Why I don’t believe in Target CPAs

Rob Moffat
Aug 9, 2017 · 4 min read

Having argued this point with a few portfolio CMOs, and read some mathematically flawed advice online, I felt compelled to put fingers to keys. I am not an Adwords professional so please let me know of the errors I have made. I would love to get a debate going here.

The background is that I was at Google back in 2007–2009, and like most employees then played around with my dollar-a-day account. While I was there Google introduced CPA bidding: the ability to track conversions and automatically adjust per-click bids to hit a certain CPA.

What confused matters was when Google started offering two options: Max CPA or Target CPA:

Target CPA approaches have seen widespread adoption (they are also the prevailing approach with bid managers such as Kenshoo and Marin). Marketers and CEOs like it as it fits well to goals and budgets: “Acquire 10,000 users, your budget is €10 per user and so €100K”.

However as a mathematician I believe this approach is just plain wrong. In particular for the companies we work with @Balderton which are trying to grow as fast as possible but not uneconomically i.e. without losing money on incremental new customers. Let me try to explain why.

Take a company which acquires most of its customers through Adwords. Some keywords offer a low CPA (brand searches, long tail with low competition), some keywords are much higher CPA (‘head’ terms). If I were to take the users I acquire from each keyword, starting with the lowest CPA and ending with the highest, I would have the chart below:

Then overlay on this chart the gross margin I make on a new customer (revenues minus COGS and any other variable costs: customer service, fulfilment, discounts etc.). Strictly speaking this should be one year LTV, taking into account repeat rates and any virality. Assume this is €10.

Then I am making profit on any keyword with a CPA of <€10, and making a loss on any customer with a CPA of >€10:

A max CPA strategy is very simple here. To maximise profits I should bid up to €10 for a new customer. I am OK to go up to a €9.90 CPA on a keyword if that is what it takes, as otherwise I wouldn’t acquire that customer and so would miss out on that 10c of profit.

A target CPA strategy can lead to some very different results. If I were looking to maximise growth I might bid for a target CPA of €10. In the graph above I would be bidding on keywords all the way to the right to get to an average CPA of €10. For some of these customers I would be paying a CPA of €20 or more, and so losing significant money. I would be growing faster, but only by acquiring unprofitable customers. A more conservative approach would be to set target CPA at €7, 70% of GM. However in this case I will either undershoot or overshoot the €10 max CPA, and so miss out on profitable customers or add unprofitable customers. In theory there would be a target CPA which would match the €10 max CPA strategy, but as CPAs are continually changing this would require constant tweaking.

This Google Sheet contains a simple numerical example, with the following output:

Hope this was helpful, provocative, or both. Comments please…

Notes/Caveats:

  • I don’t get into the complexity here of multiple Adwords positions, and that it may make sense to bid for number 3 not number 1. This would involve reducing CPA to avoid overpaying, but a max CPA strategy would still make more sense than target CPA.
  • CPA bidding is an inexact science, and margin of error can be high
  • Hard to calculate brand impact of having many more impressions / customers, which may justify some mildly loss-making keywords
  • You could replace CPA with CPC above, same logic still holds
  • Obviously most companies have many acquisition channels, with halo effects etc. I have written about multi-channel CPA before here

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