AdWords uses an auctioning process to figure out which ads show up for certain key phrases.  Based on the level of competition for that phrase, and your bid amount, Google determines at what position your ad should show up.  There are other factors that go into the algorithm as well, such as how “successful” your ad has been at getting users to “click through”.  This should not be surprising as Google has an incentive to reward ads that have a higher click-through as these are the ads that make them more money.

There’s a certain psychology that goes into the bidding process when using AdWords.  I’ve seen many people think along these lines (and have done it myself in the past):

Step 1:  Find an attractive search phrase that is targeted for my business and that will generate great potential leads.

Step 2:  Determine the price that I will need to pay to get into the top spot on Google for that search phrase.

Step 3:  Place a bid that will likely increase the chances of getting into the top slot (or pretty close).

The rationale here is simple:  If the search phrase is highly relevant, and you’re willing to pay a price that is far below the “value” that you’re going to get, might as well bid high to get the top spot to drive as much traffic as possible.  The theory is that the #1 spot in the paid listing area will drive much more traffic than the other ones.  Though it is easy to believe this (because this is definitely the case in the natural search area, it is not necessarily the case for the paid search area.

Jason Miller wrote an article recently titled “Bidding On Top Ad Spot A Waste Of Money?” in which he cites a recent study involving measuring click-through rates for paid search.  This study concludes that “While there is some advantage to the number one and number three slots, all positions in the listings show roughly the same click-through rates.”

If you’re spending any money on AdWords, this should be of significant interest to you.  If the click-through rates are about the same, you can get away with bidding less than the amount necessary to get to the top spot.  If this weren’t reason enough to bid lower than what is required to get the #1 spot, there’s an even better possible reason.

There is a chance that the actual quality of users that click through for the lower ranked ads might be higher than those that click on the ad that is in the top spot.  Why might this be?  Well, think about it this way.  The user that clicks on the #2 or #3 spot on the paid search area will likely be a bit more determined to find what they are looking for.  There is a possibility that these users are more qualified and more likely actually looking for what you have to offer.  Granted, this particular argument doesn’t have any evidence to back it up, but that doesn’t mean it’s not possible.

In short, I’d suggesting thinking about how much you are bidding for your paid search campaigns and see if you can get away with lowering your bid (and dropping a couple of spots) and see if that has any measurable impact on your traffic.  If you have already tried this, or have an opinion on the matter, please leave a comment.  Would love to hear your thoughts.