While setting up your AdWords campaign Google gives a suggested or average cost per click (CPC) for current advertisers for the keyword they are using in their campaign.  You can set your bid price (BP) based on the average CPC, but the bid price you set does not necessarily mean that will be the cost per click when visitors click your add.  Your CPC will be a combination of your closest competitor’s bid price multiplied by their quality score (QS) — a score given to an ad based on the ad content and relevancy of the ad — divided by your quality score.  If this sounds complicated it really isn’t, a quick example will help sort it out. This post will give you a break down of how Google calculates your CPC based on your competitors.

For example sake, let’s say we are running a campaign for the keyword web design.  We will also assume that Google’s suggested CPC is $5.00.  It happens that there are two other competitors also bidding for the keyword web design.  Now remember, Google also takes into consideration the quality score (QS) of your ad which is a factor in your ad rank — the ranking of your ad on the search engine results pages (SERPs).  Let’s look at a break down:

Ad Ranking for web design

Advertiser	Bid Price	Quality Score	Ad Rank
Your Campaign	$6.00	8	48
Competitor A	$5.00	9	45
Competitor B	$9.00	4	36

As you can see your ad rank is 48 which is your bid price multiplied by your quality score. Compared to your competitor’s BP x QS this put’s your ad rank on top and earns you the first position. Now on to calculating your CPC. The formula looks like this:

Your CPC = (Competitor A’s BP X Competitor A’s QS)/Your QS

This translates to:

Your CPC = ($5.00 x 9)/8 = $5.63

This means you will only pay $5.63 per click as opposed to your bid price of $6.00 (saving you ¢37 per click). Essentially, this is the price that you need to maintain based on your QS to out edge your closest competition. This way Google calculates the minimum amount necessary to maintain your position, thus giving you the best possibility of ROI.

As you can see from the example, even though Competitor A had a higher quality score, their bid price left their ad rank lower than yours. Moreover, Competitor B was willing to pay 150% for each click, but their ad rank suffered because of the poor quality score they received on their ad. This is great to note how much of a factor QS plays into your campaign and how most people are coming up short because of their lack of understanding of quality score.