December 09, 2005
Thanks to a link from John Battelle, I came across a fascinating little article about an appearance by Bill Gates on Indian television earlier this week. Noting that Google's "business model is based on advertisements from which they make a lot of money" and that "Google keeps all of the money with itself," Gates said that Microsoft intends to "share a part of its advertising revenues from its search engine with users" - by giving them credits for buying software or even outright cash payments.
What Gates is saying - and it will not be music to Google's ears - is that there's too much profit right now in online advertising.
He's right. Earlier today, in a post at SiliconValley.com's Google discussion, I argued that the wide profit margins Google enjoys on internet advertising are unsustainable:
... if Google has reaped a great and well-deserved bounty from creating a superior search engine, it has also been lucky. It happened on its ad-driven business model just as the advertising world began an epochal shift of dollars over to the net, and the dominant position of its search service and related ad-serving service has meant that it has taken in the lion's share of the spending. Moreover, it's been able to run its AdWords and AdSense services as black boxes, hiding to a large extent the way it divvies up the money that comes in. Advertisers and publishers haven't complained much because their choices have been constrained. In the end, though, markets abhor both black boxes and oversized profits.
Competition, from Yahoo and Microsoft as well as others, can be expected to reduce the profits that flow to the owners of Internet ad-serving mechanisms, while also making pricing more transparent. Moreover, advertising is a cyclical business, and at some point we'll see a stemming of the flood of advertising dollars to the web. Combine greater competition with advertising cyclicality, and you end up with a Google that operates with a considerably lower profit margin than it enjoys today. Then add in the company's free-spending culture, and, well, you've got a problem.
The online ad market is going to become more efficient. Much of the profit that now goes to the operators of the ad-serving technology will be redistributed. Some will go to the advertisers, in the form of lower rates, and some will go to the publishers, in the form of higher commissions. And if Gates is serious - and I'm betting he is - some will go to the internet users themselves, whose clicks, after all, make the whole system work. In the battle for eyeballs, bribery can be a powerful weapon.
The same Microsoft which has 87% gross margin, only invests 15% in R&D and ended up last year with 2 years worth of revenues in cash?
It gave a large cash dividend to investors - but not to its corporate customer in the form of lower prices or refunds. I suggest Bill start taking care of his corporate customers. They are not happy about subsidizing his Google counter-attack or his losses on the XBox 360.
Posted by: Vinnie Mirchandani at December 9, 2005 03:03 PM
Will be redistributed? It's already starting in a small way through a referral progam for content sites and analytics tools for advertisers. And there goes the Media Business as we know it.
Posted by: Don Marti at December 9, 2005 07:27 PM
I suspect it won't be Microsoft who takes the profit out of online advertising, despite Bill's mutterings - the drive will come from start-ups with nothing to lose, start-ups that'd very much like a bigger piece of a smaller market.
That said - an efficient market with full price transparency and narrow margins is coming for certain. Sell your GOOG stock before it gets here.
Posted by: Greg Yardley at December 10, 2005 09:04 AM
We wonder why it tooks so long to realize about the concept of share revenues with users. At www.kolablog.com, not only users can get multimedia blog setup, but they also share the ads revenue.
Posted by: Kevin Hawk at December 10, 2005 04:10 PM
I don't quite understand this whole line of thinking. First, for the small group of sites that "outsource" site search to Google, they can get regular AdSense payouts if surfers click on ads in the search results:
But I'mnot sure why you'd want ads showing up in your site search results.
Posted by: pwb at December 12, 2005 05:55 PM
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