Has Google Peaked?

Innovation, the Internet, gadgets, and more.
Oct. 10 2005 4:49 PM

Has Google Peaked?

Potential obstacles for the world's hottest tech company.

When I think of Google, I think of the arch-villain Mr. Big from the James Bond film Live and Let Die. His diabolical plan: Flood the streets with free heroin to drive out competing suppliers and dealers. Once users got hooked on his free smack, Mr. Big could leverage control over the entire market.

This is, in essence, Google's business model. Of course, instead of heroin it traffics in free software and Web sites. It's unlikely Google will start charging for them anytime soon—rather, it will continue to deploy services as a vehicle for targeting ads. But, like Mr. Big, Google depends on the broad acceptance of its products. Without massive numbers of users, the company wouldn't have the customer base to attract billions of dollars in advertising revenue.

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Starting with a few algorithms, Sergey Brin and Larry Page coded a company from scratch that today has a market cap approaching $90 billion and a stock price of more than $300 a share. When conventional wisdom said there was no money in search—that a search engine had to be an add-on to a portal to attract users—Brin and Page figured out how to sell ads based on keyword searches. Although Overture, now owned by Yahoo!, patented the idea, Google perfected it.

In seven years, the company has never known failure. But the more Google's stock price kisses the clouds, the more it looks like the search monster may have peaked.

About 99 percent of Google's revenue comes from advertising. Roughly half of that money comes from paid keyword searches—when I search for "edible body paint," I'm greeted by a number of "Sponsored Links" for online merchants (Kama Sutra Products, Body Candy) that have bid on these specific keywords. The other half of Google's ad revenue comes from its AdSense program, which offers commissions to site owners who run ads on their Web pages.

But if you live by advertising, you can die by advertising. If there were a downturn in the Internet ad market for any reason, Google wouldn't be able to meet Wall Street's expectations. Its stock, perhaps already inflated with a price-to-earnings ratio of close to 90, would lose some luster. (Yahoo!'s PE is in the 30s, and Microsoft's is in the 20s.) Google is well aware of this. In its latest quarterly report, the company warns that reduced ad spending "could seriously harm our business."

Not only does Google depend on ads, it relies on one source—AOL—for about 12 percent of its AdSense revenue. If AOL terminated its contract, Google would feel some pain and its stock price could take a significant hit. Last Friday, the Wall Street Journal reported that TimeWarner and Microsoft, Google's main rival, are talking about forging an alliance between AOL and MSN. That can't come as welcome news in Mountain View, Calif.

Another threat to Google's ad-centric business model is click fraud, which the company lists as a significant risk in its SEC paperwork, noting that it could lead to advertiser dissatisfaction and potential lawsuits. Simply defined, click fraud occurs when someone clicks on a paid search ad with no intention of buying anything, and is usually accomplished by deploying automated bots. It is either perpetrated by affiliates who receive a commission for every click they can induce, or by a competitor who wants to force a rival to run through its ad budget so it can buy the top keywords at a discount. No matter who does it, it's the online merchants who pay; they pony up anywhere from a few cents to $20 or more for each click.

Although there's no way to know what percentage of clicks on keyword ads are fraudulent, estimates range from the single digits (what Google claims) to 20 percent or more. Google offers rebates to victims, some of whom claim click fraud has cost them as much as $500,000, but stamping it out is easier said than done. With millions of keyword transactions every day, coupled with bots that are growing ever more sophisticated, click fraud can be hard to spot in traffic logs. And in the short term, search engines have little incentive to prevent it, because they get paid whether the clicks are legit or not. If Google were to deploy an automated solution that could catch every instance of keyword fraud, traffic might plummet, as would ad revenue. That's precisely what happened to a small Brooklyn-based company called Blowsearch.

For a company that depends so much on a single type of revenue, Google has stretched itself awfully thin. In the last two years, the company has released a dizzying array of products: Gmail, the Google Toolbar, Google Maps, Google Earth, Google Blog search, and an instant messaging/Internet phone service called Google Talk. There's also the Google Print Library Project (a plan to scan and make searchable the contents of entire libraries), a video search engine that's in beta testing, and a recent bid to provide free Wi-Fi to all of San Francisco.

Things are so frantic at corporate headquarters, a Google PR rep recently told me, that he didn't have time to answer questions; he did ask if I knew of anyone who wanted a PR job. As Search Engine Watch editor Danny Sullivan puts it, the fact that Google is getting into everything means that they run the risk of not doing some things well. If Google had invested more in blog search over the last few years, for example, it could have controlled the industry rather than playing catchup.

The recent announcement of an alliance between Google and Sun is another sign of potential future trouble. Usually when Google trumpets something, it has a product ready for prime time (even if it's a product that remains in beta for years). But despite the media froth about Google and Sun joining forces to attack Microsoft on the desktop, all the companies have agreed to do is distribute and promote each other's products—and without a plan to actually make it happen.

Even if the press got it right, and Google and Sun are planning to create a network-based office suite to compete with Microsoft Office, they would undoubtedly experience a bumpy ride. Would the companies follow Google's model of giving software away in exchange for targeting advertisements? If so, can you imagine drafting a screenplay about vampires and being bombarded by keyword ads for stakes and garlic? Spooky (and annoying).

Besides, would fighting Microsoft for control of the desktop be smart? As risky as it may be to continue spitting out Web products that help disseminate its ever-growing inventory of advertisements, it's even riskier to take on Microsoft, whose market cap is three times the size of Google's. After all, Bill Gates has smashed upstarts before. (See Novell and Netscape.) Google would probably be better off figuring out another way to diversify its revenue streams.

Perhaps its own success is the greatest long-term threat to its business. Because Google gives away its products for free, it's a good bet that the day a company that charges for similar services gets forced out of business, it will sue claiming predatory pricing. The government probably wouldn't allow Ford to give away cars equipped with satellite radio just so it could pump ads to drivers; the courts might find that Google, by giving away software, is competing unfairly.

Who knows, maybe Microsoft would be the one to file the first lawsuit.

Adam L. Penenberg is an assistant professor at New York University and assistant director of the business and economic reporting program in the school's department of journalism. You can email him at penenberg@yahoo.com.

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