From GooTube to GoogleClick

Is Google's latest string of deals a sign of strength or weakness?
Economist StaffApril 20, 2007

Another month, another string of victories for Google, the internet’s emerging superpower. With the most popular search engine and the most efficient system for placing text advertisements alongside the results, Google already dominates the lucrative market for “paid search” advertising (where advertisers pay only for mouse clicks). On April 13th Google announced that it would pay $3.1 billion — making this its biggest acquisition ever — for DoubleClick, the web’s largest independent broker between online publishers and advertisers in the market for “branded” or “display” advertisements (where advertisers pay each time the ad is displayed). According to some estimates, this market segment, although smaller, is now growing faster than paid search.

Before the weekend was over, Google had also struck a deal with Clear Channel Radio, America’s largest radio broadcaster, in which Google will sell — online, of course — some of the airtime on 675 radio stations to advertisers in Google’s network. This follows the announcement at the beginning of the month that Google will place advertisements on the 125 television channels of EchoStar, an American satellite-TV operator, and Google’s separate push to put advertisements into traditional newspapers. Google is thus mapping out plans to dominate not just the internet, but the advertising market too.

In the process, it is rudely taking the wind out of the sails of Yahoo!, which had rather been hoping that this would be its month to impress. Terry Semel, its boss, emphasised this week that Yahoo! remains the clear leader in display advertising. Even so, Yahoo! must now feel threatened. Mr Semel says Google’s purchase of DoubleClick “validates” his own strategy in display advertising; but Yahoo!, along with Microsoft and Time Warner, had also been bidding for DoubleClick. For Mr Semel, having been outbid by Google for a stake in AOL, an internet portal, and for YouTube, the leader in online video, this is the latest in a series of strategic defeats.

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All this is unpleasant because Mr Semel has recently been trying to engineer just the opposite outcome. Rather than defending against Google in display advertising, he had been hoping to attack it in paid search. Yahoo! has in the past placed text advertisements on its search pages based only on how much an advertiser bids for a given search term, such as “mountain bikes”; Google, by contrast, takes other variables (such as the number of click-throughs) into account and so makes its advertisements more relevant to web searchers, thus earning more revenue. In February Yahoo! launched a new placement system, called Panama, that is meant to close this technical gap.

So far, however, Panama has not helped Yahoo! match Google’s financial success. This week Yahoo! reported that profit in the first quarter fell by 11 percent compared with a year earlier, which was below Wall Street’s expectations. The boost from Panama will show up only in this quarter, says Susan Decker, Yahoo!’s second-in-command. Others are sceptical about how much of a difference Panama can make, since advertising systems depend not just on fancy software but also on signing up advertisers and publishers, as Google has done. Panama may only prevent Yahoo! from falling further behind.

Boohoo, Yahoo!

Mr Semel’s other defence is to use the growing fear of Google among “old media” firms to engineer alliances designed to contain the enemy. In March Yahoo!, along with AOL and Microsoft’s MSN, signed up to a new partnership with NBC and Rupert Murdoch’s News Corporation, which intend to form a joint venture in online video to counter Google’s YouTube. Last week Yahoo! expanded an advertising alliance with Viacom, which is suing YouTube. And this week Yahoo! announced a deal with a group of newspaper publishers — including McClatchy, America’s third-largest — to run their content on Yahoo!’s websites and place advertisements on the papers’ websites.

For MSN the picture is even bleaker. Its parent, Microsoft, is in a different position from Yahoo!, since online advertising is still minuscule next to its revenues from software, expected to be over $45 billion this year. Yet online advertising is crucial to Microsoft’s growth, says Sarah Friar, an analyst at Goldman Sachs, since it is perhaps the only new market large enough to be “needle-moving” for such a big firm. But so far Microsoft is failing. By Ms Friar’s estimates, Google will make operating profits of over $5 billion this year, growing at a rate of 36 percent for the next three years; Yahoo! will make $3 billion in operating profit, growing by 20 percent a year; and Microsoft’s online businesses will lose $2 billion this year and even more in the next two years.

Microsoft’s nightmare is that Google will at some point disrupt its main business of selling software such as Microsoft Office, which most cubicle denizens use for word-processing, spreadsheets and presentations. Google is already offering word processing and spreadsheets as free online services, and this week announced it would soon add presentation software as well, to rival Microsoft’s PowerPoint.

Yet Google’s latest deals contain a hint of weakness. Henry Blodget of Cherry Hill Research, a consultancy, notes that in its original business of placing text advertisements on its own search pages, Google makes profit margins of about 60 percent. In its more recent business of placing advertisements on web pages belonging to other people, such as bloggers, its profit margins are 10-20 percent, because it is harder to make the advertisements as relevant to the audience and it must share the resulting revenues. Display advertising also offers lower returns. Even if Google successfully expands into new fields such as television and radio advertising, its profit margins are likely to keep declining, especially since its partners will probably give Google only “left-over” advertising slots.

For the moment Microsoft is being a sore loser. Along with AT&T, it was quick to cry antitrust wolf upon hearing that Google had won the bidding for DoubleClick — sweet irony, given that Microsoft and AT&T have both fallen foul of antitrust regulators in the past for abusing their monopolies. “Advertisers don’t want a Wal-Mart-isation of digital advertising,” where one firm (like Wal-Mart in retailing) becomes so big that it can dictate prices, says Tom Chavez, the boss of Rapt, a firm that analyses online-advertising data on behalf of publishers and advertisers.

That said, Mr Chavez adds, Google is still far from becoming a Wal-Mart — and even Wal-Mart is not facing an antitrust investigation. Unlike AT&T and Microsoft, both of which exerted a strong technological “lock in” over their customers, Google operates in a more open market that is easier for competitors to contest. Regulators will scrutinise the Google-DoubleClick deal, as they should. But Google is not a monopolist — just a company that is, for the moment at least, ahead of its peers.