Understanding the Law of Diminishing Returns in Digital Marketing

The concept of diminishing returns is a cornerstone of economics, but its application is equally important and critical in the world of digital marketing. While many businesses embark on PPC campaigns with the belief that a consistent increase in budget will result in a proportionate increase in leads, the reality is far more nuanced.

This principle, often referred to as the “law of diminishing returns,” dictates that as you continue to increase your investment in a marketing channel, the efficiency of that investment will eventually decrease, leading to a higher Cost Per Acquisition (CPA) for each new customer. Understanding this fundamental dynamic is essential for any business aiming to scale its digital advertising efforts effectively.

At the heart of the matter lies the nature of audience targeting. Every digital marketing channel, including Google Ads, starts by identifying and bidding on the most valuable and qualified audiences. For a search-based platform like Google, these are the users who are actively searching for your exact service or product with high-intent keywords. The algorithm first targets these high-conversion, low-cost “low-hanging fruit” opportunities, such as someone searching for an “all-inclusive family holiday to Dubai.”

As you increase your budget, you’re essentially asking the system to find more people to show your ads to. To do this, the algorithm is forced to:

• Enter auctions for more competitive keywords.
• Bid higher to outrank competitors.
• Expand its targeting to slightly less qualified audiences, like those searching for a generic term such as “flights to Dubai.”

This expansion inevitably drives up the average cost per click (CPC) and, consequently, the CPA. The cost of acquiring your 100th lead is typically lower than the cost of acquiring your 1,000th lead because the later leads come from a more saturated and competitive segment of the market.

This principle is not unique to Google Ads; it manifests across various digital marketing channels. On social media platforms, for instance, a successful ad campaign might initially generate a flood of low-cost conversions from a highly engaged lookalike audience. However, as you continue to increase the budget, you begin to exhaust that core audience. The algorithm then has to reach a broader, less targeted group of users who may not have the same level of interest. The result is a gradual decline in engagement rates and a rise in the cost per conversion.

Similarly, in email marketing, the initial conversions from your most loyal subscribers are quick and easy to secure. But as you continue to email the same list, the open rates and click-through rates will eventually decline as the audience becomes fatigued, making each subsequent conversion more difficult and costly to achieve.

Understanding the Google Ads Auction: A Battle of Value, Not Just Bids

To truly grasp how diminishing returns play out in Google Ads, you must first understand the inner workings of the ad auction. Contrary to a traditional auction where the highest bidder always wins, the Google Ads auction is a battle of value, not just bids. Every time a user types a search query, a lightning-fast auction takes place in a fraction of a second.

Google’s system doesn’t simply award the top position to the advertiser willing to pay the most. Instead, it determines a winning ad and its position based on a formula called Ad Rank:

AdRank=BidAmount×QualityScore×AdExtensionsImpact

This formula reveals the true power of the system. While your bid is a key factor, it’s not the only one. Your Quality Score acts as a multiplier. It is a score from 1 to 10 that reflects the overall relevance and quality of your ad and landing page. A high Quality Score can allow you to win a top ad position for a lower CPC than a competitor with a higher bid but a lower Quality Score. This is Google’s way of ensuring a positive user experience by rewarding advertisers who provide the most useful and relevant content.

The Ad Extensions Impact refers to how ad assets like phone numbers, sitelinks, or location details will affect the overall user experience and your ad’s performance.

The Impact of a Target CPA (tCPA) on Campaign Volume

Adding a Target CPA (tCPA) to a PPC campaign is a common practice to gain more control over your ad spend. However, it’s a decision that directly impacts volume and introduces a different dynamic to the law of diminishing returns.

Applying a tCPA to a campaign often leads to a drop in conversion volume. By setting a specific cost constraint, you are essentially telling Google’s algorithm, “Get me as many conversions as you can, but don’t spend more than £X on each one.” This forces the algorithm to be more selective, prioritising ad auctions that have a high likelihood of converting at or below your target. It will actively avoid more competitive or less predictable auctions, which may have previously contributed to your total conversion volume, but at a higher CPA. By limiting the eligible auction pool, your campaign’s reach and its total number of conversions decrease.

When you remove a tCPA from a campaign or increase its target, you’re freeing the algorithm from this cost constraint. This allows it to bid more aggressively on a wider range of auctions, including those that were previously too expensive. This broader participation in the ad auction allows the campaign to capture more traffic and, as a result, drives an increase in conversion volume.

When to Use, Remove, or Adjust a tCPA

The decision to add or remove a tCPA isn’t about right or wrong; it’s about timing and strategy.

• When to Add a tCPA: The right time to add a tCPA is when your campaign has a history of consistent conversions – ideally at least 30 conversions in the last 30 days. This gives the algorithm enough data to learn what works and what doesn’t. You should also have a clear understanding of a profitable CPA for your business.
• When to Remove a tCPA: Consider removing a tCPA if your campaign is new and lacks sufficient conversion data, or if your primary goal is to maximise visibility and reach, not to hit a specific cost target. A “Maximise Conversions” strategy can be more effective in these scenarios, as it prioritises volume over cost efficiency.
• Adjusting a tCPA when Volume is Limited: If your campaigns are limited by your current tCPA, it means the algorithm is struggling to find conversions at your set price and is holding back delivery. To fix this, you have a few options:
  • Increase the tCPA Target: This is the most direct solution. A low tCPA can be too restrictive. By increasing your tCPA by 10-20%, you give the algorithm more room to bid in more competitive auctions, which can unlock new opportunities.
  • Improve Quality Score: A high Quality Score allows you to get a better ad position for a lower CPC. By improving your ad relevance and landing page experience, you are helping the algorithm meet its tCPA target more easily.
  • Broaden Your Targeting: If your audience is too narrow, the algorithm may not have enough auctions to work with. Try expanding your keyword match types, adding new, relevant keywords, or broadening your geographic targeting.

