Google Bear Case 1: Advertiser ROIs Dropping Fast

As described, we are terrified by the lack of diversity of opinion about Google’s business and stock: Everyone expects both to go straight to the moon.  Usually, a lack of diversity means trouble (in this case, no buyers left to buy), so we’ve asked anyone with legitimate concerns about Google’s business growth to share them with us.  We’ve gotten some excellent thoughts, and we look forward to hearing more.

For today, here’s a note from an SEM expert, who argues that Google keyword prices have now gotten so high that advertisers are starting to get better ROIs on other platforms (e.g., Microsoft and Yahoo).  The theory here is that this will eventually lead to Google market share losses, as advertisers shift to competitive platforms or media.  We have some thoughts on this, but first we’ll let the SEM expert speak for himself:

[You talked about how Google benefits from a network effect:] Google has the most users, so Google has the most advertisers.  More advertisers means more revenue which means more R&D spending.  More R&D spending means sustainable competitive advantage.

What’s unique about this “network effect” is that it doesn’t keep growing, but starts to reverse itself. As more advertisers spend on Google, CPCs rise. This lowers ROI for the advertiser, increasing the attractiveness of alternative marketing options (i.e. Yahoo & MSN, Facebook, etc).

I’d suggest speaking to a few (savvy) online marketers about their relative ROI across platforms. I expect what you’ll find is that many, if not all, see lower ROI from their Google campaigns than from similar placements on alternatives. Their tools are easiest to use and the volume is huge, but ultimately ROI is king and many people can already earn more gross profit by advertising elsewhere.

The important question from a shareholder perspective is when those ad dollars actually start shifting en masse, and whether or not that justifies a $700 price. On that, I’m not willing to take a stand.

Analysis: This is a very legitimate concern: At some point keyword prices will reach a point where no further increases can be sustained, and Google will then lose the portion of its revenue growth that is attributable to price increases (a minority at this point: Most of the year over year growth in recent quarters has come from click growth rather than price-per-click growth).

After we got this note yesterday, we reached out to a couple of SEM folks.  One said “not necessarily seeing that.”  Another said Google ROIs are indeed lower than, say, Microsoft’s, but Microsoft delivers so few qualified leads that it’s not a viable option for the bulk of his spending.  We look forward to hearing from more SEM folks in the next couple of days. Over the long term, however, this is indeed something that will eventually constrain Google’s growth rate.

As the writer notes, the trouble with this concern as a near-term “bear thesis” is three-fold:

  • It’s hard to get a wide enough sample to be confident that the problem isn’t isolated to one geography or industry.
  • It’s hard to accurately “time” (We’ve heard similar anecdotes since 2004).
  • Different geographies are at different phases of price maturity.  Specifically, the US is the most mature, and emerging markets are the least.  Google gets half of its growth from international markets, so price gains will likely continue to drive growth long after US prices hit a ceiling.

See Also: Calling All Google Bears: Please Share Your Thoughts

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