X-factor or Psychology? - The Changing Algorithm Behind Google's Adwords

Google claims that the cost of advertising (CPC) using Adwords is a fixed calculation from when they

"combine the components of Quality Score, the max. CPC bid, and the expected impact of extensions and other ad formats to determine Ad Rank."

Then as an advertiser your bid and subsequent placement is based on the results of that auction (Ad Rank).

However, over the last few years it has become clear that there is more at play than that. If we can assume that the impacts for quality score and competition  (the number of advertisers for that keyword) remains the same, then we can only assume that the final cost calculation is what is changing. If more advertisers are bidding, there is an increased competition, and the average CPC should rise or fall within a similar ratio.

Without labouring the point, in an equal market, unless EVERYONE's quality score tanks, if there are less advertisers for a keyword, it should become less expensive to advertise in that market. I think this can be discounted, because as an advertiser there is a clear incentive to maximize Quality Score.

I have been tracking the cost of advertising using Google Adwords for well over a 6 years now. You can find the raw data here. Using a basket of keywords that range from “Plumbing” to “Business Supplies”, we used Google's Keyword tool to find the average CPC and the competition for over 90 different keywords. 

Obviously this is just 90 keywords out of a possible millions, excluding combinations etc. However this data was a fairly broad sample, and was just intended to indicate trends, and to pose an argument.

Competition goes down - Cost goes up.

In the very least, we can see from the data and the graph above that, for Australia, competition has declined by 8% but the cost of advertising has increased by 32%. So effectively fewer advertisers are spending more on their advertising. 

I think there are two things that could be happening here. Either Google have an X-factor at play here (which is highly likely) or the psychology behind the bidding is a race to the bottom (or top as the case may be). So even though there are less advertisers, people are paying more because they want to be number one. 

It is easy to see why Google would want to use an X-Factor. It would help maintain the profitability of their biggest cash cow. It would be hard to trace/prove. It would give the appearance that things are getting more competitive. Lastly it would start to edge out the lower bidders that are not "serious" business, whatever that means. 

Psychology is also an important factor. I have spoken to a lot of organisations who insist on being number one for keywords (increasing their bidding above sensible levels), even though our ROI analysis shows that sometimes just being on the page is enough, and the top spot just gets tire kickers.

This could certainly be the case for keywords like "SEO" where the competition has only increase 6%, but the cost has increased over 711%. It also seems to be more prevalent in the US, where the average competition for keywords has dropped by 1% but the average cost has increased by more than 25% (when accounting for currency).  

Feel for the Entrepreneurs

Probably the "hardest done by" group would have to be the entrepreneurs. Keywords like "Plumbers" "Carpenters" etc have all increased in competition, but the proportional increase in cost is often 8 times higher. 

Goodbye 3G, Hello Mobile Phone Games

The other interesting thing the data reflects is real macro changes to markets. As 3G handsets become less sought after, the competition/pricing has tanked. Similarly, as smartphones are becoming ubiquitous, the competition for "mobile phone games" has increased 150%.

Either way, it is difficult to know for sure if it is psychology or a Google X-Factor, as we won't know if the system is forcing the bids, or if people are deliberately driving the cost up, despite what might be in their best interest. After all, if people bid just enough to get on the front page, and no more, the average cost would decrease.

The other way to look at this is, with Google's search monopoly, advertisers should include Adwords as a PART of their overall digital strategy, and not the only thing.