AdSense Makes Increasingly Less Sense for Google

Google (GOOG - commentary - Cramer's Take) 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:

1. 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.)

2. 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?

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At the time of publication, Mitra had no positions in the stocks mentioned, although positions may change at any time. Sramana Mitra is an entrepreneur and a strategy consultant and authors a popular blog on those topics and more, Sramana Mitra on Strategy. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Mitra appreciates your feedback; click here to send her an email.