What’s Google up to with Checkout? And is the new payments system a sign of strength for the company, or of weakness?
Google’s an odd duck, businesswise, but the oddest thing about it is that it sells its product (AdWords ads) through an auction that it controls. Auction pricing is pretty unusual to begin with, but auction pricing through an auction you control is very, very unusual. One consequence of allowing customers to set the price of your product, through competitive bids, is that you can’t do what most companies do routinely: manipulate demand by altering prices. At least, you can’t do that directly. What you can do, though, is provide indirect discounts by reducing the price of other products that you bundle with your core product. That’s what Google’s doing with Checkout. It’s providing certain AdWords customers – those that also use Checkout – with a discount, or subsidy, on their AdWords purchases in the form of a rebate on their Checkout fees. For every dollar a customer spends on AdWords, it gets to sell $10 worth of goods through Checkout without incurring the usual payment-processing fee (20 cents plus 2% of the transaction amount).
So how big of a discount is it? Well, let’s say you sell widgets for $20 a pop, and you already use AdWords to promote your widgets. And let’s say it costs you on average $2 in AdWords fees to sell one widget. And let’s also say that you sell 100 widgets a month, earning revenues of $2,000 and incurring $200 in AdWords fees. So you’ve earned a Checkout credit of $2,000 ($200 x 10), which means that you get to process all $2,000 of your sales without any fee. That translates into a savings of $60 [(100 x .20) + ($2000 x .02)], which means that Google has given you a 30% discount on your AdWords purchases. Any way you look at it, that’s quite a large discount.
Now, this is just one hypothetical example, and I have no idea how it matches up with the typical profile of an AdWords customer. But I think it’s fair to say that the AdWords discount earned by Checkout users will often be substantial.
What does this indirect discount mean in the context of auction pricing, though? If all Google’s customers signed up for Checkout and received the same discount, it would be a wash. The prices of auctioned AdWords keywords would simply go up to offset the general discount. On net, Google would make the same amount of money, and its customers would spend the same amount of money. But not every AdWords customer will use Checkout. A lot of them, in fact, don’t use AdWords to sell merchandise or services over the web, so they have little need for Checkout. That means that keyword prices should go up a bit, but not enough to offset the discount Google’s paying. Nor will the company make up the discount in added sales. The customers receiving the discount will tend to buy more, since the prices won’t go up enough to fully eat up their discount, but those not receiving the discount will tend to buy less as the prices go up. (I encourage readers with deeper knowledge of mathematics and economics to check my reasoning here, as I may well be missing something.)
Now, certainly Google has some ulterior motives. By encouraging companies to use Checkout, it makes Checkout more attractive to consumers – and as consumers sign up, Google will be able to harvest more information about them and their buying habits. That will be worth something, as it will allow Google to target its ads more precisely. And if Checkout takes off, Google could eventually increase its fees or reduce the discount, thereby making money off the service itself. But these are theoretical benefits that may or may not materialize in the future. Right now, it’s hard to see Checkout as anything other than a discount program for AdWords. Google CEO Eric Schmidt admitted as much to the New York Times: “Mr. Schmidt said the company was willing to lose money on [Checkout] transaction fees because it felt the package would increase advertising spending. ‘The math works because we can have lower prices and higher volume,’ he said.” I don’t think “the math” works as he describes it, though. Yes, the net prices of keywords should go down for Checkpoint users, but the actual prices should go up (as those receiving the discount bid more), and I’m not sure that will translate into higher volume overall.
In this context, the program seems to signal weakness in the AdWords market rather than strength. Companies rarely give price discounts when demand is buoyant. Discounts are something you use when demand is softening. One thing Checkout will do is give an artificial boost to keywords prices, which may be helpful to Google when it comes time to report its results and discuss market trends with analysts. Any sign of erosion in keyword prices would make investors nervous.
There’s one last twist here. By effectively boosting keyword prices for AdWords, the launch of Checkout should increase demand for alternative keyword-based ad programs and boost their own prices. The biggest immediate beneficiaries of the Checkout discount may, in other words, be Yahoo and Microsoft. That’s another odd effect of auction pricing: one competitor’s attempt to provide a discount, through an indirect subsidy, may actually raise the prices of other competitors’ products. Weird.