Searchonomics

Yes, we're talking about the economics of search, something very few people take the time to understand. Many people scoffed at Google's business model as it was on its way to be a multi-billion-dollar juggernaut. As of late people have begun to respect and fear Google appropriately. However, there has been some chatter about the vulnerability of the pay-per-click model on the internet. Microsoft's recent purchase of JellyFish and, more importantly, its foray into a cost-per-action paid search model (let's forget about the cash rebates for searchers for the moment) has people talking about a potential paradigm shift in paid search. At the root of this is the perception that click fraud is such a threat to advertisers that they will suddenly flock to whichever search engine comes up with a viable cost-per-action service. Let's discuss this notion.

Ads follow eyeballs

First of all, an obvious lesson that analysts often forget is that advertisers follow audiences first and foremost. If Google continues to widen its lead in search on a query basis, Google will also continue to dominate in paid search on a revenue basis.

Click Fraud

Now, speaking more directly to click fraud, it is a threat to the pay-per-click model, but not to the extent that people often think. Although I have just as strong an aversion as the next person to people making and losing money on fraudulent clicks, the pay-per-click model naturally adjusts in the long term to account for these bogus transactions.

For example, if an advertiser suffers a series of fraudulent clicks, either Google will refund the advertiser her money, or the ROI for that advertiser goes down. In the former case, no harm is done. In the latter case, the advertiser will likely bid less money for the clicks that no longer offer the same utility, and her ROI will likely trend back to where it was previously.

Would it be better to just charge advertisers only on converted sales?

Yes and no, depending on your perspective. On a theoretical level (we are talking about economics here) a cost-per-sale model would indeed be a better economic model. If all advertisers pay exactly how much a sale is worth to them, then those advertisers would have their marginal benefit equal to their marginal costs, their economic profits (as opposed to accounting profits, which are different) would be zero, and the search engine would capture all of the possible value from the advertiser. This scenario makes economists really happy.

This theoretical notion is backed up in the real world by statements made by many advertisers who said they would likely pay more on a per-sale basis if the cost for that sale were fixed and guaranteed.

Then, what's the holdup?

It seems that everyone makes out better with this type of system. Right? Well, not really. In reality, the paid search marketplace is much more complex, with some advertisers wasting large sums of money on keywords and others practically printing money by converting sales for pennies on the dollar. For the former type, a cost-per-action (action being any meaningful action such as an e-mail sign-up, a sales lead, or an actual sale) system will make ad campaigns much easier to manage and much more lucrative. However, for the latter type, the removal of the less accountable pay-per-click and CPM payment models would be a huge threat to the profitability of savvy advertisers.

Many e-commerce sites have made it their business to actively manage keyword campaigns to maximize ROI. A cost-per-action system would, in aggregate, increase these successful firms' ad ratios, threatening the sustainability of their business. Some firms will go from posting great economic and accounting profits to going out of business very quickly. So, not everyone will benefit from a cost-per-action model that essentially levels the advertising playing field.

Oddly enough, the leveling of the playing field in this case will likely benefit deep-pocketed advertisers more so than smaller advertisers. For many keyword phrases the overall prices will rise as a result of a more accountable advertising system. Larger companies who pay high prices on generic keyword phrases for defensive purposes will continue to do so, but these companies might also find it worthwhile to seek a broader array of keywords if they are only paying for a pre-defined action that has calculable value. This will likely cause a raise in costs for many small businesses that rely on the low-hanging fruit that long-tail keywords have provided for quite some time. Also, the conversion rates for these e-commerce sites will no longer be the reward that it used to, as a sale would then likely cost as much as its incremental benefit, and not a small fraction of it, as is often the case for a savvy entrepreneur.

What are the implications for Google and Microsoft?

Even though Google stands to capture more value from advertisers by switching to a more accountable ad system, the culture at Google to this point has largely been shaped by the pay-per-click model and the small businesses who utilize the system. Since so much of Google's revenue comes from small businesses, the company might be hesitant to uproot the ad system that has been so good to it. The evidence: Google could very easily implement such a system, but hasn't yet. Google already allows you to track conversions on your site for a number of different goals (actions). Applying the payment system to reflect these statistics is not a stretch at all for the world's most powerful tech company. (Google has done limited testing of a cost-per-action ad system with select customers.)

Microsoft's new cost-per-action system in conjunction with cash incentives is an interesting move because it strives to innovate with its ad system and attract new search users at the same time. With that said, it doesn't present a solution to search itself and in the long term undermines Microsoft's clout in web search by turning it into a product search engine. (For more about this, refer back to my post "It's Search, Stupid.")

YouTomb: Where Videos Go to Die

There has been a bit more chatter lately about the Google-Viacom dispute over copyrighted material on Google's YouTube. I just found a site that documents videos taken down from YouTube for whatever reason. YouTomb is an MIT-run website that currently tracks over 227,000 videos and has documented over 4700 videos taken down for copyright reasons. As you can see on the Stats page, Viacom has the second-most videos taken down for copyright reasons.

Google Earth API

Google Earth, which had previously been available only as a desktop application, can now be seen from a web browser. Although most sites that currently use Google Maps will most likely stick with that quick-loading, two-dimensional service, some sites will certainly benefit from this new functionality.

