Get Off My Portfolio Algorithms

"There is a time in every man's education when he arrives at the conviction that envy is ignorance; that imitation is suicide; that he must take himself for better, for worse, as his portion; that though the wide universe is full of good, no kernel of nourishing corn can come to him but through his toil bestowed on that plot of ground which is given to him to till." - Ralph Waldo Emerson, 'Self-Reliance'

Back in late 2002 when Efficient Frontier started doing SEM work for clients, it was the only firm talking about applying quant hedge fund portfolio algorithms to the optimization of paid search campaigns. The few SEM firms who were more than a couple guys in their pyjamas made no reference to portfolio optimization, sticking instead to the rules-based mantra that their products are based on.

As Efficient Frontier took the market by storm, however, some SEM competitors (all of them rules-based) decided that, rather than just sit there while being beat by EF in competition left & right, they would start talking about portfolio optimization as well in the hopes that advertisers wouldn't know the difference between:

a) portfolio algorithms that use historical cost and revenue data to model all yield scenarios across the keyword portfolio and automatically, consistently pick the optimal set of bids (Efficient Frontier's approach); and

b) portfolio optimization as practiced by rules-based SEMs(Did-It, Performics, Inceptor, 360i and AtlasOnePoint). When anyone other than Efficient Frontier talks about applying a portfolio approach to keyword management, what they mean is simply applying a rule(s) to a bucket of keywords and hoping that a human can tease a little more performance out of a few head-end keywords by hand.

As shown in this two-keyword bidding example, applying 1+ rules to a bucket of keywords is the perfect way to doom your paid search campaign to mediocrity, yet that's exactly what the above firms (and others) are trying to pass off as portfolio optimization.

While Efficient Frontier has solidified its lead as both the largest SEM firm worldwide and the one delivering the best ROI, the competitor in me gets angry seeing desperate competitors making false claims.

As I reported November of last year, there are many underhanded tactics EF competitors use, but falsely claiming portfolio optimization capabilities hurts the SEM industry the most because it sets improper expectations that result in advertisers giving up hope that better ROI can be had from their campaigns.

Anyone who claims to be capable of applying portfolio theory to the optimization of keyword sets should be able to provide proof. For starters:

Appropriate math backgrond - our founder, Anil Kamath, was VP of International Equity Trading at D.E. Shaw, a hedge fund that specializes in using quantitative models for program trading. Anil has a master's & a Ph.D. in computer science from Stanford and has authored multiple technical papers in the area of optimization. He also is the first and only person in the SEM space to file a patent for the application of portfolio algorithms to the optimization of paid search campaigns. If the SEM firm doesn't have anyone with a quant hedge fund background, then you should run away. As detailed recently in this great Business Week article, great quantitative/algorithm minds are extremely rare, and if your SEM firm's braintrust hasn't cut its teeth investing billions of dollars in the global equity markets you can bet they won't have the skills you'll need to beat your competitors at anything other than trading baseball cards.

Predictive Modelling Capabilities - the natural result of a set of algorithms that can leverage historical and actual impression/click/cost/revenue/margin data across a large keyword set is - surprise! - predictive models that can show the advertiser all of the possible efficient operating points for that keyword set. If an SEM firm claims portfolio optimization capabilities, ask to talk to a client of theirs and ask that client a) if they have access to keyword portfolio ROI models specific to their account; b) if those models are accurate; and c) if those models can look backwards and forwards.

Accurate Google AdWords Click Model - applying portfolio algorithms to PPC is useless unless your algorithms can see through Google's opaque marketplace. Unlike Yahoo Search Marketing (at least until Panama), AdWords doesn't tell you what CPC will yield what bid position, and if you simply take Google's Traffic Estimator at its word you'll be basing decisions on data that's off by 40%+, 70% of the time. Ask the SEM firm how they estimate traffic on Google, and if they say "Google has a handy traffic estimator", run away and don't look back. Now that I'm telling you this, though, expect all SEM's to start saying the same thing - so go to the next level of proof and ask one of their clients whether or not they get access to keyword-level *and* portfolio-level traffic forecasts, and whether those forecasts have been accurate over time. I'll bet if you do this that you get blank stares back from the SEM firm.

Efficient Learning Methodologies - if an SEM is truly leveraging portfolio algorithms, then in addition to getting more volume and/or margin out of a campaign, they should be able to learn about new keywords, tail keywords, and under-explored keywords efficiently - meaning spending as little as possible and in a controlled fashion to learn as much as can be learned about those keywords. What does proof of this look like? Well, for starters they should be able to explain what their learning methodology is, how it's built into their system, and how they leverage sparse data sets. If they can't do that, show them the door or expect any learning they get on your keyword portfolio to be incomplete... or expensive.

Effective Recency Strategy - in keyword optimization, recency is the notion of weighting recent data more or less heavily than historical data to take into account seasonality, inventory, promotions, and market volatility, among others; practically, it should also take into account inaccurate or incomplete historical data that if taken at face value would lead any optimization astray. Here again, don't just throw the SEM firm a softball; instead ask the open-ended question "What does recency in search marketing mean to you and how do you take it into account when optimizing campaigns?" If their answer isn't satisfactory, head for the hills.

Rules Are For Fools - if an SEM says they can do portfolio optimization but has a self-service product demo filled uniquely with references to keyword or campaign-level rules, consider this the SEM equivalent of the bait and switch and tell them to get back to you when they've made up their mind.

I know a lot of this sounds pretty complex, and I imagine some of you might think that it's unreasonable to expect the SEM salesperson you're talking to to know enough to speak at this level of detail - heck, the same might even be said of most online marketing professionals. I know that for me, learning about what portfolio algorithms are and what they aren't has been a multi-year learning process.

Nevertheless, knowing what it actually means to effectively apply modern portfolio theory to your paid search campaigns will go a long way to determining your success in search today, in other online marketing channels tomorrow, and in radio, TV and print several years from now.