Many business owners using Google advertising think the highest bidder gets the top spot and that it gives them the edge in getting more business. Is that really true?

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Small businesses, in particular comment that they feel that they don't have a fighting chance against their larger competitor's ad budgets.

Is that really true?

Well, in this post, you're going to discover exactly how Google Adwords works.

If you take notes, you should walk away understanding what you may be doing wrong and what areas of opportunity you have to improve your ad campaigns for your business.

To watch the full video (8:15), scroll down to the bottom. Now, let the education begin on how Google Adwords works.



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Google uses an auction system to rank the ads that appear in the search results page to determine the cost for each ad click.

In this talk, I'll take you through a general overview on how the ad auction works.

First and foremost, Google users want ads they see to be relevant.

They don't want to be bothered with ads that aren't closely related to what they're searching for.

And advertisers want to show relevant ads so users will actually click on them.

Meantime, Google wants to provide a good experience for users and a good value to advertisers so they come back and use our services again in the future.


What A Traditional Auction Look Like (0:41)


Say we have four advertisers competing for space in the search results page and each has indicated a different amount they're willing to pay for a user to click an ad and visit their website:

  • $4
  • $3
  • $2
  • $1

I'll refer to these amounts as the bids.

Now in a traditional auction ad positions will be determined exclusively by bids. The highest bidder will get the first position, second highest bidder the second position and so on.


Google's Second Price Auction (1:07)

how_much_you_pay_google_adwordsGoogle uses a variation of what's called a second price auction.

In a second price auction, the buyer doesn't have to pay their full bid.

You only have to pay the amount of the next highest bidder below them.

So in this particular case, if the first advertiser was bidding four dollars; they don't have to pay three dollars, which is the bid of the second highest advertiser.

Same thing applies to advertiser two and advertiser three.

This design allows each advertiser to bid their true maximum willingness to pay for a click, but they only have to pay just enough to beat the competition.


PPC - Pay Per Click (1:45)


Now in our Google auction, advertisers only have to pay when they actually receive a click and the order isn't based just on bids.


Because, we want to show more useful ads in a higher position on the results page

Because users want to see relevant ads.

Advertisers want to present relevant ads to the user's

Google wants both advertisers and users to have a good experience so they come back and continue to use our system.

So we consider some other factors in addition to an advertiser's bid.


Factor #1 - Expected Click Through Rate (2:12)


This is our prediction of how often your ad would be clicked on when it's shown.

All across Google, we rely on users feedback to drive decision-making and user click through rates tell us what Google users really respond to.

By allowing users to vote with their clicks, we have millions of people who are helping us to decide which ads are best for each search query.


Factor #2 - Landing Page Experience (2:34)

landing_page_experienceAn ad is only useful to a user if the landing page it leads to helps them find what they're looking.

A highly relevant landing page yields a higher score.


What is a high-quality landing page look like? (2:45)

landing_page_optimizationWell it should have:

  • Relevant and original content that helps the user complete the task
  • Should be easily navigable and be transparent about the nature of your business, how your site interacts with the visitor's computer and how you intend to use a visitor's personal information


Factor #3 - Ad Relevance (3:03)

how_google_adwords_works_-_ad_relevanceGoogle determines ad relevance by analyzing the language in your ad to determine how well it relates to query.

This is a way to measure the ad's relevance to the user's search and to make sure that only useful ads are shown

It also prevents advertisers from simply paying their way onto searches that are unrelated to the product or service.


Factors That Determine The Quality Of Your Ad (3:23)


Your expected click to rate, landing page experience and the ad relevance are all factors that describe the quality of your ad.

We also consider the expected impact of any ad formats it may show with your ad.

Ad formats are enhancements to search ads that more prominently show users information about your business.

Things like:

  1. A phone number
  2. Site links
  3. Your website's domain in the ad headline

Advertisements with these formats give users more information and more reason to click on an ad.


