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Pricing in reverse: use a product's price to figure out what you need to build (ninjasandrobots.com)
153 points by nate on April 17, 2012 | hide | past | favorite | 44 comments

I have been using this strategy since quite some time now to develop a frontend product. And then use the profits from that product to advertise and attract enough visitors that lead to at least 1 more sale - and create a perpetual traffic cycle out of it. (I'm writing a 60 page book on it.)

Some things I've learned from experience.

1. You don't want to use the Google Keyword Tool. Thats a good tool for keyword suggestions. Not for keyword bidding. You want to use Google's Traffic Estimator tool instead. You will have to login to your Google Adwords account to use it. (Adwords > Tools & Analysis > Traffic Estimator)

2. You don't want to use category defining keywords. You want to make it slightly long tail. Don't search for "crossfit". Search for "crossfit training". Don't search for "speed reading". Search for "learn speed reading". Why? Because Google starts minimum bids for category defining keywords from $1 - even if there aren't any competing advertisers on that keyword. This inflates the numbers in your formula.

3. After searching for a keyword in the Traffic Estimator tool, click on "Impressions" and hover your mouse over the cliff in the graph they show. That is the Max CPC you want to take while calculating your price. (http://i.imgur.com/upj77.png)

With the above steps, the CPC you get for learn speed reading is 41 cents. If you expect a 1% conversion rate, you need a product that sells for about $41 minimum.

If you go to the clickbank.com marketplace and search for speed reading, you will see that the most popular product on speed reading (Quickeye Speed Reading Software) is infact priced at $47.

I've noticed if you lower your Max CPC bid, the Traffic Estimator will show that you get a lower click-through rate, but at a better price. Do they restrict your add to less competitive time frames to give you that better price? Does that then impact your conversion rate, or is a click a click?

If you lower your CPC bid then the Traffic Estimator shows you the rates for lower positions. The ad on the top of the page always gets more click throughs than the ad that is shown 5th on the page. And thats what Traffic Estimator takes into consideration.

But you should know that the Traffic Estimator is just that - an estimator. Your real cost per click and ad positioning with Google depends on a lot of other factors. Including things like how good your landing page is. And how better your ad is than others.

So determine the CPC at the cliff on their graph. And then optimize your Google ads. (Also, a lot of ad networks are cheaper than Google Adwords. So use Google Traffic Estimator to find an optimal price point. But start advertising your product at other places.)

> Including things like how good your landing page is.

That will impact CPA, not CPC.

Actually, Google has this measurement scale called "Quality Score." Your landing page is one of the things they evaluate to measure the quality score. And your quality score affects your CPC.

You can read more on it here: http://support.google.com/adwords/bin/answer.py?hl=en&an...

The brilliant point in this post is... "I can't just sell an ebook for $102. I'm going to have to create some kind of online video course perhaps. Maybe I could create a software program to help speed readers practice. Etc."

Too many businesses limit their marketing to their existing margins, instead of finding ways to increase their margins and open up more doors for marketing.

The way I see it... Businesses are investment vehicles and marketing is how you turn over your investment. The more times you can turn over your investment, the more money you make.

I am constantly perplexed by people bragging about how little they spend on advertising or marketing. I would be much more impressed if you bragged to me about how much you can spend on profitable marketing.

It is definitely useful to do these sort of 'back of the envelope' calculations. A few things to bear in mind:

-It is strongly in Google's interest to inflate bid prices. I would take their suggested bid prices with a pinch of salt. The Google traffic estimator shows that I should be able to get around a 4% CTR on [speed reading] at around $0.50 per click in the USA: https://adwords.google.com/ko/TrafficEstimator/

-The amount you have to pay for a conversion in Adwords depends hugely on how well you play the game of Adwords. Most people using Adwords have very little idea how to set up or manage their accounts and are paying a lot more per click than they need to (I have looked at quite a few Adwords accounts).

-There are more countries in the world than the USA. You may be able to get clicks and conversions a cheaper elsewhere.

