With the recent allegations against for violating anti-trust, and anti-competition statuses, I began to wonder what other potential Achilles heels does the search engine giant have? Sure the F.T.C may not have taken any formal steps against Google, but as an investor I want to detect any other potential problems before they arise. Google (GOOG) is currently one of the largest companies in the world with a market cap of $237 billion. The company is the go-to search engine on the internet, and almost everyone has "Googled" something before. So how does a search engine make money? Simple, it gets paid by companies all over the world who want to advertise on its search platform. Ninety-six percent of Google's revenues come from this advertising. With a virtual monopoly and control over a large user base, what could possibly go wrong?
The company is a major target for click fraud. Click fraud occurs when website owners sign-up to place Google ads on their websites. For every click on these ads, Google will pay these website owners a certain amount for putting these on ads their website. To capitalize on this agreement, website owners often find lucrative ways to receive more clicks. The more clicks they get, the more money they will earn. More importantly, the more forced or fraudulent clicks these owners generate, the lower the quality of Google's third-party ad campaign. With technology rapidly increasing, website owners are finding more and more ways to generate click fraud without getting caught. Investors should truly understand the potential disastrous effects click fraud could bring about, before they decide Google is a strong investment.
Understanding Google's Business
Google's revenues are broken up into two primary segments: Advertising from Google's websites, and Advertising from Google's 'Network Members' websites (also known as the Adsense program). The first segment applies to ads directly related to search content. Here's an example:
As you can see, Google usually places these ads on the top of a search, or sometimes on the right sidebar. Google usually blends these ads in very well with searches, and the ads are often very closely related to the search. The advertiser will pay Google for the amount of clicks they rather, rather than paying for having their ad up for a certain amount of time. This is an excellent business model which generates $26 billion, of Google's $39 billion in revenues. On the other hand, there are revenues which are generated by Google's Network Member's websites. Here's an example:
We've all seen these ads before. Always sporadically placed on a third-party website, and always cluttering the website. With $10 billion in revenues from this segment, any attack at Google's third-party ad quality would have an enormous impact the company's top-line.
Understanding Click Fraud
Google's 'Network Members' consists of millions of websites that contain ads from Google. Each of these 'Members' often do whatever they can to maximize the number of clicks they receive on their ads, by disguising Google's ads with other content on the page, or even having 'bots' which are programmed to automatically click the Google ads by disguising the activity as human.
- Disguising Google's Ads: This is something many of us have encountered before. We go to search for something online, find a website we believe is relevant, scroll through that website, and think we've found what we were looking for. We click that link, and all of a sudden were on a different website trying to sell some sort of product. How did that happen? With the world becoming much more tech-savvy, Google's Network Members are becoming very skilled at blending in Google ads with other content on their website. The web surfer never wanted to click that ad, but usually did so by accident. What does that mean for the Google 'Network Member'? It means they're richer than they were before, and the ad isn't translating into profits for the company paying Google to advertise. Some websites have even gone to the extreme of exploiting click fraud though malware. The website TrafficSolar would infect computer with malware that cause a pop-up window to open up every time an internet user would go to major websites such as Expedia or Gap.com. The pop-up ad would mirror exactly what the website looked like, and would even let users make their purchases. By doing this, users would still be able surf the website normally, but TrafficSolar would earn clicks by having users surf the web through this pop-up. As the world becomes more tech-savvy, Google Network Members will begin to take more advantage of this ad program with Google, and ultimately diminish the quality of this type of advertising.
- Disguising Ad Clicks with 'Bots': Some Google Network Member's take a much more extreme route by purchasing these 'bots', which are programs created to disguise clicks as human. What a basic 'bot' does is use a list of proxies, which are different IP addresses that 'bot' can connect to the internet through, and begins to click the various ads on the page through these different IP addresses. The end result is Google seeing the ads being clicked on by different IP addresses, which they in turn believe are different users. This is only one example of a 'bot'. If you search "google adsense bot" you'll see example of many different internet users asking for programmers to create different types of these 'bots'. There was recently a case where the FBI busted a group of Russians and Estonians that were generating $14 million from click fraud, and another group in China that had infected Android with click fraud bots. You can read the article here. These may seem like small matters given Google's massive size, but small problems like this can grow exponentially as technology advances. (Source: Forbes)
Of course, Google is doing whatever they can to deter click fraud. They often look for clicks coming from the same IP address, mass influxes of clicks, and the timing of these clicks. Google is relatively quiet about their techniques because the more they reveal, the easier it'll be for users to get around their detection mechanisms. The company claims about 2% of these clicks are fraudulent. Other websites have done studies claiming Google's click fraud is really around 19%. That would mean $1.9 billion of Google's revenues are actually fraudulent. Google has been sued multiple times, including a $90 million class action lawsuit against Google for click fraud, and recently by a Seattle based locksmith over the same issue. With how quiet Google has been over these matters, it wouldn't surprise me that they have a bigger problem on their hands than they make known. Facebook (FB) has also faced a similar issue. The company has also been sued multiple times for click fraud, often through usage of fake user accounts. There is a whole article on it here. The number of fake Facebook accounts and the similar exploitation of click fraud make it very difficult for the company to justify their ad quality. Many critics have argued that Facebook will not be able to succeed with their ad program for this reason. With their situation looking eerily similar to Google, this very well might be the case. (Source: Forbes)
Competitors Exploiting Click Fraud
Click fraud can also be used as a tool to harm competitors. Some competitors will Google the name of a company, and purposely click on related ads, in order to run up that company's bill for advertising on Google. On the other hand, companies also might go to their competitor's site and purposely start over-clicking on the Google ads the company placed there. By doing this, companies hope to frame their competitors for click fraud. If Google wants to maintain the quality of their advertising programs, they must find different ways to charge their customers, and pay their third-party advertisers. The pay-per-click system can be easily manipulated, and it will only get easier in the future.
How Investors Should Approach the Situation
Although click fraud may not be affecting Google currently, investors should take a step back and observe how the company deals with the problem in the future. If more cases of click fraud arise and begin to damage Google's third-party ad quality, the company will certainly begin to change that part of their business model, and make the company that much stronger. Unfortunately for some companies, it takes a substantial amount of attacks or negative events until they decide their business model needs to be modified. The negativity that these events could cause would almost certainly provide a buying opportunity into a company with an excellent user platform, and large market share. The lack of a margin of safety with Google makes me very worried about initiating a position until this issue of click fraud is fully addressed. With the sales of 2,224,810 insider shares and the purchase of none over the past 6 months, Google's executive's don't even see the company as a strong buying opportunity.
Google's Network Members' ad program presents a substantial threat to the company. With a quarter of the company's revenues coming from this segment, they cannot afford any attacks on the quality of these third-party ads. As users become rapidly more tech-savvy, it will be extremely difficult for Google to detect disguised click fraud from millions of different Google Network Members. If customers begin to stop advertising with Google because of its third-party advertising, the company could suffer substantial losses in revenue. Unless the company devises a new way to pay their Network Member's for hosting their ads, Google may be in serious trouble of having their reputation further damaged.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in GOOG over the next 72 hours.