Best Practices to Mitigate Diminishing Returns

Understanding the auction and the law of diminishing returns is the first step; the second is to implement a strategy to combat its effects. The goal is not to eliminate diminishing returns – as that is impossible – but to push back their onset and make your budget as efficient as possible for as long as possible.

1. Focus on Quality Score and Conversion Rate Optimisation (CRO): This is your most powerful lever. By consistently improving your Quality Score, you can lower your CPC and increase your Ad Rank. A higher Quality Score is a result of three key components:
   • Ad Relevance: Ensuring your ad copy is directly related to the user’s search query.
   • Expected Click-Through Rate (CTR): Writing compelling ad copy that encourages clicks.
   • Landing Page Experience: Creating a fast-loading, mobile-friendly, and highly relevant landing page that makes it easy for the user to convert.

Simultaneously, relentlessly optimise your conversion rate. A higher conversion rate means you’re getting more leads from the traffic you’re already paying for, which directly lowers your CPA and buys you more room to scale.

1. Refine Your Keyword Strategy with Long-Tail Keywords: As you increase your budget, avoid the temptation to just bid on broad, expensive keywords. Instead, focus on expanding into specific, high-intent long-tail keywords (e.g., “family holidays to Dubai” instead of just “Dubai holidays”). These keywords have lower competition, are less expensive, and attract users who are much closer to making a purchase decision. This ensures that even as you scale, you are still targeting a highly qualified audience.
2. Diversify Your Marketing Channels: The most effective way to combat diminishing returns in one channel is to not rely solely on it. As your Google Ads campaign starts to see a rise in CPA, reallocate a portion of your budget to other digital marketing channels. This could include social media advertising (Facebook, Instagram), content marketing, email campaigns, or SEO efforts. By expanding your footprint, you can reach new audiences and find new “low-hanging fruit” opportunities that provide a better return on ad spend. A diversified strategy creates a more resilient and sustainable growth model for your business.

In conclusion, the law of diminishing returns is an unavoidable part of digital marketing. However, by embracing a deep understanding of platforms like the Google Ads auction and implementing strategic best practices – such as focusing on Quality Score, refining your keyword strategy, and diversifying your channels – you can effectively mitigate its impact and build a long-term, profitable digital marketing engine for your business.

Frequently Asked Questions (FAQs)

What is the “learning phase” for a Google Ads campaign?

The learning phase is a period of roughly 7-14 days after a new campaign is launched or a significant change is made (like adding a tCPA) but this can last up to 4-6 weeks. During this time, Google’s algorithm is actively gathering data and testing different ad placements, bids, and user signals to find the most efficient way to achieve your campaign’s goals. Performance may fluctuate during this phase, and it’s important to avoid making major changes to allow the algorithm to learn effectively.

How do I know what a “good” tCPA is for my campaign?

A “good” tCPA is entirely dependent on your business’s financial goals and historical data. A common best practice is to first run a campaign on “Maximise Conversions” for at least 30 days to establish a baseline. You can then use your average CPA from that period as a starting point for your tCPA. Setting a target too low from the start will often choke your campaign’s volume, as the algorithm will not be able to compete in enough auctions to deliver a sufficient number of conversions.

Why would I use a tCPA instead of just “Maximise Conversions”?

While “Maximise Conversions” is an excellent strategy for gathering data and maximising volume, it does not constrain your costs. This can lead to a rising CPA as you scale, a clear sign of diminishing returns. A tCPA allows you to actively control and stabilise your cost per conversion, ensuring that your ad spend remains profitable even as you increase your budget.

What should I do if my campaign is consistently overspending my tCPA target?

If your campaign’s actual CPA is consistently higher than your tCPA target, it could be a sign of a few issues. First, your tCPA may be unrealistically low for your industry and competition. Consider gradually raising the target. Second, it could be a sign of a low Quality Score, poor ad relevance, or a low-converting landing page. Focus on optimising these elements, as a more efficient campaign will naturally have a lower CPA.

Can I use tCPA on a brand new campaign?

It is not recommended to use tCPA on a brand new campaign. The algorithm needs a significant amount of conversion data to learn from before it can effectively optimise towards a tCPA target. Starting with “Maximise Conversions” will allow you to build up this data, establish a baseline CPA, and then transition to a tCPA strategy once you have a solid foundation.

Does a “Limited by Budget” status always mean I need to increase my budget?

Not necessarily. While the “Limited by Budget” status can be a signal to increase your budget for more volume, it can also be a sign that your tCPA is too low. In a tCPA campaign, the algorithm may stop spending if it can’t find enough conversions at your target price. Before increasing your budget, try raising your tCPA target or improving your Quality Score to give the algorithm more room to work.