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How Search Relevancy and Ad Optimization are working together to improve advertiser results.

I am often asked by traffic people to comment on the differences between buying clicks from Google through the Adwords program and earning clicks from Google via the Organic Listings. Putting aside for a moment the fact that method #2 makes me feel like Robert Duvall in a Napalm Storm (lol), the reality is that it comes down to ROI. Assuming you know what you are making per click, the question boils down to what it costs you to buy a click, versus what it costs you to produce a page that will garner a similar click. I must draw attention to the word "similar", since, in my experience, there is a qualitative difference between the two. But, that difference is shrinking. Here's why.

Google has been working hard to improve the quality of its search results with, among other efforts, the institution of Trustrank.
Now that trust factors figure into determining which organic listings Google displays on its results pages, relevancy and searcher satisfaction are increasing dramatically. The inevitable consequence of this is a reduction in average search time and a reduction of advertiser impressions per search. Fewer impressions sounds like a bad thing for advertisers, but it's not.

Many advertisers falsely believe that Adwords ads
displayed on Google results
pages are intended to compete with organic
listings. This is not true. There is also the perception that the
Adwords bidded-click system is designed to extract maximum revenue
from the advertiser, with little concern for delivering the advertiser's
ads to their most likely customers. This is also false.

The standard of performance Google has been working
towards is that every search should end as quickly as possible,
for having been satisfied. In some cases, the end
of that search will be an organically listed Web site. In other
cases, it will be an Adwords advertiser's site. But how can Adwords
advertisers compete with increasingly relevant organic listings
of increasing quality? The answer is they don't have to.

Just as organic listings are continuously optimized
for relevancy and trust, so too are Adwords ads optimized on the
basis of click-through rate (CTR).

Rather than assess the appropriateness of displaying
an Adwords ad on a given results page on relevancy alone,
Google's automated CTR optimization ensures that only ads that are
performing for advertisers are displayed. This
is why click-based advertising is such an improvement on CPM-based
advertising for the advertiser. Unless you are advertising for visibility
alone, and have no desire to bring visitors to your own site, what
you care about is having people click on your ad.
Thus, it is not that the ad with the highest bid will be displayed,
but the best performing ad. A high click bid but no clicks is as
worthless to Google as it is to the advertiser.

CTR performance figures into a "Quality Score":

"We want to ensure that your keywords get
a fair chance to run and that we do all we can to properly gauge
their performance. We use a Quality Score to do this. Each keyword
is given a Quality Score based on data specific to your account,
including your keyword's clickthrough rate (CTR), relevance of
ad text, historical keyword performance, the quality of your ad's
landing page, and other relevancy factors.

Quality Score = keyword's CTR + relevance
of your ad text + historical keyword performance + other relevancy
factors... more

      The following diagram provided
by Google illustrates the process of CTR optimization and determining
the Quality Score of a keyword:

Some advertisers feel that the Quality Score is
somehow a judgement against them. Quality Score benefits the searcher,
because it prevents results pages from being crowded with irrelevant
ads. But it also benefits the Adwords advertiser, because it spares
them the wasted expense of paying for clicks from anything but the
most interested prospective customers.

 Another trend that is benefiting Google Adwords advertisers is
the dramatic growth of the Google Network. What is the Google
Network?

"The Google Network is made up of sites and products
who partner
with Google to publish targeted AdWords ads via their site
or product. Google can target your ads to search results and relevant
web content on a wide variety of sites and products to help you
reach a vast and highly-targeted audience... more

The Google Network is growing by leaps and bounds, and benefits
Adwords advertisers in the following ways:

1. It increases impression opportunities for Advertisers beyond
   Google search results pages.
2. Ads are displayed on destination Web sites,
   where prospective customers are closer to finding what they want
   and where they will spend more time, thus creating still more
   impression opportunities for advertisers.
3. Google Network sites provide a rich context for even finer,
   more specific targetting.
4. The wide topical and geographic reach of the Google Network
   gives Adwords advertisers access to markets and customers they
   might never otherwise have reached.
5. Adwords advertisers are able to connect with prospective customers
   even when they have not used Google search.

Members of the Google Network participate in a program called Google
Adsense.

Learn more about Google
Adwords.