Check out the examples below given by Google:

http://code.google.com/apis/earth/documentation/examples.html

Also, check out the short video introduction from Google:

Microsoft's New Strategy

Microsoft's Ray Ozzie hinted at a new search strategy that doesn't have Yahoo! as its centerpiece. He mentioned semantic search, and the following PC World article goes as far as to talk about Powerset, a Xerox-backed firm I mentioned in my "It's Search, Stupid" post not more than a day ago.

http://www.pcworld.com/businesscenter/article/146388/ozzie_hints_at_microsofts_search_future_downplays_yahoo.html

Is Microsoft Cheap?

I found a good article from Barron's that speaks to Microsoft's seemingly cheap shares.

http://online.barrons.com/article/SB121158281856318635.html?mod=googlenews_barrons

Among the reasons Microsoft might not be undervalued are the following:

• A deal with Yahoo! could be costly in dollar terms (in the $40-$50 billion range)
  
• A deal with Yahoo! could face regulatory scrutiny
  
• Full integration of the Microsoft and Yahoo! could take a long time, effectively ceding more market share to Google in the meantime
• Continued scrutiny of Microsoft's latest Vista OS puts into question the company's earnings projections for the next few years

With that said, Microsoft's recent down-tick is probably a tad overblown. Microsoft still has a monopoly over the desktop and isn't going anywhere anytime soon. The reason for the recent weakness is not because of a shift in long-term fundamentals but rather a signaling of Microsoft's weakness on the internet, which should have been apparent to investors long ago.

Anyway, Microsoft shares will likely tread water before more light is shed on the "Yacrosoft" ordeal. But if Microsoft makes a bold statement that affirms its ability to find its own web strategy without Yahoo!, investors will likely reward Microsoft shares greatly. The only way I see more downside in the stock is if Microsoft buys Yahoo! outright for anything more than it's initial $31-per-share offering.

It's Search, Stupid

Last week Microsoft announced its plans to offer internet users cash rebates for using its Live Search. These drastic measures are a response to ever-decreasing market share in web search and newly available money to the tune of $50 billion dollars (about half of which Microsoft actually has in cash) due to a failed Yahoo! acquisition.

Why offer cash rebates?

Microsoft must differentiate itself in search because it hasn't had a shred of success playing by Google's rules. April's ComScore statistics show all other major search engines losing market share to Google. Google's share grew to 61.6% from 59.8% in March. Not only is this a huge jump from before, but is also likely understated. (Server statistics from the most popular content websites typically show that Google could handle as many as 90% of US search queries.) So, how does Microsoft differentiate itself? Well, what they could do is try to undermine the AdWords system that offers Google the huge cash flows that are the lifeblood of the company. The AdWords pay-per-click system isn't very intuitive to most people, especially since it is quite prone to click fraud. Even without click fraud, less-than-savvy advertisers (and they do exist) can spend hundreds, if not thousands, of dollars on clicks before realizing that it isn't yielding any sales.

What Microsoft is now proposing is an ad system that charges advertisers only on a sale converted through its Live Search. This "pay-per-action" fee will then be returned in cash to the consumer who made the purchase. (It is now a lot clearer why Microsoft purchased the Madison-based JellyFish.com for $50 million, which pretty much does the same thing.)

Sounds Great! Right?

Yes, it is a great idea for JellyFish, but not for Microsoft. Live Search is about search, not shopping. People go to Google because they want to find things. Sometimes those things are consumer goods, but often they're not. Most people will use the search engine that does the best at finding anything they want. Google has the largest index on the web and can offer decent search results on even the most obscure keyword phrases. This is reassuring to the average internet user, and the simplicity of using one search engine for all searching needs causes most people to default to Google. Microsoft may offer money and cater to a niche search user who wants to look for deals on the web, but that will turn Microsoft into a product search engine, not a search engine. In the short term many users will go to Microsoft for their online purchases, but in the long run Microsoft will cede even more search credibility to Google.

What should Microsoft do?

Instead of relying exclusively on differentiation through ads, Microsoft should concentrate on differentiation through search. In search you need to build the audience first and then worry about monetizing later. (The conventional wisdom being that the advertisers will go where the audience is, and not the other way around.) With Microsoft's current market share, there really isn't much for the company to monetize. In order to augment its audience Microsoft should consider the following:

Spruce up the search results page. Microsoft should offer search that features different media sources more prominently. Google's Universal Search is still not that universal. Most keyword searches yield ten web results. Ask.com is the only search engine that is holding ground against Google and it is likely because of its incorporation of richer media sources to its search results, which works very well for some keyword searches, and thus, for many internet users.

Tout yourself as a "natural language" search engine. Many people still use natural language to search on the internet. However, there's currently no search engine equipped to handle such queries effectively on a large scale. By acquiring a firm like Powerset, which claims to return better "semantic" search results, Microsoft can buy some credibility (and more importantly, differentiating attributes) in the realm of search. Then, by utilizing its existing indexing technology and huge marketing budget, it can bring a viable Google alternative to the marketplace.

Now, with that said, it's not that easy. Maybe Powerset is a bunch of smoke and mirrors. Perhaps Microsoft will fail to attract new users by "junking up" its search results pages. These are both real possibilities. However, one thing that the Microsoft/Yahoo saga has taught us is that Microsoft is desperate for an effective web strategy and they're willing to throw $50 billion around to get it. They have to do something. I just don't think paying people to search is the answer.