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This article continues on from the previous Traffic Quality - part 5 article. It goes through the math on why taking low conversion rate clicks is good for Google. It also relates to 3 ficticious domains, domain1.com, domains2.com and domain3.com from the previous article.
For example, let's imagine that the quality floor is 10% of all clicks need to convert for an advertiser for them to remain profitable. I know that this is a high number but it will make the math easier. The clicks may come from a variety of sources, all of which have been tracked as to their typical conversion rates for that advertiser.
 If Domain1.com has an average conversion rate of 10% then we can accept all clicks from that domain, including the ones that are below the quality floor as the average is 10%. Likewise it just so happens that domain2.com has a higher conversion rate which means that it allows Google to absorb some of the lesser performing clicks from domain3.com.
Let's imagine that the volume of clicks for each of the above domain names is the same. We can now calculate out the formula for the Quality floor for the advertiser:
Scenario 1
Quality floor = (100 x .1 + 100 x .15 + 100 x .05) / 300 x 100%= 11.7%
Scenario 2
Quality floor = (100 x .1 + 200 x .15 + 300 x .05) / 600 x 100% = 9.2 %
Obviously for any given number of clicks from domain1.com and domain2.com we can then calculate out the number of sub-standard clicks that we can accept from domain3.com. For example, let's change the conversion rate for domain3.com to 1% and send 500 clicks from domain1.com and 1000 from domain2.com then to maintain a quality floor of 10% we can send:
Scenario 3
10% = (500 x .1 + 1000 x .15 + Clicks x .01) / (1500 x Clicks)
Clicks = 555 from domain3.com
As we can see the greater the volume of clicks above the quality floor the larger the number of sub-quality converting clicks we can send and yet still maintain a happy advertiser. This formula is very easy to calculate and maximizes Google's ability to earn revenue.
Now let's change the payout rates. Let's imagine that the advertiser is buying 300 clicks for 10 cents and that the parking company takes 80% of this. As we all now know Google smart prices domains with lower conversion rates downwards (say by 20%) so let's take a look at the additional revenue that Google is gaining from the traffic volumes in scenario 4.
Scenario 4
Google Profit = (Revenue from advertisers) - (Payment to parking company)
= ($0.1 x 10 + $0.1 x 15 + $0.1 x 5) - ($0.1 x 10 + $0.1 x 15 + ($0.1 x 5) x .8) x 0.8
= ($1 + $1.50 + $0.50) - ($1.0 + $1.5 + $0.4) x 0.80
= $3.00 - $2.32
= $0.68
What's interesting is that if domain3.com was not smart priced downwards then the Google profit would be:
Google Profit = $3.00 - $3.00 x 80%
= $0.60
The smart pricing function increased the Google profit by an additional $0.08.
Scenario 5
In this case the advertiser wishes to purchase 2,055 clicks at 10 cents per click and Google will maximize the advertiser's spend through the three domains once again. Domain3.com will again have the conversion rate of 1%.
Without smart pricing
Google Profit = 2055 x $0.10 - 2055 *$0.10 x 80%
= $41.10
With smart pricing on domain3.com
Google Profit = 2055 x $0.10 - (500 x $0.10 + 1000 x $0.10 + (555 x $0.10) x 80%) x 80%
Google Profit = $205.50 - $155.52
= $49.98
As I see it here is the fundamental problem. Google is incentivized to smart price domains downwards as this increases their profit line. What's more is that it is also to Google's benefit to ensure that there are a maximum number of clicks for each advertiser as long as the advertiser is kept above the quality floor. These two levers allow Google to manipulate both the advertiser by maximizing clicks and the domainer/publisher by punishing lower quality clicks.
Perfect information combined with enormous computing power has provided Google with the data necessary for the ultimate optimization system. That system involves consuming as many clicks as possible while keeping the advertisers happy. Google then has the ability to "tweak" publisher's payouts via the smart pricing algorithm.
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