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The Bill for Bad Clicks

Jonathan Berr

Click fraud is a $1.3 billion problem that affects Google(GOOG), Yahoo!(YHOO) and Microsoft's(MSFT) MSN, along with publishers and advertisers, according to a report released Wednesday by market researcher Outsell Inc.

Click fraud is a long-standing concern of search engines, who charge advertisers based on the number of times someone clicks on their ads. The problem manifests itself in many ways, such as when someone clicks on the ads of a competitor to drive up their marketing costs. Other times, Web site publishers improperly click on their own ads to get revenue.

The company, which estimates that 14.6% of all clicks are invalid, reached its conclusion from a survey of 407 advertisers who together spend $1 billion annually. Outsell, which pegs the U.S. search market at $5.5 billion, estimates that $800 million in search advertising spending is wasted. The survey also found that 27% of advertisers have cut their spending, on average, by 33% because of concerns about click fraud, equal to $500 million in lost revenue for the search engines.

"That means that the industry -- as fast as it growing -- is being dragged back," says Chuck Richard, Outsell's media analyst. "Because the search engines don't report on their statistics, advertisers are free to dream up whatever numbers that they want."

Click fraud is very hard to quantify because there is no standard definition of what it is, and the problem is hyped by companies who are trying to sell anti-click fraud services. In addition, search engines, which refund money to click-fraud victims, don't provide advertisers specific information about which clicks were invalid, says Kevin Lee, former chairman of the trade group Search Engine Market Professional Organization

"It's something that marketers should be paying attention to," he says, adding that Outsell's 14.6% fraudulent click estimate is higher than others he's seen. "People who sell reports are similarly tempted to hype the number."

The 27-page report criticizes search engines for providing no data to back up their often-stated claims that click fraud is under control and has no material impact on their businesses. Investors, too, are concerned about click fraud and likely will question the search engines about it when second-quarter earnings are released later this month.

"The current 'don't ask, don't tell' stalemate is impeding progress at a time when 27% of advertisers say they will reduce their pay-per-click spending and another 10% say they intend to do so," Outsell says. "The industry must openly acknowledge that there is a major problem, adopt independent audits and open itself to new approaches."

In response to the study, Yahoo! and MSN reiterated that they take click fraud seriously and are continuing to work on ways to thwart it. Yahoo! hadn't seen Outsell's report. MSN had no immediate comment. Google, which didn't respond to request for comment, has made similar statements in the past.

Search engines have long argued that they can't reveal data about click fraud for security reasons, an argument that Outsell disputes.

"The actual scale of the fraud, plus the buzz in the marketplace among advertisers and in the press makes this an issue that won't go away," Outsell says. "Search engines need to report the fraud they intercept, the fraud they refund, the claims they reject and the trends over time."

Worries about click fraud will continue, since spending on search is expected to hit $11.7 billion in the U.S. by 2010, up 170% from 2004, according to Forrester Research. The majority of the spending occurs on Google, the No. 1 search engine.

Last week, Yahoo! reached a settlement in a class-action lawsuit regarding click fraud. Earlier this year, Google settled a similar case for $90 million.

For now, Wall Street is willing to give the search engines the benefit of the doubt.

"The key point that is missed often is that click fraud, no matter how big or small, is already built into the pricing mechanism in the market because of the unique structure of paid search," writes Safa Rashtchy, an analyst with Piper Jaffray, who thinks that the Outsell report overstates the problem of click fraud. "Nobody is continuing to use search and lose money because of click fraud, and search is not facing the risk of declined usage because of that -- it's already there. It is like viruses on the computers and the Internet -- we continue to do our work, but with some hassle from time to time.''