More often than not, PPC budgets are set based on a hunch rather than being rooted in data – ROI and the point of diminishing returns. Paid search should be managed based on a ROI that is maximized to the point of diminishing returns but only when figured with other online marketing programs.

First let’s understand PPC ROI, not to be confused with the return on ad spend (ROAS), which is additional value gained after media spend. Here’s the PPC ROAS equation:

PPC should be evaluated based on the overall return on investment, which should include agency services. Here’s that equation:

It’s valuable to generate both ROAS and ROI – ROAS to help manage the day to day activity within an account and ROI to put value on the program as a whole. Depending on the sales cycle and type of business, ROI may be harder to generate. For instance, a lead gen site may want to use CPA instead of ROI to calculate the point of diminishing returns.

The paid search point of diminishing returns is the point in which additional PPC spend decreases the overall return on the account. The law goes, when you hit your point of diminishing returns, stop spending. However, the point of diminishing returns is a formula that is most applicable in production scenarios, yet it’s still extremely valuable and largely unused in PPC programs.

To effectively use the point of diminishing returns for paid search, the law needs to be applied and evaluated in comparison to other online marketing efforts. For instance, a robust online marketing plan might include the following programs: email marketing, banner campaigns, SEO, affiliate marketing and PPC.

First step is to evaluate these programs on the same level by generating an ROI for each program. Here are some monthly numbers we can use:

Let’s assume the PPC account is managed using the point of diminishing returns, any more spend is trickled down into campaigns that bring down the overall PPC account ROI. Thus following this theory, spend is frozen and current ROI is maintained. The issue here is that while an increase in spend may drop the PPC ROI, the return for this program is still much higher than other programs, thus the point of diminishing returns becomes irrelevant.

Say for instance, there is an additional budget available to invest online and an investment in PPC drops the ROI% – contrary to the point of diminishing returns practices. The graph would looks something like this:

Any additional spend over $7,000 decreases the account ROI. Yet the 250% ROI earned at the $9,000 is still higher than other programs – assuming ROI for other programs is also at the point of diminishing returns.

The law diminishing returns can be effective when applied to paid search but only when evaluated in conjunction with other online efforts.