RealMoney Silver - AdSense Makes Increasingly Less Sense for Google

AdSense Makes Increasingly Less Sense for Google
By Sramana Mitra
RealMoney.com Contributor
8/2/2007 8:00 AM EDT

Google (GOOG) has two main businesses, AdWords and AdSense. With the acquisition of Doubleclick, this will become three.

AdWords, which has been close to 60% of its business so far, is a keyword search-based advertising platform, whereby advertisers can place text ads against Google searches. AdSense, in contrast, places text ads on publishers' sites based on keywords of the text that is published on those sites. The concern here lies with the latter's ability to maintain its current position against new competition in an expanding Internet advertising world.

A Technical and Business Innovation

Google's AdWords business model is very powerful. Someone searches for a keyword, and Google places the ad on the right pane next to the search results. The person clicks on one, and the advertiser pays for those clicks.

Since a keyword search is a pretty robust measure of people's interest, this is a high-impact advertising method, and Google's founders have been labeled as geniuses for inventing it. It is as powerful a business model innovation as it is a technological one.

AdSense, however, is a different story.

Sticking It to the Little Guy

AdSense has two problems from the perspective of a small publisher:

The "cost per click," or CPC, business model -- someone has to not only "view" the ads, but actually click on it, for the publisher to get paid -- is too advertiser friendly and not adequately publisher friendly. The advertiser gets to show the ad to an audience, basically for free, without compensating the publisher.
They want the fairer "cost per mille," or CPM, model -- someone "desirable" simply needs to view the ad for the publisher to get paid -- where this freebie is taken away. (Granted, the CPM model is only effective if you have a very targeted audience.)

The "cut" that Google takes off the ad revenues a small site generates is too high. They want this to go down.

Getting a Sense of Revenue Share

How much is AdSense's share in Google's business? To find the answer, we scanned Google's balance sheet and cash flow statement for the past year, including those of the last quarter (second-quarter 2007). Predictably, there is no indication of AdSense's figures.

Analysts, however, maintain that the figure hovers between 37%-44%. A somewhat clearer picture emerges in the April 21-27 issue of The Economist, where it is revealed that AdSense adds about 10%-20% to Google's profit margin, while the share of AdWords is a phenomenal 60%. (Note: The Economist figures are of profit margins, not revenues.)

However, going by analysts' estimates of revenue share, the perplexing question is, how can Google possibly earn from AdSense as much as about 40% of its revenue when it has to share the AdSense spoils with millions of Web publishers?

No one knows how the revenue is split between Google and publishers, and Google has so far kept quiet on the topic, much to the annoyance of numerous customers.

On Monday, Google lost a major customer, Digg, with over 17 million unique visitors a month. I believe, they will lose many more in the next 18 months, as competitors like Microsoft (MSFT) , Yahoo! (YHOO) , Ask, Time Warner (TWX) , NBC, etc. get their ad network strategies together. Clearly, AdSense is Google's weakest link, and if indeed it is ~40% of revenue, this should hurt at least a bit, even though AdWords will continue its triumphant run.

Google, by the way, does not send AdSense payables to publishers unless it crosses a threshold amount of $100. Unlike popular Web sites that earn numerous times that amount every month, this is not the case for millions of small Web sites who have to toil hard (in some cases for years) to actually lay hands on their AdSense earnings.

According to an estimate, this withheld AdSense payment was about $370 million at the close of fiscal-year 2006. Now that is a decent sum of cash -- about 3.5% of its 2006 total revenue -- which in all likelihood must have grown more by now. Of course, it still isn't revenue, since it will eventually have to be paid out. Nonetheless, it is a sizeable cash cushion that can come in quite handy.

Flawed Thinking

So far, Google's AdSense program has had virtually no competition. Further, such is its reach and inventory, that despite fears of an online publishing glut and text-ad blindness, the fact remains that Web publishers still believe they will earn cash by displaying AdSense ads on their Web sites. They have little choice.

How much does it cost Google to display these ads? Apparently not much, since AdSense is nothing but an additional option exercised by AdWords advertisers. This means that as long as AdWords ads are flowing in, there is probably no significant cost involved to sell AdSense Ads.

However, the fallacy in Google's thought process is that in skewing their offering too much in favor of advertisers, it will lose the publishers, especially the big ones who generate most of their revenue.

Growth Exposes Weakness

According to a PwC analysis, world over, the Internet will remain the fastest-growing advertising medium, with a projected 18.3% compound annual growth rate reaching $73 billion in 2011.

By that time, online advertising will comprise 14% of the global advertising market. An estimate has it that online brand advertising growth, at a 20% CAGR from 2006-2010, will exceed online-search-advertising growth over the same period. This is why Google bought Doubleclick, which is more a brand/display-advertising-oriented solution.

This growth will usher in new and different players, and as a result, publishers will realize that they have a much more lucrative opportunity in monetizing their content via non-AdSense channels that do an effective job of procuring high-CPM advertisers in search of strong brand-advertising venues.

AdSense is vulnerable. However, Google can easily ensure that it is not. If it comes up with a compelling Doubleclick-based solution to serve the publishers audience-targeted, high-CPM display advertising, they will welcome such a solution. It will violently cannibalize AdSense, but hopefully, it will save Google.

As the Russian General who defeated Napoleon realized the need to concede Moscow to save Russia, so would Google need to realize that AdSense's days are numbered.