-There are probably lots of keywords related to speed reading that are cheaper to bid on than the exact match [speed reader], e.g.

speed reader course

speed reader techniques

speed reader software

speed reader tips

speed reading

speed reading course etc

They will probably have lower search volumes, but it shouldn't be hard to come up with a few hundred of these. Some of them might also have higher CTR and conversion rates.

-I think the numbers used are reasonable (1% CTR, 1.5% conversion rate). My own numbers are a bit better than that, but not too far off. But my average cost per click (selling downloadable software) is waaaay lower than $1.53.

"Most people using Adwords have very little idea how to set up or manage their accounts and are paying a lot more per click than they need to"

Would you please share some general advice on this?

For someone without much cash, expeimenting in a new market I would give the following advice:

-Don't use broad match to begin with.

-Stay off high volume terms - instead make up the numbers by adding a large number of long tail terms.

-Consider geo-targeting: I've seen much lower CPCs on ads targeted at a small region.

-Take your time - getting big fast will cost you.

My email is in my profile if you have specific questions

It is a big subject. But there is a lot of information out there in blogs and in the Google documentation. Take a day or two to read and learn the basics and expect to spend lots of time tweaking. I have written a few articles here: http://successfulsoftware.net/category/adwords/

This one covers some of the worst and most common newbie mistakes: http://successfulsoftware.net/2010/02/10/5-great-ways-to-was...

I don't think this is accurate at all.

Suppose you do have an ebook. Theoretically, certainly, you can find the price at which no consumers purchase your book, and the price at which nearly every consumer who sees your book purchases it. Thus you have a demand function. Optimize your demand function, and you have the ideal price for your book.

Sure, you can go backwards. Again, theoretically, peg a price, then write an ebook such that its demand curve results in your desired optimal price. Practically, it's impossible to measure potential consumer preferences and interest with much accuracy, but at least it starts you off thinking about what the consumer wants. And the more your consumer wants your product, the more demand shifts outward. I agree that this "backwards" model may be a beneficial mindset, because your product will already be optimized for consumer wants.

But why would you use Google AdWords as your measure of demand? I could spend a month writing a speed-reading ebook, create an search-engine-optimized website, and notify my friends. With $5/month hosting I already own, my cost structure is essentially zero. Every e-book I sell is pure profit, and I never touched AdWords.

The trick is optimizing AdWords spending. For every $1 I spend, will I gain $1 of revenue? If yes, keep spending until that's no longer true. Ceteris paribus, a $100 video course will generate more revenue per $1 of marketing spending than a $20 ebook, because you have 5x more chances to make the sale. That's too much of an abstraction, however. Maybe only 0.01% of click-throughs will be a $100 video course, but a solid 1% of click-throughs will buy a well-reviewed $20 ebook. So thus it's actually more profitable to advertise on Google AdWords

Perhaps a conversion rate of .015 is a decent ballpark for estimating AdWords revenue. But not total demand for the product.

"Optimize your demand function, and you have the ideal price for your book."

As Brilliant as that statement is, it reflects a limited mentality.

This post is arguing, "Optimize your product and demand function to have the ideal price."

Exactly! That's a great way of summarizing the "backwards" mindset.

It occurs to me that an ebook has a completely elastic supply curve, so the optimization of the demand curve is the equilibrium price.

He's trying to eliminate ideas for products, not sell an existing one. I.e. if he writes an e-book, is the cost of sales going to make it a net loss, if so, he should make a product at a higher price point or pick a different niche.

Adwords is appealing since it's an auction, and they let you see some of their data. In your example of using SEO instead, you have to do the SEO work with either your time or someone else's, so it's not like the cost is zero.

How does this make sense? It seems to be assuming that the conversion rate is independent of the product's price, the product's quality, and, perhaps even more crazily, what the product is and how it relates to the search term.

Am I missing something obvious here?

Yeah, you are. The assumption is you wouldn't try to sell an e-book for $102 (it says this explicitly) and you wouldn't try to sell fertilizer on the e-book advertisement (it doesn't say this, but it is common sense.). It is also assumed that we aren't making a shoddy product, nor something earth shattering.

