Pay-per-click advertising is a lot like an art auction. Advertisers will place bids to get their ads in the best spot, much like art collectors bidding against other collectors for the most highly sought after piece. You can decide which keywords (or paintings) you want to make a bid on and you can set a different amount for each.
This is where these two auctions start to differ.
When you bid $20,000 on a Van Gogh, this is the price you’ll pay for the painting, assuming your bid was the highest. But in search engine advertising, you don’t necessarily pay the amount you originally bid. In many cases you will pay less for the actual click and the CPC is calculated each time a search is done, therefore the CPC can be different every single time. So how is cost-per-click (CPC) calculated?
Bing Ads and Google AdWords calculate CPC in essentially the same way. Both search engines will use ad rank, which involves your bid (also called Max CPC) and quality score.
These equations, although different, will result in the same CPC because Max CPC (as used in Bing’s equation) is a function of ad rank.
Since Google has a more simplified formula, we’ll use that. Let’s look at an example in which your competitor has an ad rank of 15 and you have a poorly written ad with a quality score of 3. You will pay a premium $5.01 for the click.
CPC = (15/3) + 0.01 = $5.01
With the same example, if your quality score is very high, say 10, you will pay less for that same click.
CPC = (15/10) + 0.01 = $1.51
As you can see, a high quality score can be of great importance to the amount you pay.
Even though the CPC formula does not refer to your Max CPC directly in its calculation, the Max CPC is used to determine quality score and quality score is used in conjunction with the Max CPC to determine ad rank. Whereas it is important to understand how CPCs are calculated, it is confusing and can prove inconsistent as the engines are at liberty to change their formulas.
Your bid plays a role, albeit small, in determining your CPC. Your bid plays a larger role in determining your ad rank. Therefore, bid management is important to make sure you bid enough to land your ad in a good SERP position, but you are better off improving your quality score by keeping closely knit keywords in ad groups, optimizing your landing pages and writing relevant ad copy.