Unless you were born yesterday (which would really suck because of its proximity to Christmas), you already know that Google is fundamentally an advertising company. In 2008, Google generated over $21 billion dollars in revenue and over 95% of that revenue was generated by Google’s Adwords program. Year end numbers for 2009 will probably be at least as impressive. Google’s success, however, depends on it not remaining simply an advertising company.
The Google Revenue Equation Explained
Google makes money when someone clicks on sponsored web search result or an advertisement placed elsewhere by Google (like the advertisements to the right of this text). I emphasize the word “clicks” because the mere fact an advertisement displays does not, itself, generate any revenue for Google. The Google Adwords program only charges the advertiser if someone clicks on the advertisement. Similarly, Google’s Adsense program, the system that pays websites to display Google advertisements, only pays websites if the Google-placed advertisements displayed are actually clicked.
The Google “Revenue Equation” is really no secret: the more people online and the more time they spend online the more revenue Google generates. The reason this has held true (around $20 billion true in 2008) is that Google dominates online search and online advertising and many people click advertisements occasionally.
Problems with the Google Revenue Equation
Google relies heavily on its success in mapping and organizing the web via its proprietary search engine technology to generate revenue. While I do not know the breakdown of advertising revenue from *.google.com sites and other sites, I suspect that the vast majority of Google’s revenue is generated by sponsored search results and other advertisements on *.google.com. This is problematic because web searches are becoming less and less relevant to many web users.
First, there are other ways to satisfy curiosity, research and find relevant information–Wikipedia phenomenon. Any aggregator of information draws people away from Google’s web search. If you want a tidbit of information (ranging from the cast of a television show to information about aerospace), Wikipedia is a very good starting point. The footnotes can direct you to other websites, often more authoritative and more comprehensive than Wikipedia itself. Google is entirely shut out. However, it would be fair to point out that most Wikipedia pages are probably assembled with the assistance of Google’s search engine. But, keep in mind that there are far more readers of Wikipedia pages than there are authors. Although it is difficult to label Wikipedia a competitor of Google’s (Wikipedia is a 501(c)(3) under the tax code and presently generates more than 50% of its traffic from Google searches), it draws traffic away from traditional search engines. Again, any aggregator of information draws people away from Google’s web search.
Second, “sticky” social networking sites like Facebook and Twitter are drawing people away from websites that generate money for Google. Not only are more and more people joining these sites, many spend an increasing percentage of their online time on these sites. Furthermore, these sites are also becoming portals for real-time news reports, Twitter especially. Most major newspapers tweet breaking news and links to their news stories. Many blogs, including this one, generate more traffic from Twitter than from Google searches. As social networking sites add features, they also draw people away from some Google properties. For example, some people rely heavily on Facebook and Twitter for private messages and rely less on Gmail.
Third, newbies rely more heavily on Google’s search than experienced web users. Newbies often do not know where to begin or how to find content that will interest them. Experienced web users have found their favorite sticky websites and use bookmarks and favorites to organize them. I would argue that the attractiveness of running a broad-based web search diminishes substantially as a person spends more time online (an inherent problem in the Google Revenue Equation). Many people would rather search their favorite sites or specialized sites that have information that they find interesting. Also, I contend that newbies are more likely to click on advertisements than experienced web users for the reasons cited above and out of confusion. Accordingly, newbies are worth more to Google than experienced web users.
Fourth, a bubble could develop in the online advertising market. While there is unlikely to be a shift away from online advertising to other forms of advertising, the ROI for online advertising may become more transparent to advertisers in the future and some may choose not to invest heavily in online advertising. If this occurs, it would have a material effect on Google’s revenue.
Wait, Google’s Not Run by Dummies!
Google is is keenly aware of how to generate revenue and constantly and shrewdly diversifying.
First, Google is attempting to rely less heavily on the Google Revenue Equation. Google is successfully marketing to businesses and governmental entities its web-centric, cloud properties like Google Docs, Google Calendar, Gmail and other business tools as a replacement for hosted servers and Microsoft products. In doing so, Google seeks to generate a higher percentage of its overall revenue (something north of 5%) from non-advertising sources.
Second, Google is trying to bring the web to newbies, those that produce the most revenue for Google. Chrome OS is fundamentally all about bringing the web to people who either do not know how to use computers and/or do not have the need for sophisticated standalone software. It would be ideal for children, senior citizens who are not tech savvy and the developing world. First, it will be easy to use. It is simply a web browser–nothing more and nothing less. Second, it can run on very inexpensive hardware, thus bringing more people online. (Rumor has it that Google sent out an RFP to leading netbook manufacturers to mass manufacture a basic notebook that can run Chrome OS. I believe that Google can significantly profit by giving away (literally gratis) cheap Chrome OS netbooks to newbies.)
Third, Google is attempting to create its own sticky properties and acquire sticky properties. Orkut is a social networking site owned by Google but it has been a almost a complete failure (except in Brazil where it is the dominant online social network, I recall reading).
Google Wave could become a sticky property. First, Google Wave is Wiki-like, potentially drawing traffic away from sites like Wikipedia. Second, it has the potential to compete with social networking sites like Facebook and Twitter. Google Wave, however, is more difficult to understand and use than other forms of communication.
Google has sought to acquire sticky properties, most recently Yelp. I would expect Google to spend a significant percentage of its coffers on purchasing sticky properties. This will be a difficult path to pursue, however. Already, Google is encountering antitrust resistance to acquisitions. (We learned this week that Google is drawing FTC scrutiny of Google acquiring AdMob. This hints at what regulators think of Google making acquisitions, although AdMob is an advertising company, like Google.) Maybe Google will make a bid for Facebook one day? One hurdle, perhaps insurmountable, would be antitrust regulatory concerns under the Hart-Scott-Rodino Act. Going with the Facebook hypothetical, Google could be on somewhat better legal ground, oddly enough, if it had never deployed Orkut.
Fourth, Google is trying to capitalize on real-time news and indexing of social networking sites. Not so long ago, Google inked a deal with Twitter to incorporate real-time Twitter results into its web search engine. Also, as it did with Google Finance, Google is experimenting with streaming real-time results.
Fifth, Google is actively looking for content that it can sell to subscribers. Google is seeking to add premium content to YouTube, including first run television shows which would stream without commercials. It faces stiff competition in this area from Apple which is aggressively pursuing major outlets for content deals.
Sixth, Google is diversifying away from the keyboard and web searches. Google is quite seriously entering the mobile devices arena (phones and tablets), not only by programming the Android OS but also by manufacturing the upcoming Google Nexus One handset. Google is looking to dominate voice transmission; Google Voice is simply the tip of the iceberg. Google acquired a VOIP provider this year and will roll out a Skype-like service which will integrate with Google Voice. When phone number porting is added to this equation, Google will be a juggernaut in the transmission of voice.
Bottom Line
Google is an advertising company and the Google Revenue Equation is ingenious and simple. However, Google’s success depends heavily on proactively pursuing revenue that is generated by other means. This clearly appears to be Google’s approach. Again, Google’s not run by dummies.
[Credit: Ben Parr, Co-Editor of Mashable, in his July 11, 2009 post entitled "The Google Revenue Equation, and Why Google’s Building Chrome OS," introduced me to the basics of the Google Revenue Equation.]
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