Andy McIlwain @ andymci.com

Q. Keyword grouping can be hard. From a top level perspective, what’s your process for grouping?

Larry: Here’s a high-level overview of my strategy:

1. Start with broad keyword research. Assemble and aggregate keyword data from as many sources as possible, including Web analytics and keyword tools. Starting with plenty of keyword data allows you to test various avenues and determine which pockets of keywords perform best—it’s difficult to predict which keywords will actually end up working the hardest.
2. Form top-level keyword groups. These should be fairly broad and large. A good rule of thumb is to form top-level groups around your main offerings. So if you sell baked goods, top-level groups might include “cake,” “pie,” and “cookies.”
3. Create smaller subgroups. Each top-level group will break down into more specific groups of keywords—usually with a modifier tacked onto the offering. Subgroups under the cake group might include “chocolate cake,” “birthday cake,” “cupcakes,” etc. Do this with all your top-level groups and you’ll start to see a taxonomy, or hierarchy, emerge.
4. Keep going until your low-level groups are very small and tightly related. Pay particular attention to verbs and modifiers within a search query, which can reveal different layers of intent on the part of the searcher. The inclusion of transaction-oriented terms like “buy” and “compare prices” indicates someone late in the buying cycle. These clusters make great, highly targeted ad groups.

The entire article goes into much more depth, and can be found here: How To Group Your Keywords; Plus: Q&A With WordStream’s Larry Kim