[credit provider=”Ken Sena, Evercore.”]
This post is from BI Intelligence, our new industry research and analysis service. The service is currently in beta. For more information, and to sign up for a free 30-day trial, click here.In scrambling to explain why they were wrong about Google’s quarter, most analysts are blaming “expectations” (translation: We weren’t wrong–it was you idiots who were wrong.)
They’re also pointing out that the quarter wasn’t as bad as it looked.
And the latter point is true.
But there are still a couple of key concerns about the quarter, both of which could have long-term implications for the company.
- Google’s core search business slowed more sharply than expected, even in the U.S. Analyst Ben Schachter from Macquerie was one of the few analysts to point this out. Google’s display business grew faster than expected, but this only meant that the core search business was even weaker than it looked. This slowdown, moreover, was not just the result of mobile usage affecting click prices. In the U.S., it was also not the result of foreign exchange rates.
- Mobile search, which is accounting for an ever-bigger percentage of overall searches, is less profitable than standard PC-based search–and this is not likely to change. Many analysts dismiss lower keyword prices for mobile search by saying the mobile search market is just immature. This misses a key point. Except for location-aware local commerce searches, most mobile searches do not result in incremental spending by searchers. They merely shift the spending from the PC to the mobile device. Also, mobile search distribution is, at least for now, more expensive than Google’s PC-based distribution.
On the growth slowdown…
The growth of Google’s overall business slowed from 33% in Q3 to 25% in Q4. Most of that slowdown was the result of international, which slowed from 41% growth to 28%. But the US slowed, too. Q3 growth in the US was 26%–about the level it maintained the entire year. Q4 growth in the US, meanwhile, slowed to 23%.
Anecdotally, we have heard that one big challenge that Google is facing these days is that Amazon is starting to have an increasing impact on revenue from product searches, which have been a critical generator of Google’s growth over the past decade.
Amazon could be affecting product-search revenue in two ways:
First, as Amazon grows and offers a more comprehensive and informative product selection, more people may be starting their product searches at Amazon. This would cut Google out of the process entirely.
Second, Amazon itself is now selling third-party product-keyword ads on its product search pages. (See below). These ads could be skimming off spending that might historically have gone to Google. If Amazon continues to become the first stop for more and more online product searches, this could begin to bite into a very lucrative part of Google’s revenue stream. And Amazon, unlike some general search providers, is not going to fold up the tent and go away.
For example, here are some ads at the bottom of an Amazon search-results page for “toaster oven”:
On mobile searches and dropping costs-per-click…
Many analysts view mobile search as an explosive new revenue growth engine for Google. This ignores a critical point. Most individuals do not spend more money buying things merely because they can now use the web on their mobile devices.
The commerce searches that generate most of Google’s revenue, in other words, can now be conducted on a mobile device instead of a PC, but this does not mean that they will lead to more spending. It just means that the consumer has more ways to access Google’s search engine.
The reason this is important is that, as was made very clear in this quarter, Google’s revenue is not determined by the number of clicks it gets on its search ads. It is determined by the return-on-investment of Google’s advertisers. And this ROI, in turn, is determined by the amount of money Google searchers spend, not by the number of times they click.
All of which is a long way of saying…
With the exception of mobile searches for local commerce products–coffee, lunch, etc.–most mobile Google searches probably do not lead to searchers spending more money than they would have if they had only had a PC to search with. Instead, most of these mobile searches are either not commerce searches (weather, contacts, locations, etc.) or are commerce searches that would otherwise have been performed on a PC.
So, unless/until Google invents a huge new commerce search business that is only relevant on mobile devices–a hypothetical product that has been hyped for years (since the mid-1990s), but has never really taken hold–the ROI for mobile search ads is likely to be far lower than it is for PC-based ads.
And that means that analysts who expect the “number of clicks” to drive Google’s revenue going forward are likely looking at this metric the wrong way.
(The chart from Ken Sena at Evercore below shows the trends in paid clicks and revenue-per-click. The important point is that the revenue-per-click is derived from the total amount advertisers spend rather than the number of times searchers click).
Ultimately, Google’s revenue is determined by the amount advertisers spend, not the number of times searchers click. So obsessing about “number of clicks” and “revenue-per-click” is actually a misleading way of looking at the business.
[credit provider=”Ken Sena, Evercore.”]
THE BOTTOM LINE:
Google’s business is still robustly healthy. The company is now generating run-rate free cash flow of an astonishing $12 billion a year, and it is still growing at 20%+ per year. But Google still has yet to develop a second major business that is as profitable and promising as its core business (display and mobile are still small relative to the standard search business and they are nowhere near as profitable). And Google’s core business is, gradually, maturing.
Google is also about to strap a dying elephant on its back in the form of Motorola. Although CEO Larry Page reiterated that Google will run Motorola separately, it’s impossible to imagine that it won’t be a distraction, especially if its business continues to suck wind. If Google instantly flips Motorola’s manufacturing business and just keeps its patents, fine. But there seems at least a reasonable chance that Larry bought Motorola, in part, because he wants to try to compete with Apple in the integrated hardware-and-software business.
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