Google’s parent company Alphabet may have topped expectations when it reported Q2 earnings Monday, but that didn’t keep the stock from slipping about 3% in after-hours trading.
One reason could be the increasing traffic acquisition costs (TAC). Google has to share some of its mobile ad revenue with partners who bring users to its search engine or who run Google ads on their own websites.
These partners include companies like Apple, which has made Google the default search engine on the iPhone, and the various websites that integrate Google’s advertising products.
Total TAC last quarter was $US5.09 billion, up from $US3.98 billion a year ago. That’s 22% of all of Google’s ad revenue, according to Monday’s earnings report. TAC was 21% of Google’s revenue a year ago.
But the situation is more striking if you look at the number more closely:
- TAC to “network members” (i.e. websites, particularly mobile websites, that funnel traffic to Google, as well as programmatic advertising) represented 71.6% of network revenue in Q2. That’s the highest level since 2009, according to Pivotal Research analyst Brian Wieser.
- TAC to “distribution partners” (i.e. smartphone makers and mobile carriers) represented 9% of advertising revenue, and increased 52% year-on-year — the largest such increase in any quarter since 2008, Wieser said.
Google has always paid TAC, and most investors and analysts deduct those expenses from Google’s revenue when they assess the company’s top line.
The problem is that as TAC goes up, Google’s “net revenue” declines. And shifting technology habits, including the shift from PCs to smartphones, appears to be forcing Google to pay out a greater share of its revenue.
“It appears that product mixes including the changes in the kinds of inventory that Google sells via its networks (for example brand safe and viewable ad inventory, especially including video) could be causing Google to incur higher costs than was previously the case,” Wieser wrote in a note to investors.
Macquarie analyst Ben Schachter pointed to Google’s Q2 net revenue as a “meaningful deceleration.” It’s not the end of the world, Schachter said, but it illustrates the changes to Google’s business model as more and more of its search traffic now comes from mobile devices like iPhones that require Google to share some of the revenue.
Alphabet’s CFO Ruth Porat noted on the company’s earnings call Monday that she expected some traffic acquisition costs to continue to rise. She said that the increase in mobile searches and programmatic advertising were responsible for the rising TAC. But Porat characterised it as a positive, since the rising payouts to partners reflecting the increasing use of Google’s service.
“It really provides another lens on just how strong our mobile business is,” Porat told one analyst in response to a question about the rising TAC costs.
And while Google is paying out more TAC, Porat stressed, the company is also growing its overall profit dollars.
Get the latest Google stock price here.