DEMYSTIFYING DIGITAL | How to avoid the pitfalls of online advertising

If your digital agency handles your pay-per-click advertising and they’re charging you a fixed/flat price per click, they’re ripping you off.

If your digital agency handles your pay-per-click advertising and they’re charging you a fixed/flat price per click (e.g. “10 pesos per click”), they’re ripping you off. The practice is called arbitrage, and it was recently forbidden by Facebook. I expect Google to follow. Arbitrage happens with both major global brands and smaller local ones.

Arbitrage is the practice of buying something in one market and then immediately selling it at a profit in another market. While the term was originally used in economics and finance, the practice has found its way into search engine marketing. Here’s how it works.

Big Brand Incorporated (BBI) decides to hire Digital Marketing Agency (DMA) to send more traffic to their website. DMA recommends buying pay-per-click advertising on Facebook and Google. In this way, BBI only has to pay for every visitor sent to the site. Digital Marketing Agency proposes a fixed/flat fee of 10 pesos per click. They justify the cost as follows: “5 percent of the people that come to your website become customers. That’s one in twenty. At a cost of 10 pesos per visitor, it will cost 200 pesos to acquire one customer.” BBI thinks this is great! They make an average of 3,000 in a year from each new customer, so a cost of acquisition of 200 pesos is excellent. They happily sign a contract.

What BBI doesn’t realize is that DMA is only paying Google and Facebook one or two pesos per click and pocketing the rest of the money. That’s arbitrage. We’re looking at two markets: Google and Facebook’s pay-per-click market, and the market for the agency’s services. The agency buys advertising in Google and Facebook’s market for 1 or 2 pesos per click, and sells it in their own services market for a 500 percent to 1,000 percent markup. Does it still sound like a great deal for BBI, who could be getting a new customer for 40 pesos instead of 200, or put another way, could be acquiring five new customers for that same 200 pesos, instead of one?

But why in this example does each click cost “one to two pesos” and not a fixed amount? The answer has to do with how Google and Facebook determine their pricing. Each ad that shows on Google is tied to a keyword selected by the advertiser, and each ad that shows on Facebook is tied to a demographic similarly selected. There may be many advertisers interest in the same keyword or demographic, or there may be few to none. Google and Facebook set their prices through something called an ad auction.

In an ad auction, an advertiser bids on how much they are willing to pay for each click. Whoever has the highest bid pays a cent more than the next highest bidder. So if you are the highest bidder at $1, and the next highest bid was $0.50, you’ll pay $0.51 for each click. Obviously certain keywords will be more highly sought after (like “best insurance company” or “manila hotels”) when competition for customers is high (as it is in the insurance and hospitality industries). High competition means more people bidding on keywords, which means higher cost-per-click. Low competition means the opposite. Sometimes agencies will buy low competition keywords in order to make a larger margin on the arbitrage, since lower competition keywords cost them less. They’re still charging the brand the flat rate per click, no matter what the price of the keyword.

Facebook has long opposed arbitrage. In fact, Facebook’s terms of service for agencies states: “You must disclose to your clients the actual amount that you spent on Facebook advertising based on the auction pricing, including the actual Facebook metrics (e.g. CPC, CPM rate) and the amount you charged as fees. We reserve the right to disclose this information to your client upon their request.” When asked to comment, Google Philippines did not respond to an inquiry by posting time.

But why does Facebook care about arbitrage?

In an interview with Business Insider, Facebook said “Our goal is to protect end-advertisers working with 3rd and 4th parties… It is important that brands, agencies, all advertisers understand where their dollars go and have a specific strategy when buying Facebook media.” My own take as an analyst is that while the above is true, another consideration is that Facebook realizes that agencies practicing arbitrage are making more money on Facebook advertising than Facebook itself is, and they aim to recapture some of that business.

This has two important implications: 1) If you are a brand and your agency isn’t disclosing to you how much they are paying Facebook, they are breaking a rule Facebook instituted to protect you; 2) You may go directly to Facebook and ask them how much money your agency has paid them for your ads. I highly encourage you to do this.

How do agencies get away with arbitrage? Agencies that practice arbitrage will often create a Google AdWords account for their clients, but not provide them access to that account. In this way, only the agency sees the actual ad spend. They charge a fixed/flat fee per click to their client, which is inclusive of both the ad budget and the fee the company charges to manage the campaign. However, they won’t tell the client how much of that fixed fee is going towards ad spend and how much the agency is keeping. They’d be hard pressed to do so since the cost-per-click fluctuates due to the ad auction.

To prevent this from happening to you, make sure any pay-per-click ad campaigns being managed for you are created in your account (that you have access to) and your credit card is being charged directly by Google, Yahoo, Bing, Facebook, or whichever ad networks are being used. Not only does this allow you to fully account for your ad budget, it also provides portability if you ever decide to leave that agency and work with another. Otherwise, you can’t take your account and ad campaign to the new agency; they’ll have to setup your campaign from scratch, which will cost more. Make sure you have control over your accounts and demand transparency when it comes to your ad budget and how it is spent. It is after all, your money.

If an agency doesn’t practice arbitrage, how do they make money selling ads? The time spent writing the ad copy, designing the graphics (for display ads), rotating the ads, and general management is considerable. That has to be accounted for, plus a reasonable profit margin. Ethical agencies do this by charging a fee based on percentage of budget. My agency charges 20 percent. If your ad budget is 100,000 pesos per month, we guarantee 80,000 of it will be spent directly on advertising at the price charged to us. And we’re happy to provide proof of this. The other 20,000 pesos goes to us for the services we provide in creating and managing the ads.

Search engine marketing arbitrage is a practice that can only exist in a market where buyers don’t know it exists. Hopefully, as general proficiency in digital marketing continues to rise among brands, it will become a thing of the past.

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Categories: Digital Advertising


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