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Economics of internet

Assume the following data is from a keyword ad campaign run at Yahoo by a national transmission repair shop AAAGearFixer. You are consulting with them, and they have told you they are only interested in the possibility of ads that run in the top 3 slots.

Tested Keywords:
Exact phrase: transmission
Exact phrase: transmission repair
Exact phrase: bad gears

Assume that a transmission repair yields a contribution margin (that is, price over marginal cost) of $215. The company tends to ignore repeat business.

Exact phrase Searches per month Click Through rate: Position 1 Click Through rate: Position 2 Click Through rate: Position 3 Conversion rate to service following click
transmission 350,000 3.0% 1.0% 0.2% 1%
transmission repair 55,000 5.0% 3.0% 2.0% 2%
bad gears 1,500 20.0% n.a. n.a. 5%
Assume data is accurate. No ads showing on Yahoo for "bad gears" prior to test.

Exact phrase Max High Bid
Position 1 Max High Bid
Position 2 Max High Bid
Position 3 Max High Bid
Position 4
transmission .75 .57 .56 .52
transmission repair 1.00 .56 .45 .37
bad gears No bids No bids No bids No bids
Actual prices on December 12, 2006. Yahoo bidding tool. Minimum Yahoo bid =.10 for top spot.

Part A: If AAAGearFixer buys the top position for each keyword, how many customers will they expect to acquire per month through this channel?

Part B: If the other bidders do not change their bids, is this the most profitable keyword strategy for AAAGearFixer ?

Part C: Is it a failure of Yahoo's pricing that customer acquisition costs for AAAGearFixer through this online channel seem to be so low relative to customer profitability?

Part D: Assume that adding the "Click to Call" service described in Problem 1 causes an additional 5% of the searchers to place a call and these calls have a 3% conversion rate to new business. Assume the call center can handle 6 calls an hour, regardless of whether the caller becomes a new customer. Due to the skills needed to diagnose a problem, the average wage for the call center worker is $24. Should AAAGearFixer add this feature?

See attached file for full problem description.

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STEP 1

Part A
If AAAGearFixer buys the top position for each keyword, through this channel it can expect to get the following number of customers:

Transmission: Searches 350,000, Click through rate at top position 3.0% and the Conversion rate to service following the click is 1%. To get the number of customers AAAGearFixer gets from the word transmission is 350,000 X 0.03X0.01 = 105
Transmission repair: Searches 55,000, Click through rate at top position 5.0% and the Conversion rate to service following the click is 2%. To get the number of customers AAAGearFixer gets from the word transmission repair is 55,000 X 0.05X0.02= 55.
Bad gears: Searches 1,500, Click through rate at top position 20.0% and the Conversion rate to service following the click is 5%. To get the number of customers AAAGearFixer gets from the word transmission is 1,500 X 0.2X0.05= 15
Hence to find the total number of customers they expect to acquire, we add 105 + 55 + 15 = 175.

STEP 2

Part B: If the other bidders do not change their bids, this is the most profitable keyword strategy. The reason for this is not far to see. Any other combination would mean lowering the volume of the business generated.
Let us consider the current choice of AAAGearFixer as we have found above the business generated from the word transmission is 105 ...

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