Over the past couple of years you've met a number of AdWords experts on our blog -- and, in that spirit, we'd like to introduce Fred Vallaeys, the Product Evangelist for AdWords. You may have met Fred in person, or heard him speak at recent industry events. If you're someone who attends these types of events keep your eye out for him: he loves to hear feedback from our advertisers firsthand.

Today, we begin a new series on a subject that is key to advertiser success: Return on Investment (ROI). In this series, Fred will cover why ROI matters, how to track it using tools available from AdWords or other sources, and how to optimize AdWords advertising for ROI.

Now that the stage is set, let's get started. Here's Fred:

I've heard it said at conferences that online advertising is the most cost-effective way for businesses to attract new customers -- but how exactly is such a claim measured? Well, one of the beauties of AdWords is that results are easily measured. Not only do advertisers get reports about clicks and impressions within their account, they can also track conversions of visitors to their site. One possible downside of having all that data, however, is that advertisers may become distracted by tracking lots of metrics at the expense of losing focus on the ones that matter the most.

On the other hand, many advertisers don't spend much time at all monitoring their campaigns. They might check only one metric, such as impressions, clicks, CTR, or their overall spend -- and so long as they don't see anything obviously amiss, they don't make any changes to their ads, maximum CPCs, etc.

Regardless of how much or how little an advertiser measures results, it's possible to miss out on potential profit if close attention isn't paid to the one metric that almost certainly matters the most: ROI. And while impressions, clicks, CTR and costs are all important components that contribute to the ROI, these metrics only show part of the picture.

The ROI metric can be defined in two ways: the revenue generated for every dollar spent on ads, or the amount of profit generated from every dollar spent on ads. I'm going to focus on profit here, since that's what most advertisers inquire about.

The formula for ROI is as follows (keeping in mind that the "revenue minus cost" in the top line equals profit):

For any campaign where the advertiser's goal is to get a conversion, whether it be a sign-up, a sale, or something else, the ROI should be greater than 100% -- which simply means that for every dollar spent on AdWords, they've made a profit. The greater the ROI number, the greater their profit.

Here's an example -- let's say an advertiser has two keywords ('flower delivery' and 'fresh flowers') and spends $50 on each. For the same $50, the advertiser receives 50 clicks for 'flower delivery' and 100 clicks for 'fresh flowers':

KeywordImpressionsClicksCostAverage CPCConversionsProfitROI
flower delivery1,00050$50$1.005??
fresh flowers1,000100$50$0.5010??

Based on the data in the table, the keyword 'fresh flowers' seems like the better of the two because it has a lower average CPC and it leads to more conversions (sales). But without tracking the ROI on both keywords, an advertiser would have to guess whether it makes sense to change the bids for these keywords. If they were only looking at the average CPC or the conversions per keyword, they may be making assumptions that could end up costing them money.

Now, here's that table again -- but with figures added for ROI:

KeywordImpressionsClicksCostAverage CPCConversionsProfitROI
flower delivery1,00050$50$1.005$100200%
fresh flowers1,000100$50$0.5010$50100%

Notice that the keyword 'flower delivery' has a much better ROI, even though it generated fewer conversions and fewer clicks for the same advertising cost. This could be the case for a variety of reasons -- for example, users who clicked on the 'flower delivery' ad may tend to buy products with a higher profit margin. The average profit per sale on the keyword 'flower delivery' is much higher ($20) than 'fresh flowers' ($5), which justifies the higher CPC for the keyword 'flower delivery', even in light of fact that it receives fewer conversions.

When an advertiser tracks and monitors their ROI, they are seeing the complete picture. This allows them to make smarter decisions about their online ads and, ultimately, make their business more profitable.

Now that you've seen why ROI matters and how it can help you to make more informed decisions, Fred will tell you how to track and monitor your ROI in part two of the series. Then, in part three, he'll take a close look at some tools and strategies for optimizing ROI. We hope you'll stay with us for the entire series -- and as always, please feel free to comment along the way.

Update: Republished to correct formatting of tables