adwords / adsense pricing explained

Understanding how Google determines the value of a click through AdWords / AdSense is a key issue because the pricing model is complex while being crucial for your business ROI. We'll first expose the general process and then get look at realistic case study. 
adsense / adwords pricing process 
 
Identifying keywords 

The first thing the AdSense bot does is to set a list of keywords that seem relevant to your page's content (contextual targetting). This is done through a complex algorithm nobody really knows except Google ! 
listing Competing Advertisers

For each keyword, a list of competing advertisers is established. Doing so for all the keywords results in an extended list of advertisers competing to show there ads on your page. 
Pricing every ad

Then based on the maximum amount of money (max bid) every advertiser is ready to pay, an ordered list is established from the highest bid to the lowest one. Then the Vickrey pricing model is applied as shown in the following example : 
a pricing case study

In our page, let's say that the AdSense bot has detected the 4 following keywords as relevant :
Advertising
Cost per Click
AdSense
Pay out 

Then for each keyword, AdSense lists interested advertisers as follow :KEYWORD ADVERTISER MAX BID ($)
Advertising Pordgast inc 2,25 
  John immo 0,25 
Cost per click Pay-it-less.com 6,50 
  Ultimate aBooks inc 1,02 
  more4less.com 2,52 
  Ariel Blown 0,75 
AdSense Google inc 4,00 
  James LeGrand 2,00 
  adsense4money.com 1,50 
  millionsinminutes.com 0,50 
Pay Out Google inc 2,00 
  neevie ltd 1,85 


The next step is to list those advertisers from the highest bidder to the lowest one. This gives the following list :ADVERTISER MAX BID ($) 
Pay-it-less.com 6,50 
Google inc 4,00 
more4less.com 2,52 
Pordgast inc 2,25 
James LeGrand 2,00 
Google inc 2,00 
neevie ltd 1,85 
adsense4money.com 1,50 
Ultimate aBooks inc 1,02 
Ariel Blown 0,75 
millionsinminutes.com 0,50 
John immo 0,25 


Unfortunately for some advertisers, all ads won't be shown as ad space on the page is limited to a single large rectangle ad unit which can hold no more than 4 ads. This means only the first four will be displayed. 

But how much will every advertiser be charged for a click ? The answer is : 1 cent more than the advertiser following him. The next chart gives the CPC for every advertiser :POSITION ADVERTISER MAX BID ($) CPC 
1 Pay-it-less.com 6,50 4,01 
2 Google inc 4,00 2,53 
3 more4less.com 2,52 2,26 
4 Pordgast inc 2,25 2,01 
Invisible James LeGrand 2,00  


As you can see, the most agressive advertiser "Pay-it-less.com" won't pay $ 6.50 but just 1 cent more than "Google inc" max bid to deserve his first position ! The process goes on until we reach the last advertiser (James LeGrand) who is only useful to determine what the fourth one (Pordgast inc) will pay.
AdSense Pay Out 

Now that we know how much every advertiser will be charged for a click, how much of the money will an AdSense publisher get ? This is called "pay out".

Pay out ratio can never be close to 100% because Google has costs to run its AdWords / AdSense programs and needs to make some profit! Today, nobody really knows for certain what the ratio is for AdSense, however we assume it is between 50 % and 60 % !

So if someone clicks on the second ad, you will earn something close to $ 1.30 

Lately, Google introduced CTR as a new criterion to define an advertiser's position in the list. Now the AdWords / AdSense algorithm uses CTR * Max Bid to order publishers using the same general logic as shown in this example.