Google is doing a marvelous job at keeping the Quality Score factors and calculations a secret. Hard to believe, but it is working.
Naturally, if something is being kept a secret, people all over the world are trying to uncover it. This is not what we're trying to do here; we are simply trying to explain in more or less plain English how an assumed Quality Score value and assumed competitors' bids affect your ad's ranking and your CPC. The only thing we rely on is Google's very own explanation.
According to Google, your ad's position and the CPC are based on the following formula:
Ad Rank = CPC bid x Keyword Quality Score
This is how Google defines it: (Google AdWords Learning Center: Pricing/Ranking: Ad Ranking - Slide 8)
"Three advertisers are running ads on the same keyword. Each advertiser has a different CPC bid and Quality Score.
The Quality Score is not visible in your account. Google calculates a rank number by multiplying the CPC bid by the Quality Score.
Advertiser A has the highest rank number (0.72). This means they get position #1.
Next, Google calculates how much to charge each advertiser for a click.
The CPC is the minimum amount needed to maintain a rank number higher than the next lower ad.
This is one cent more than the amount that would result in a rank number that would cause the ad to appear in the next lower position.
So for advertiser A Google divides advertiser B's rank number (0.65) by A's QS (1.8).
The result is the CPC that would cause advertiser A's ad to appear in advertiser B's position, $0.36.
To appear above that position, Google adds 1 cent to this amount. This results in the actual CPC of $0.37.
For advertiser B, Google divides advertiser C's rank number (0.38) by B's QS (1), which equals $0.38; The amount that would cause advertiser B's ad to appear in advertiser C's position.
To appear above that position, Google adds $0.01 to this amount. This yields $0.39.
Notice that advertiser A is paying less than advertiser B, even though they are in a higher position.
This happens because advertiser A has a higher QS.
Finally, we have advertiser C.
Since there is no other ad appearing below advertiser C's ad, Google simply charges C the minimum bid for that keyword based on its QS, in this case, $0.01."
Since the above probably isn't the easiest explanation, let's look at a simplified example (follow the colors):
|Advertiser||CPC bid||QS||Rank Number||Position||CPC|
|A||$1.50||1.9||$1.50 x 1.9 = 2.85||1||1.75/1.9 + $0.01 = $0.93|
|B||$1.75||1.0||$1.75 x 1.0 = 1.75||2||1.36/1.0 + $0.01 = $1.37|
|C||$1.70||0.8||$1.70 x 0.8 = 1.36||3||$0.05|
Advertiser A's QS is 1.9, his Rank Number 2.85 ($1.50 x 1.9) (highest of all, which gives him ad position #1).
Advertiser B's QS is 1.0, his Rank Number 1.75 ($1.75 x 1.0) (second highest, which gives him ad position #2).
Advertiser C's QS is 0.8, his Rank Number 1.25 ($1.75 x 0.8) (lowest, which gives him ad position #3).
To calculate the CPC, we do the following:
Take Advertiser B's Rank Number (1.75) and divide it by Advertiser A's Quality Score (1.9), which results in $0.92, add $0.01, and you have $0.93, Advertiser A's final CPC.
Do the same to calculate Advertiser B's CPC:
Take Advertiser C's Rank Number (1.36) and divide it by Advertiser B's Quality Score (1.0), which results in $1.36, add $0.01, and you have $1.37, Advertiser B's final CPC.
Advertiser C is the last competitor, so he only pays the minimum bid for this keyword, let's say $0.05.
Yes, as in Google's example, Advertiser B is paying more than Advertiser A: although his bid is higher, his lower Quality Score increases his CPC.
Of course you can't really apply the above formula since your Quality Score is only known to Google and you don't know your competitor's bids or Quality Scores either. You can only guess by searching for your keyword, see whose ads show up and try to analyze their ads and their websites.
But if you play with the numbers, you will see that altering the Quality Score has a dramatic impact on your final CPC: Imagine you are Advertiser B and your Quality Score increases to 1.4 — Your CPC would be calculated like this:
1.36 (C's Rank Number) / 1.4 (instead of 1.0) = $0.97 + $0.01 = $0.98.
It would also increase Advertiser A's CPC, so again the #1 spot might not be the best after all. It adds up.
Our blog post on how to have fun with Excel and Google's Quality Score.