Google, Adblock, And The Future Of Internet Advertising

| About: Alphabet Inc. (GOOG)
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During a recent conversation with my mother, a health-related question came up that I didn't know the answer to. Obviously, I suggested she Google (NASDAQ:GOOG) the question on her nearby laptop. She did so, then proceeded to click the first link that came up.

"No," I said immediately. "That's the wrong link."


"It's the wrong link," I repeated, pressing the browser's back button. "The links at the top are ads. You never click those."

Now, my mother, by her own admission, isn't the most technologically savvy person in the world. Yet I'd assumed everyone knew that when you run a Google search, the first results in the little yellow box are paid advertisements that in many cases, aren't actually what you're looking for.

In fact, I'd even forgotten that advertisements were displayed on Google searches. Why? Well, I've been using the internet for so long that my eyes naturally drift over ads. Wherever I am -- Google, SeekingAlpha, etc -- I rarely actually notice the ads. On search, for example, my eyes automatically snap to the part of the search results screen I've outlined in red.

As I stated before, my reason for doing this is that in my experience, advertisements rarely provide me with the content I'm looking for. It's not just me who thinks this, though. Larry Page and Sergey Brin (the founders of Google) wrote a very interesting paper titled The Anatomy Of A Search Engine way back before Google became the omnipresent force it is today. One of their conclusions:

[W]e expect that advertising funded search engines will be inherently biased towards the advertisers and away from the needs of the consumers.

The fact that a lot of ads are just plain not useful to consumers means that many, like me, are prone to ignore them. This is a phenomenon that has been documented on web searches, Facebook, and more generally.

This "ad blindness" among the tech-literate crowd is compounded by the fact that many (like myself) often use tools like AdBlock Plus to remove annoying rich-media ads encountered while browsing the web. (As someone who routinely listens to music while working, there are few things more annoying than opening a tab and hearing someone rambling on about detergent and/or kitty litter and/or whatever.) More and more people turn to such ad blockers each year. AdBlock Plus, the free Firefox add-on, has nearly 14M users, according to Mozilla. Undoubtedly, other consumers use similar products, resulting in a much higher population which isn't even being reached by internet advertising.

The Future Of Internet Advertising

After telling my mother that clicking on ads was "a mistake," I came to a stunning realization: this is a huge deal for a lot of companies, none less than Google. Think Google makes money from selling technology? Think again; 96% of Google's earnings come from advertising. Ninety six percent. If even 10% of the world's users decided to use Adblock or a similar program, Google's revenue would drop 9.6%.

It's inevitable that over the next few decades, older Americans not as familiar with the internet will be supplanted by digital natives who've spent their whole lives on it. This has huge ramifications for companies like Google that derive significant chunks of revenue from internet advertising. The "youngsters" are much more likely to ignore ads, or worse, use ad-blocking programs to screen them out entirely. Just as DVR users fastforwarding through ads has caused problems for broadcast networks, so will savvy internet users ignoring/blocking internet ads cause problems for internet advertisers.

It's also important to consider that younger users more familiar with the internet are far less likely to ever click on advertising; 47% of users in the 35-44 demographic ignore internet ads altogether. A full 80% of Facebook users (who typically tend to be fairly internet-savvy) ignore Facebook ads. To analyze my original point a little differently: there are two general scenarios for my actions on the internet. The first is when I'm searching for information. In this scenario, I don't click on advertising, because generally, the ads are trying to sell me something, and I don't want to be sold anything. I want information. (The ads can get really terrible sometimes -- my favorites are the "acai berry" ads and "work from home earn twenty billion dollars a minute" ads.)

The second scenario is when I'm trying to buy something. This is generally a place where advertising would be effective -- except that, as a regular user of the internet, I already know where I want to go. Generic need-to-buy-something? Amazon. Looking for a good deal? Slickdeals. Home improvement? Clothing? My preferred retailers' sites.

The point is, internet advertising is largely ignored by a growing segment of the population. To be sure, this has NOT caused any adverse material impact on ad revenues to date -- evidenced by companies like LinkedIn (LNKD) and Twitter as well as Google, Internet advertising will continue to be very lucrative as people increase their internet exposure through multiple new platforms like smartphones, tablets, TVs, game consoles, etc:

The 2012 fiscal year is off to a good start for internet advertising as the first quarter welcomed a record-breaking $8.4 billion in revenue, more than any previous first quarter.

Revenue from internet advertising has clearly been growing strongly, as evidenced by the chart below. If the current growth trend continues, annual ad revenue on the Internet (across all four quarters) will eclipse $40 billion sometime in the next few years. As more users worldwide gain internet access, this figure should stand to increase solidly over the next few years.

So while I'm not suggesting that this "ad blindness" effect will cause Google's revenues to collapse anytime soon, it's important to think about long-term demographic trends and how they will affect current business models in the future. For example, while television ads used to be a "sure thing," new innovations like DVRs are causing nightmares for broadcasters because they often allow viewers to simply skip ads. It's relatively easy to figure out that print advertising is a hopeless way of reaching kids raised on Kindles and iPads, but is it really so hard to extrapolate that to Internet ads becoming increasingly ineffective as more and more users ignore ads or block them entirely? These are factors to monitor in the long-term, just as DVR ad-skipping was a factor to monitor in relation to television advertising.

It'll be interesting to see how companies like Google respond to these challenges over the next 10-20 years. Google has a history of innovation, and an actual page on advertising innovation. The meteoric rise of unstructured data gives advertising providers a lot of leverage in targeting users, and some technology even includes heuristics to track users across devices.

In my opinion, just as "old tech" companies like the mail meter company Pitney Bowes are having to re-imagine themselves in a brave new world, so too will Google have to re-imagine its strategy in the future.

Disclosure: I am long (NYSE:PBI).