Tuesday, March 11, 2008

Search Advertising vs. Social Applications

In an earlier post I argued that search marketing is a break-even business for those investing in it. In this post I want to get down to some hard numbers and determine where the break-even is for investing in your own social networking tools.

Analysis 1: Let’s look at the costs of search advertising. The costs range from $0.10 to $5.00. Here is a sample average cost currently on Google:
$0.55 – “Nike”
$0.85 – “running shoes”
$0.72 – “social networking”

Commerce sites have a range of making a sale from a click-thru typically between 1 in 50 to 1 in 250. In the case of “running shoes”, the cost would then be 50 X $0.85 = $42.50. Figure a pair of nice running shoes is about $100, with a gross margin of about 50%. So an on-line retailer would make $7.50 gross profit. And that is for an excellent conversion rate and not counting the overhead of fulfillment and running the business. If the rate falls to 1 purchase in 60 click-thrus, then it is a loss. Competitors simply bid up the rates such that search marketing takes the profit away from e-commerce companies relying on it to win new customers, and it does nothing for retaining customers.

Analysis 2: I have some data from a web site. It has 235,000 unique visitors (about 30,000 come from search advertising) and 3.8 million page views per month. There is a registered user base of 80,000. They currently do a lot of search marketing (about 20-25% of total revenues!) and spend about $25 to get a new customer. Let’s assume that we add a set of social networking applications, and the cost of that is $100,000. We would need to produce 4,000 customer orders for the cost to be equivalent to advertising. There are three basic ways to produce those 4,000 new orders:
1. 5% of the 80,000 current users make an additional purchase.
2. 3 % of the 155,000 monthly visitors who are not members make a purchase.
3. 5% of the 80,000 current users invite a friend, who then makes a purchase.

Can a set of social applications that engage users more (have current registered users and site visitors (1 & 2) use the site more) translate to a 3-5% increase in purchases? Or will 5% of registered users really convince their friends to buy from this site via referrals? Maybe some combination? Of course it depends on the product or service that is being sold. But since the $100,000 is a one-time expense, after the break even time of 1 month or 1 year, the return is pure profitable business. None of what occurs in Analysis 1 above where the search marketing eats your profit each time you attract a buyer.

Again, I am not saying there is not a need to do search marketing. However, it seems that the 3-5% improvement via social applications is something that a creative marketing and advertising team could deliver.

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