: Your 4% will go down to 0.4% or even lower. You DO want your ad to go into the sports section of the website, but you now need to know this:

Out of your 10,000 unique visitors: How many of them visit the sports section ? (The site owner DOES have this information: All webservers can provide it) – If it is only 1,000 out of 10,000: That changes not only the raw numbers of how many people you can expect to respond, but also the price you can expect to pay for your ad.

This article is already quite long, so I will leave the next logical lessons to another time: The demographics of the site audience (what are their ages ? Occupations ? Incomes ?), as well as ad placement and type (Tower banner ? Box ads ? Animated or not ? Pop ups (NO!!!)and so on)

A comment on the 4% rule

I will not pretend to be the person who came up with this guideline, or even the first to notice it, because that would not be true. I have been in the advertising and marketing industry for about twenty five years, now: The four percent conversion rule held true a quarter century ago, as it still does, today: It generally holds true whether you are talking about print, radio, television or Internet ads. It holds true if you are handing out flyers or speaking to individuals, one-on-one, on a street corner.

The four percent rule also provides a VERY useful guideline to your advertisments: If you are seeing 4% conversion: Your campaign is running well - the average, expected amount. If it is below 4%, there are issues with your ad run and they need to be looked at and addressed. If you are running higher than four percent: Your campaign is excellent: Take note of what you did and try to replicate and continue it!

If someone tells you that this is not true, that they see a 30% or 70% conversion rate on their ads: One of two things is true:

  1. Their ads are in such a highly targeted and specialized group and industry so as to be unrepeatable by anyone else
  2. They are not telling the truth. The easiest way to tell is if they are not multi-billionaires. Even a 30% conversion rate on ANY ad for ANY product or service would make you wealthier faster and in greater amounts than anyone on the planet. (Use of the Hypno Toad from Futurama does not count!)

As always: If you have questions or commentary, feel free to email me at marc@canadianisp.ca or comment on the CanadianISP Facebook page at https://www.facebook.com/CanadianISP/

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