Overture Plunges as Margin Questions Resurface

In his report, Baker says his research indicates that Overture's smaller distribution partners account for 70% to 75% of Overture's profits, though they only generate about 35% of Overture's revenue. That disparity, says Baker, likely arises because the smaller sites on Overture's network are offered lower payments than big players like Yahoo! in return for employing Overture's paid-search listings on their sites.

Though Baker acknowledges that smaller Web publishers have less bargaining power than larger ones, he says that Google's entry into the paid-search market gives all publishers "an alternative to play off against Overture." In addition, because Google generates much of its revenue on its own site -- revenue it does not have to share with any distribution partner -- Google can pay more than Overture can for traffic generated from third-party Web sites.

Pressure Points

In his calculations, Baker estimates that Google could "easily" pay its search engine partners 80% to even 100% of the revenue they generate from running Google's paid listings on their site. That revenue split would put pressure on Overture, which doesn't push traffic to its own site, to pay a higher percentage of revenue to third parties, says Baker. Overture says it expects to pay 61% to 63% of revenue on traffic acquisition costs next year; Baker estimates that industrywide, traffic acquisition costs will rise from 55% in 2002 to 65% by 2004.

To be sure, the market isn't as simple as Baker's calculations. Overture has repeatedly been able to beat analysts' estimates, and it has done a good job of operating and improving the quality of its service to advertisers. In addition, though Google's books are nonpublic, it appears that Overture has been able to generate much higher absolute dollars in revenue than Google.

Thus the Overture debate plays on.