Ad Rank = Quality Score x Maximum Cost-per-click (CPC) bid Amount

All the Google Ads relevant to a keyword are ranked based on their Ad Rank. The Google Advert with the highest Ad Rank gets the top spot, the ad with the next highest ad rank gets the second spot, and so on till the last eligible ad for the auction, or the last available position in the displayed ad list.

Now, what you actually pay for a Google Ad is basically the lowest amount required to beat the Ad Rank of your competitor below you. It’s called the discounter and is one of the most important aspects of determining the Google Adwords Cost for your business. Here’s the formula Google Adwords uses to calculate the actual cost-per-click

Actual CPC = Ad Rank below yours/Quality Score + 0.01

Let’s look at it in detail, with an example and you’ll see why it’s so important to improve your Ad Quality Score

Let’s say you have Ad Quality Score (QS) of 8 for your Google Ad for the keyword “san+francisco+beach+house+for+rent”. Let’s say you want to rank at 1st position for this keyword, no matter what, and you bid an exorbitant amount of \$100 per click. So your Ad rank is,

Ad Rank = \$100/click x 8 QS = 800

So a competitor would need to have an Ad Rank of more than 800 to beat you. It means that even if he has the maximum possible quality score of 10, he would still need to bid at least \$80.01 to be on top. Instead, let’s say he bids a realistic amount of \$10, then the amount you pay would be as follows,

Ad Rank below yours = 100 (\$10/click x 10 QS)

So Actual CPC = 100 / 8 + 0.01 = (100 Ad Rank below yours/8 Your QS + 0.01) =  \$12.5/click

As you can see, even though you bid \$100/click, you only have to pay \$12.5 for your position.

Now, if your Quality Score for that auction was 10, then the amount you pay would be

Actual CPC = 100/10 + 0.01 = (100 Ad Rank below yours/10 Your QS + 0.01) =\$10.01/click

In fact you can actually end up paying LESS than the spots below you.

Let’s say you bid the same crazy amount of \$100 per click, get the top ad placement and here are the next 3 advertisers in the google ad listing for your target keyword

Position 2 : QS = 5 for \$10 bid amount

Position 3 : Qs = 7 and \$7 bid amount

Position 4 : QS = 5 and \$9 bid amount

Now let’s look at their Ad ranks and minimum bid amounts you need to pay to beat theirs, assuming your Quality Score =8 , as before

Position 2:

Ad Rank = 50 = (QS 5 x \$10/click)

Actual CPC = \$6.26 = 50/8 + 0.01 = (50 Ad Rank below/ 8 Your QS)+0.01

Position 3:

Ad Rank = 49 = (QS 7 x \$7/click)

Actual CPC = \$9.81 = 49/5 + 0.01 = (49 Ad Rank below/ 5  QS of position 2)+0.01

Position 4:

Ad Rank = 45 = (QS 5 x \$9/click)

Actual CPC = \$6.44 = 45/7 + 0.01 = (45 Ad Rank below/ 7 QS of position 3)+0.01

As you can see, you need to pay only \$6.26/click for being in position 1, compared to what you would have to pay if you were in position 2 or 3. The same holds true if you would have appeared in other spots too, such as 2, 3 and so on. In the above auction, if you had appeared in spot 2, you would have paid less the advertiser in spot 3 and so on.

You can also read our Complete Guide to Adwords Remarketing and Complete Guide to Adwords Conversion Tracking.