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Google (GOOG), one of the most powerful technology companies, is drawing almost all its revenue from one source: Advertising. Over the past a few years, Google has started many initiatives such as Android, currently the number one mobile OS, and Google+, pushing 100 million users soon. However, one thing has not changed: Google still draws 96% of its revenue from advertising. The following tables present Google's revenues by source ($ million) and percentages:
Source: Google

For a company that is doing pretty well, there is nothing wrong with being good at one thing, as long as that one thing has room for growth. But the room for growth is exactly the trouble that Google may run into in the years to come. Google's first quarter filing in 2012 paints an even more worrisome picture. According to Google:

  • Paid Clicks - Aggregate paid clicks, which include clicks related to ads served on Google sites and the sites of our Network members, increased approximately 39% over the first quarter of 2011 and increased approximately 7% over the fourth quarter of 2011.

  • Cost-Per-Click - Average cost-per-click, which includes clicks related to ads served on Google sites and the sites of our Network members, decreased approximately 12% over the first quarter of 2011 and decreased approximately 6% over the fourth quarter of 2011.

The net effect of paid clicks (+7%) and cost-per-click (-6%) over the fourth quarter of 2011 is virtually zero. The net increase over the first quarter of 2011 is 22%, healthy, but not exactly an impressive increase either. Part of the problem might be attributed to the widespread of Adblock as an extension on Firefox and (not as effectively) Chrome, which can cause Google major problems by killing its ad effectiveness. There is really nothing Google can do about Adblock.

Global advertising spending is largely a zero sum game. The total size of the pie would slowly grow (~5% pace) or decline with the economy. Global advertising expense can slotted into the following categories: Television, internet (search, display, video, mobile), newspapers, magazines, radio, cinema and out-of-home (traditional and digital). Last year, 45% of the growth in ad spending came from four big emerging economies: Brazil, Russia, India, and China (we know Google is losing China over a political dispute). The global total is approximately $425-450 billion in 2011-2012. Google is taking a market share out of this pie.

Out of the major media categories, TV is still the king, with $175 billion or 41% of global market share. Internet, the part most relevant to Google, is projected to grow at a fairly slow pace of 11.2% to $87 billion. So in order to have above average growth, Google has to grab a larger share of the market at someone else's expense. Other than Internet, can Google gain from the other media categories?

  • TV, Radio, Cinema

Since Google does not break down its revenue from YouTube, it's hard to gauge how much profit Google makes from it or how fast it is growing. However, one thing is clear: YouTube has largely lower quality content. It is highly unlikely that major TV or movie producers would let Google use their content without getting handsome financial returns. The conclusion: This is not Google's business, and it's unlikely that Google will take share from it.

  • Outdoor

This is not Google's business. With digital displays, the outdoor market may actually take market share from Google.

  • Magazine & newspaper

Both are in decline, but since Google does not have its own content, it likely would only benefit marginally from display advertising switched from print to online.

So Google's opportunities are within the online advertising category:

  1. To expand its leading position in search advertising

  2. To take market share from other players on search advertising

Based on recent results, search advertising is facing a slowdown. It will be difficult for Google to maintain above 20% growth in this category. So the only real opportunity of growth has to come from display advertising. In this, Google has a major shortcoming: It does not own content. The only way Google gets its lunch in this category is through Adsense. Larger websites generally deal with advertisers directly without Google as the middleman, so Adsense only draws cash from mostly lower quality content at small websites. Moreover, Google can show keywords for related ads or display ads in those websites. With limited space, it can only show either type. With keywords and display ads cannibalizing each other, the limited benefit is not even necessarily drawn from Google's competitors.

There is another threat for Google in display ads: Facebook (NASDAQ:FB). How much Facebook knows about each of its 800 million users cannot be underestimated. Such knowledge is extremely important in accurately targeting each user using display ads. In this regard, Google's prospect in display ads isn't rosy at all. Google+, so far, is not yet a qualified threat to Facebook.

And there is Android, which doesn't earn Google money directly. It is actually hemorrhaging money to Microsoft (NASDAQ:MSFT) by paying license fees. With Android, Google mostly makes money from mobile search. But it is again a more or less zero sum game for advertisers. If people found what they want on a mobile device, they will search less on a computer. Google might not get as much of a net positive effect in this regard.

Growing pains explains Google's lackluster stock performance over the past five years. I hate to point this fact out, but ten years after its IPO, Google has already entered middle age. The recent stock split spells more hunger for power and control, rather than value creation for shareholders. Very likely, Google's share price won't go anywhere for many years to come, just like what happened to Microsoft (MSFT) from 2001 to 2012. Don't get me wrong. Google is still a very respectable company. The point of this article is that investors cannot expect above market level returns from Google given its lack of room for stellar growth.

Source: Google Reaches Middle Age