How big a problem is click-fraud?

According to The Times of India, "A growing number of housewives, college graduates, and even
working professionals across metropolitan cities are rushing to click paid
Internet ads to make $100 to $200... per month". Investors in search and advertising stocks had better understand the scope of the click-fraud problem. Some thoughts:

1. Most pay-per-click (PPC) ad revenue comes from search. Over 50% of Google's revenue (numbers here) came from its own search site, and the vast majority of PPC revenue generated by Yahoo!, AskJeeves, FindWhat and LookSmart also comes from search. PPC ads on search pages are susceptible to two forms of click fraud: investors looking to boost the profits of stocks they own, and competitors trying to raise their rivals' advertising and marketing costs. Both problems are probably limited in scope, since they don't generate tangible profits for the "clicker".

2. PPC ads run by publishers are more problematic. Publishers get paid for clicks on ads on their own site, and are therefore incentivized to fraudulently pay others to click on their ads. Seth Godin thinks that click-fraud is such a serious problem that the company is "a house of cards". Like the India Times, he highlights the results of a Google-search for "earn rupees clicking ads".

3. Mechanisms are available to limit click fraud. The PPC ad companies block repeated clicks from the same IP address. (That probably isn't enough, though. StopClickFraud.com describes how fraudulent clickers limit their clicks per IP address to avoid blocking.)  Oliver Thyman argues that "mathematic formulas like Fourrier Analysis might be able to calculate the level of click fraud and see unlikely changes" in usage patterns. Crucially, Google has publicly acknowledged the severity of the click fraud problem, and has hinted that it  is working on solutions.

4. Investors need to see advertising technology trends in a wider perspective. Pay-per-click ads have been wildly successful because they are measurable and more closely tie advertising costs to advertisers' profits. Seth Goldstein convincingly argues that ads will become more and more linked to real performance: "The future of Internet advertising is sales". Note the implication here: PPC ads will converge with affiliate marketing programs, which are entirely success-based. In a world of 100% success-based advertising, there's no room for click-fraud.

The bottom line? Click fraud might raise the search engine firms' profits in the short-run. But in the long-term, it destroys advertisers' return on investment and the "performance-based" nature of PPC ads. So PPC ad-dependent companies like Google, Yahoo!, FindWhat, LookSmart, and Mama.com will be forced to combat click fraud. In that context, it's significant that FindWhat.com claimed on its Q4 conference call that it eliminated profitable revenue because it didn't deliver underlying value to advertisers.