The Strange Economics of Paid Search Advertising

TheStreet.com's article titled "The Threat to All of Google's Revenues" by James Altucher predicts keyword inflation is coming to an end because companies will focus more on optimization of free search results instead of paying for expensive Google (GOOG) ads.

TheStreet.com's conclusion is not logical. Search Engine Optimization ("SEO") and paid Google ads would appear to be what economists call "substitute goods" for advertisers. This means that as keywords become more expensive, merchants should tend to substitute spending on SEO. In other words, for as much as SEO is a substitute for paid search, it should only slow the rise of keyword prices, it should not stop the rise.

But there are other factors about paid search that many people do not seem to grasp. For crowded e-commerce segments like retail electronics, scoring high on the free search returns requires a large SEO budget. The small e-commerce companies working on tight margins can't afford to compete in SEO, so they frequently just don't bother trying. They tend to either go through a big player like Amazon (AMZN) that can afford a big SEO budget, or they buy paid search ads from Google so they can appear on the Google sidebar.

The point is that when a big player like Amazon, for example, increases its SEO budget, it tends to drive competitors off Google's free search returns. These sites then become buyers in the paid search ad auctions and bid up paid search rates. This is how increased SEO spending usually leads to higher paid search ad revenues for Google, not lower - the exact opposite of what TheStreet.com claims.

TheStreet.com also claims that, "Keyword inflation is coming to an end... search users are up to six times more likely to click on the first few organic results than they are to choose any of the paid results."

It is wise to be skeptical of statistics that promote the business of the statistician. We should also be suspicious of statistics that are vague in a way that benefits the statistician. This particular statistic belongs in both categories.

The statistic implies that paid search is not very important because only 1/6th of all searches result in a paid search ad getting clicked. This claim is irrelevant because most searches are non-commercial. Also, many times people don't click on paid search links because there simply aren't any paid search links related to exactly what they are searching for. Anyway, 1/6th is an extremely high click through ratio and Google is doing admirably.

Now approximately 10% of my own personal searches ARE commercial. For a long time, I avoided Google's paid ads out of habit. Like most people, I usually tried to avoid ads where possible. However, I recently realized that Google ads were different - they often had better pricing than the "free" search returns.

That is because the websites getting "free" search returns in crowded areas are doing lots of expensive SEO to get there. In fact, they are frequently outspending the paid search advertisers because many people only click on organic searches. This makes the margins much larger with "free" organic search. So counter-intuitively, the "free" organic search returns are in many categories the high rent district, and the paid search ads the low rent district. Go ahead and try it with "hdr-hc7" (it's a camcorder).

On the first page of search results, the "free" organic search returns had a lowest price of $989. The paid search links had 13 instances where the price was between $919 and $935. I suspect that over time more Google users will realize that the paid Google ads often have better values than "free" organic search results. Maybe Google will help things along by explaining this counter-intuitive fact to its users. Maybe some e-commerce related search returns should offer a tip like, "Tip: Sponsored links tend to have lower prices - more info here."

Disclosure: Author holds a position in GOOG.

Comments

[alpha24seven]

I Google all the time and for one will say that is 100% accurate.

"search users are up to six times more likely to click on the first few organic results than they are to choose any of the paid results."

I'm not sure if I've EVER clicked on a paid search link.

Just me perhaps.

[JeffMolander]

Andrew:
I also find James Altucher's viewpoints to be uninformed. As well, I respect your viewpoint and opinions. That stated, I disagree with many of them and their premises.

Much of what drives pricing and spending on search (across the board) are habits and strategies that marketers have practiced for years now and show no sign of changing soon. Amazon is a perfect marketer to cite given its long history of, in effect, <strong>outsourc... </strong>much of its "natural" SEO work to third parties -- affiliates/associates. No need for a large SEO budget.

This may seem like nuance but Amazon's tactic here is not only key in its overall spend (in effect, it pays on performance only... in the form of a cost per transaction to its affiliates) but its top down decision-making strategy. This practice (outsourcing SEO to affiliates) has been mimicked by nearly all major online retailers and most studies that I read indicate a continual <strong>slow-dow... in SEO spending</strong>... overall.

Why? Marketers suggest that playing the "Google Dance" no longer interests them (it's too expensive).

BUT what few (outside a handful in my peer group) seem to be discussing is the impact that Google's Universal Search initiative will (is having??!!) have on broader search spending. Quite literally, millions of "page one and two" search results are being pushed off the page by new search results (emanating from Google Maps, YouTube, Google Base, etc. etc.). If anything has the ability to create broad spending change Universal Search does more than anything else.

On a recent podcast I hosted, Dr. Amanda Watlington (a respected search industry expert) said:

<i>"You've got to optimize everything… get out of the business of thinking about it as just text (as the only important thing)...

... I think it’s (Universal Search) one of the biggest changes that we've ever seen."</i>

Indeed, this statement is highly (dangerously?) un-informed...
<i>"Keyword inflation is coming to an end... search users are up to six times more likely to click on the first few organic results than they are to choose any of the paid results."</i&g...

... but I believe for other reasons. Namely, the AdSense network and the multi-million (many say nearly billion) dollar business of domaining (i.e. Marchex) is not factored in. While we do not officially know how reliant GOOG is on revenue generated by so-called "Made for AdSense Web sites" you can bet it's significant.

Bye the way, I think the conclusion you draw in your camcorder pricing example (free results are often more expensive) may also be driven by the virtual monopolization of "free" results pages by third party affiliates (hence, prices at the retailer need to be increased to offset the revenue share with affiliates). In any case, it's an interesting conclusion and one that is worth further thought in terms of predictable (leverageable) consumer behavior (which is critical to most affiliate marketing approaches).

[SolRosenberg]

If I'm searching for "hdr-hc7" (i.e. I already know the exact model I want), I'm just heading over to Froogle (lamely renamed Google Product Search) and sorting by price.

[JeffMolander]

From SearchengineWatch.com:

"... Google's switch in May to Universal Search has more than a few marketers awash with panic over loss of rankings – and understandably so – since some have lost visibility due to other digital content such as video, images, or blogs, etc. occupying valuable real estate within the search results.

If you're feeling much the same, here's a bit of advice: Relax. All this hand-wringing is for naught. Universal Search actually represents a huge opportunity for marketers – that is, if you're smart enough to seize it."

More: searchenginewatch.com/...