Factor #4 - Ad Rank (4:02)

how_google_adwords_works_-_ad_rankSo Google combines your bid with multiple quality factors:

  • Click through rate
  • The landing page
  • Ad relevancy
  • Expected impact of ad formats

To calculate a score for your ad called ad rank.


Determining Ad Rank Quality (4:12)

how_google_adwords_works_-_ad_quality_formatsLet's go back to our four sample ad buyers and see how their ad rank compares.

Here are our four advertisers bidding

  • $4, Low, No formats
  • $3, Hi, Eligible for only one format
  • $2, Hi, High expected impact
  • $1, Medium, Medium impact

There ads had different quality: low, hi, hi and medium.

They also apply different formats with varying impact.

First ad doesn't have any formats enabled so there's no expected format impact.

The second ad is only eligible for one format and has a low expected format impact.

The third is eligible for several extensions and garners a high expected impact.

The last ad is medium.


So How Will These Ads Rank? (4:50)


So in this example the first ad has an ad rank of 5.

Next ad has an rank of 15.

Third has an ad record 20.

The last has an ad rank of 8.

It's this add rank score that determines ad position in the results page.

In addition, only ads with sufficiently high rank appear at all.


How Ads Are Ranked and How Much Do You Pay Per Click? (5:31)

how_google_adwords_works_-_lower_cpcSo with this ad, with an ad rank of 20 it gets first position even though it has a lower bid

Why? Because of its quality and formats.

The second-highest ad rank is 15, so that ad gets position two.

The third-highest ad is 8, it lands in position three.

The advertiser bidding four dollars has such a low quality and format impact that it doesn't get a position on the page at all, despite having the highest bid.

So now we know how the ads are ranked, but how much do you actually pay per click?

You pay the minimum amount that is necessary to maintain your position and any formats that are shown with your ad.

So let's get back to our ad rank table and talk about the advertiser in position one.

He's competing with the advertiser in position two.

So the amount he has to pay is going to be just enough to beat the ad rank of the advertiser in position two.

For example.

Although he bid two dollars, he could have bid as low as $1.73 and he would still have out ranked the advertiser below him

So that's what he'll pay-per-click: $1.73

Similarly, the amount that advertiser in position two has to pay is the minimum needed to beat the ad rank of the advertiser in position three and so on down the page.

So in this example, the top-ranked advertiser winds up paying less than what he was actually willing to pay per click and it's the same for the other advertisers as well.


How Advertisers Can Influence Their Cost Per Click and Ad Rank In The Auction (6:22)

how_google_adwords_works_-_improvementsBy improving your quality or adding ad formats, you can potentially improve your ad position.

You could also end up paying a lower cost-per-click.

So let's take a look at the advertiser in position two.

Suppose she improves her ad and landing page. Now her ad rank goes up to 18

Her position here doesn't change.

But what happens to how much she pays per click?

Before, even though she bid three dollars, she only needed to bid $2.68 to beat the ad rank of the advertiser immediately below her.

So that's what she paid: $2.68


How Ad Quality Impacts Price (6:36)

ad_quality_impacts_priceBut now that she's improved the quality of her ad, assuming everything else stays the same, she could have bid as low as $2.42 to beat the advertiser below her.

So her cost-per-click goes down to $2.42.

Why? Because the price an advertiser pays is partially based on her ad quality.

Now imagine this advertiser wants to move to a higher position.

She increases her bid to $3.50. Now her ad rank goes up to 23.

That's enough to give her the highest ad rank to move into position 1 and what does she pay?

The amount that would be just enough to beat the ad rank of 20 below her.

Assuming everything else stays the same, it might be say, 3 dollars and 38 cents in this particular case.


The Wrap Up (7:41)

adwords_supportWhy do we handle ad ranking and pricing this way?

Like I said at the beginning, it all goes back to the ecosystem Google, our users and our advertisers all live in.

When users see better ads they're happier and the more likely to actually click on those ads

And that make advertisers happier, which makes Google happy.

Because with happy users and happy advertisers, we get more people using our system.

If you have more questions want more information please visit

Thanks for your attention.

Full Video: How Google Adwords Works (8:15)



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