Another Reason Google's Business Model Is Brilliant

There was widespread discussion in the blogosphere about the rate of growth of paid clicks beginning to fall off at Google (GOOG). This was a major factor driving the stock's price lower.

After the close yesterday, Google reported profits increased 30% and revenue moved up 46% to $3.7 billion. The company reported net income of $1.31 billion, or $4.12 a share, compared with $1 billion, or $3.18 a share, a year earlier. (See transcript.) The EPS figure was well above analyst estimates.

Paid click growth was 20 percent year-over-year, much stronger than the anemic growth rate comScore was estimating.

In this post, however, I want to look at a feature of Google's advertising methodology that is probably less well known to financial bloggers, but certainly more well known to search engine optimization (SEO) experts.

AdWords is the system that serves up the text ads that are viewed alongside search results. Advertisers associate their ads with keywords that appear in searches. Google uses an auction-based system for its AdWords product that allows advertisers to bid on each keyword to define how much they will pay for a click on their ad.

In my own personal interaction with AdWords, I see continuous keyword inflation. In other words, bids for good keywords continue to rise. If an advertiser wants to be able to have their ad displayed on Google search result pages based on a keyword pertinent to their product offering, they need to continuously monitor the price of the keyword and maintain a bid high enough to keep their ad active. Otherwise, the keyword is considered inactive by the AdWords system and the ad gets no impressions.

As competition for the best keywords increases, prices go up. Now that the (patented) system is in place, this takes virtually no investment on the part of Google. In this case, it is Google's customers that are driving the increase in ad revenues for Google. If advertisers want search ad exposure, they have no choice but to pay.

This is another reason why the company's business model is brilliant.

Comments

[mojobeta]

Because of Googles long standing leadership in ad/search,the company understands more than anyone about how to tweak ad/click formula than anyone. And this extends to overseas business. Thus, the Q1 results will only grow as overseas business grows. Next week analysts will understand this , raise estimates and targets and Google will trade at 600+.

[globalmacro]

I hope analysts lower estimates. Low expectations will drive this stock higher.

[deaverb]

Excellent points about pricing power, Warren Buffett's favorite attribute of a stock, of adwords. At Simply we started out with CD Software in categories they were not "used to" and got up to a million impressions (our objective, not clicks) before their AI system caught up to us (all of 7 days!) and they bumped us from 10 cents per click to $1. We hung around for 15 days more; they bumped many to $5. We surrendered. But they had built a new business--and other higher priced ad people took over. Impressive. And fast.

The better you do, the higher the price; think of it, where else does a volume discount become a volume INCREASE?