Google's Budget Guzzling Engine

We (online advertisers and the agencies representing them) are the gas that feeds Google’s revenue engine, and in Q4 2009, Google proved just how much of a gas guzzler it is. The company reported revenues of $6.67 billion for the quarter ending December 31, 2009, an increase of 17 percent compared to Q4 2008. Clearly, even in a tough year, Google has figured out how to make a great living off of advertisers across the globe. Yes, the Q4 2008 was already well into the economic meltdown, but Google still managed to squeeze year-over-year growth out of the earlier portions of 2009, with 7 percent revenue growth in the third quarter and 3 percent growth in the second.

Interestingly, among many data sets I’ve seen, the majority of revenue growth has come from larger advertisers who have the staying power to raise budgets and crush their competition. This staying power and ability to invest ties in nicely with an analysis of Google’s results.

So, let’s look at the drivers of such growth in a year when many consumers and businesses were still operating in a frugality mindset. First, it’s important to understand the multiplicative nature of much of Google’s ecosystem. This means that if advertisers increase more than one of their revenue-producing KPIs (define), the revenue increase is compounded. Without searchers there can be no search advertising revenue and that’s where it all starts.

Google’s query share indicates the percentage of the total searches which it captures: according to comScore, in December 2008 Google had 63.5 percent of searches under its umbrella of sites. One year later, in December 2009, comScore’s report had Google at 65.7 percent. That’s a 3.3 percent change (lift, not subtraction) and therefore, based on query volume alone, one would expect Google’s revenues to rise by over 3 percent.

Number of paid clicks and click yield: Google reported that, “Aggregate paid clicks, which include clicks related to ads served on Google sites and the sites of our AdSense partners, increased approximately 13% over the fourth quarter of 2008.” Now, this is a total percentage increase (including both Google.com and AdSense partners), but clearly Google got more clicks not only because of query share gains but due to other factors. Two of those factors might be the “Google hug” where ads moved from the rightmost side of the browser adjacent to the organic results, as well as the new trademark bidding policy in place for 2009. Of course, Q4 sees a spike in product and trademark searches and 2009 was the first year when the more relaxed trademark policy was in force. Google is also able to improve the number of clicks per thousand searches because the relevance of ads is constantly improving, which brings us to CTR (define).

If the click-through rate on ads overall goes up, Google and its advertiser see more clicks per thousand searches. It’s easy to congratulate Google for having improved the Quality Score algorithm, driving better ads to the top of the results. However, advertisers didn’t sit still all year either. Some advertisers improved their ads.

My belief is that for sectors in which large and small advertisers bid for listings in the same SERP (define), the larger advertisers are pulling further and further ahead. Larger advertisers can do more landing page testing, build micro-sites, and therefore drive up conversion rates. Their brands and reputations may have already given them a conversion rate advantage and the usability improvements cement this advantage. A small site can’t compete on conversion rate, and therefore can’t bid as high. The strong get stronger and the weak get weaker. Let’s call this phenomenon the “Google Advertiser Digital Divide.”

Costs per-click have also risen. According to Google, “Average cost-per-click, which includes clicks related to ads served on Google sites and the sites of our AdSense partners, increased approximately 5% over the fourth quarter of 2008.” CPC (define) increases could be driven by a variety of factors. Advertisers may be factoring in non-DR value of search visits (not likely in my opinion), may be accepting a lower ROI (define) (not something I’ve seen a lot of), or might have improved their site experiences to improve conversion rates. My bet is on the latter. Better landing pages and better landing page choices improve conversion and improved conversion provides an advertiser with leverage, meaning the bids can rise and the same ROI can be achieved.

When all the factors we discussed above are taken into account, it’s easy to see where a 17 percent gain would come from. With more searches, an increased CTR, and higher CPCs, we get a significant spike in monetization and revenues.

The fourth quarter is also special in SEM (define) circles across all the engines because retail conversion rates often rise. Searchers are in a shopping mode and more likely to buy. This temporary improvement in conversion rates provides leverage in much the same way as an overall improvement in site usability. Bids rise as the marketer takes advantage of the change in reserve price CPC.

Which side of the digital divide do you want to be on in 2010? Want to find out how you stack up? Take the SEMPO State of Search Engine Marketing survey and you’ll get a free copy of the final report.