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Is the ad bubble leaking?

January 05, 2006

A month ago I suggested that "the wide profit margins Google enjoys on internet advertising are unsustainable." The only question was: When exactly will those margins start to shrink?

In a post today, John Battelle reports on a recent announcement from FTD, the big florist, that provides at least a little evidence that the air may already be leaking out of the online ad bubble. As anyone who has spent any time on the web knows, florists are big-time advertisers. On December 29, FTD issued a press release announcing an order shortfall in its consumer segment over the holidays. The company's CEO explained: "During the Christmas season, certain online search engine costs increased significantly over the prior year, and as such we made the decision not to pursue the resulting high cost order volume ... Further, we have begun making additional investments in our marketing staff to help build a more diversified marketing portfolio."

Search-based ads are, of course, sold through auctions. It's only natural that an auction will tend to push the price of an ad up to the breakeven point - the point at which the cost of the ad equals the revenue the ad brings in. At that point (and certainly at any price beyond that point), the ad becomes economically unattractive. Rather than continue the bidding war, an advertiser - like, say, FTD - will choose "not to pursue the resulting high cost order volume" and will instead begin investing in alternative marketing programs that promise higher returns on every dollar spent. Per-click ad prices will then fall back to a more economically attractive level, and the company running the ad network - Google, say - will make a little less money per click.

Certainly, it would be wrong to read too much into a single, carefully worded statement from one company. But it seems FTD's experience may not be an isolated one. A year ago, Meg Whitman, CEO of eBay, another huge online advertiser, said of rising search ad prices, "It's incumbent upon us...to figure out how to moderate these quite significant increases in media costs,'' according to Business Week. FTD's actions thus point to a "possible conclusion," as Battelle writes, that "search marketing may be on its way toward a slowdown, if not a plateau." At the very least, the FTD release serves to highlight the danger in assuming that recent rates of growth in online ad earnings will be sustainable indefinitely. For any given ad, the per-click price will hit an economic ceiling, and advertisers will then stop bidding the price higher. The ability of advertisers to precisely measure the value of a click makes search ads attractive. But it also ensures that, in the end, the price will come to rest at a rational level.

Comments

Another indication of paid search slowing is the increased activity around finding cheaper ways of doing it. Yesterday I was sent a little mpeg that described a new software service that helps users determine the outlier keywords that they can purchase for $.10/click. One of the tactics was to bid on misspelled words! Act of desperation if you ask me.

Posted by: Tom at January 6, 2006 07:57 AM

I think it's a mistake to conclude that self-serve, bid-for-placement advertising models must also be approaching a peak or plateau. There's something else going on here.

True, prices will come to rest at some "rational" level for any given advertiser. But, what's a rational price for one advertiser is different than what's a rational price for another. That is, new advertisers, and better, more efficient advertisers will continue to emerge and drive prices up. Indeed, some advertisers have been grumbling about getting outbid since the dawn of bid-for-placement models.

In 2006, as the mix of advertisers continues to change, we can expect to hear more grumbling and hissing.

Moreover rational price for any given advertiser changes over time, as that business is forced to examine its own cost structure, better understand its customers, improve its targeting, optimization, merchandising, etc. As an advertiser makes those improvements, it's able to justify paying higher prices.

Posted by: Paul Needham at January 6, 2006 02:23 PM

Sorry, I must be misunderstanding something. Doesn't the (auction) house always win? Google still gets the top dollar even if all parties are not winners- after all, an auction is, by definition, a winner takes all game.

Posted by: Papillon at January 6, 2006 08:27 PM

Paul: Good points. (See trackback link above for a full post on the topic by Paul.)

Papillon: Google's isn't a winner-take-all-auction. But anyway, if there's less competition among bidders, than the price will fall, along with the auction house's per-click take. Of course, the per-click price is only one factor. Another is the number of clicks. (There's no constraint on supply, unlike in auctions of goods.)

Posted by: Nick at January 6, 2006 10:27 PM

That is such a good point to see this trend when google gets too hot. I like it.

The prediction is right where exisiting E-commerce covers nearly whole business market.
But, at present, the real world is much bigger than e-business related companies. So many traditional companies have not harnessed the Internet force for sales as much as FTD/eBay had done and some of them even have never tried it(OK, at least, in China, around my friends, even though some bosses think they know the Internet pretty much).

A FTD quits, two or even more other FTDs still just start to join in Google's game.

So I believe the bubble might be leaking at a point, but it is growing in recent years(AT LEAST year.)

Posted by: Lemon at January 7, 2006 02:58 AM

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