The article is suggesting you use adwords demand compared to your expected optimal product price to determine if that market is over or under served.

I don't think so. I would think the technique of dividing CPC by the prospective conversion rate might be useful in determining ballpark costs for Adwords as one specific channel of marketing, but it's quite a leap in logic to say "this is what your product's price needs to be".

The idea that a potential market can be understood through such a swift and simplistic means is taking the paradigm of Adwords testing to absurd lengths.

I think the OP meant that this is the bottom line margin you need.

As an Auction Marketplace, with highly motivated prospects, searching for what you offer, only a click and a buck away, and an extremely low barrier of entry, I would argue that Adwords is as close to an efficient marketplace as possible, and represents the high end of the cost per customer within the framework of profitability.

Agreed. Basic econ theory predicts that if you hold all else equal and increase the price of a product, sales will drop.

If the Google ads list the price of the item clearly, then perhaps the conversion rate won't suffer so much, as those who click through are mostly the subset of people who are willing to pay the higher price.

But, if the ads do not list the price, then we have to assume that some fraction of those who click through will be scared off by the price, and that those same people would have bought had the price been lower.

Furthermore, as has been demonstrated in many A/B testing case studies, a website's conversion rate is heavily dependent on copy, design, product photos, and other such factors. It's not unusual to see sales double after a good round of A/B optimization. And that's just taking into account cosmetic changes. If you consider other market factors as well, you'll see that conversion rates can vary tremendously between different sites.

Therefore, I don't think you can just assume a given conversion rate and then solve for the price.

I think the author underwrote very conservative numbers. You can always adjust the math on your own. His reasoning is sound though.

IF you list the price in the ads, that would maybe explain the measly 1% CTR and high CPC's (Low Quality Score).

I have rarely seen a case where charging more didn't increase profits, even if you lose sales and get some bad clicks. (within the context of providing the perception of more value than the price.)

His point is simply, take the most expensive source of traffic online and underwrite to solve for the bottom line margins you need to advertise.

> "take the most expensive source of traffic online and underwrite to solve for the bottom line margins you need to advertise."

Sure, but if you assume away all other sources of traffic, you're finding a break-even price. The reason this might actually make you profitable is because you've got nearly-pure profit flowing in from "free" sources: word-of-mouth, organic search engine results, good reviews, etc.

Which means your price may be much lower than optimal, if your book appeals to an audience with lots of disposable income. Or, perhaps, only people searching for "speed reading" on Google will actually buy a book about it, and no one else in the world cares enough to spend $20 on improving such a skill. And your price may be far too high to be profitable. There's a ton of selection bias in using Google AdWords as your baseline.

Plus, you discount 2.5k searches for "how to speed read," 2k searches of "how to read faster," and 1k for "speed reading techniques". You can't easily add them to the formula, since they all have different conversion rates. Users searching for "how to speed read" will be far more receptive to a ebook about speed reading than someone searching for "speed reading" in general.

I agree in practice this formula is not very practical. It is however a good place to start in getting a picture of what it takes to buy customers in your industry. (Bear in mind the author is talking about math before ever building your product.)

I think his point is more that adwords, as an auction marketplace, represents the higher end of what it costs to buy a customer, so if you underwrite conservative numbers for buying customers with adwords, and used that number as the threshold of the minimum price you have to charge. This number is a great bottom line margin to build your product around.

I don't entirely disagree with this article but I do know that Google Ad prices are driven by market demand which means that if you price your product to break even on Google Ad conversions you are really just piggybacking on your competitor's math. That's what they have found to work. If enough people use this logic you'll converge on an average market price - not what customers are willing to pay.

TL;DR: You are participating in a pricing feedback loop with your competition.

... which is part of the point of this simplistic method : You're quickly able to pick the brains of all your (future, potential) competitors, without even knowing who they are, or researching what they're selling.

Maybe you can envision a higher-priced product with the same purchase rate (a win), or a lower-priced product with a vastly better purchase rate (also a win). But, using the assumption that there are people already trying to optimize their offerings in the market-place, the back-of-the-envelope calculation from the article is a quick sanity check.

Reminds me of something I'm coming up against with a physical product I'm selling online.

We started by creating our product, picking a price point, finding off-the-shelf packaging and going from there. End result is a box that's too large, costing us up to $25 to ship. Our product is currently priced at $95, including shipping anywhere in Australia. Already our sales are low due to the cost.

I'm starting to see value in picking an easy-to-ship product, or designing a product around ease and affordability of shipping.

Our next steps are: choosing a fixed-price postage satchel so we can maintain consistent postage ($11ish), having boxes custom-made that fit in that satchel (not much more expensive than what we're getting now) and then tweaking our product to fit those smaller boxes.

One of (probably many) caveats to keep in mind is that how ad prices relate to fundamentals can differ a lot across markets. For example, in some markets companies are willing to take a loss on advertising (in the sense that conversions times conversion rate is less than advertising cost), because they value acquiring a customer highly. Sometimes they even are willing to pay more to acquire a customer than the (direct) lifetime value of that customer, if the goal is to build up critical mass to break into a network-effects-heavy market. At the other end, in some markets, prices are based on fairly short-term returns, so people pay $0.50 only if there's a reasonable expectation of > $0.50 in conversions.

He could just divide the CPC by the conversion rate and figure this out in about one sentence:

$1.53/0.015 = $101.33

This is a great check on your product plans-- for example, it will catch you trying to sell things for $20 when you can't make money at that price. When I think of "pricing in reverse", I think customer -> problem -> value -> price -> price -> cost. Check cost at the end. Most people think cost -> product -> price -> value -> problem -> customer. This leads to poor solutions and bad pricing. As Nate notes, using his method allows him to realize that he needs to create more value.

I think this article represents a great starting point when brainstorming, but obviously it should be only one of many tools in your toolbox. Some of the more critical posts here are attacking it as if the author suggests this is a fool proof formula for product success.

Interesting analysis, but with one flaw - Assuming 1-2% conversion rate, and $1 on avg on google ads (thats what I have seen at least for most keywords with decent frequency), your formula is yielding $50-$150 for everything you build.

I don't see a lot of keywords where you can just assume they'll all be $1 CPC. Project management software: $14 a click. "iphone camera app" - $2.90 a click, "stop smoking" - $4.62 a click. And those are just the first 3 i looked up.

The article assumed 1% Click Through Rate (CTR) not a $1 cost per click (CPC).

This is a a great article however confirms the sad fact that you need to pay Google (a lot of money) to drive customers to your website. What happens if you don't need to pay for traffic? Do you still sell your book for $102?

Slick mobile version. I'm reading the article from my iPhone and I'm impressed.

I love it. It's all Dustin Curtis' doing and design. http://dcurt.is/. He created the SVBTL blog network I'm a part of.

Was just reading your website and saw the Joe Vs. The Volcano clip. That's one of my favorite movies and I've never met anyone else that has even heard of it, much less quotes from it. We might have to be friends.

That's awesome :) Fantastic movie. Are you on twitter or facebook or have a blog?


Amy Hoy doesn't say you should use adwords, does she? Correct me if I'm wrong as I've only read the free chapters and watched the video, but she basically tells you to find a suitable group of customers, see what kind of product they need, and create it. Also, blog about things which that group would find interesting, like 37signals does, to connect with these customers.

Now after reading this article I wonder whether this can actually work. Can you not make a living by creating a product and getting some sales from your blog + SEO?

It seems to have worked for people you're quoting. Why the doubt?

This article states that 37signals uses online ads in addition to their 'thought leadership' marketing strategy, which, if true, I would find slightly discouraging.

Although a good little starting point, this just helps you break even when considering your advertising expense. Are there other expenses? Do you hope for any actual _profit_??

How does one compete with Gmail, then?

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