David Evans of Market Platform Dynamics and Thomas Eisenmann of the Harvard Business School gave a talk today on Google's Next Moves that added some depth to the understanding of Google's business model and made some predictions for the future.
David Evans described Googlenomics:
Google's 75% share of the paid search dollar stems from two simple principles:
- Secure space upon which to sell advertising and drive traffic to said space.
- Give stuff away to create space and traffic.
Evans pointed out that the Google Terms of Service give Google the right to place ads in its services in the future even in places and ways that they don't do so today.
The technology behind the ad revenue model has three parts:
- Search engine
- Keyword bidding
- Quality Scoring
Prices are set in a Second Price Auction which has been found by economists to generate the maximum return for the seller. The resulting price depends upon the keyword purchased, for a Luxury Hotel in New York, the price of the number 1 position is $3.89 per click, but a Hot Dog Vendor only has to pay 59 cents.
The goal for Google is to maximize the revenue per search, as given by the following formula:
RPS = APS x CPA x PPC
where
RPS = Revenue per search
APS = Ads displayed per search
CPA = Click-throughs per ad
PPC = Price per click
Maximizing revenue is not simply a matter of getting the highest price for an ad, hence the quality scoring algorithm which will give favored placement to a lower priced ad if it will generate more clicks.
Interesting facts:
- 40% of searches are related to a potential purchase.
- 40% of searches come from partners, e.g. New York Times, that embed the Google search bar.
Google's superior revenue per search comes not only from its superior technology but also from its scale, which allows it to attract more advertisers who will bid on more search terms. These two factors account for Microsoft's desire to acquire Yahoo.
Thomas Eisenmann talked about the competitive challenges facing Google and its likely actions:
There are three different screens where ads can be placed: TV, Mobile, and PC. Each of these has a potential competitor who can impede access, such as the cable companies, mobile operators, and Microsoft, respectively. Google can counter this threat either by "playing nice" through openness initiatives such as OpenSocial and the Open Handset Alliance or it can play tough and enter the market directly, such as acquiring Facebook or purchasing wireless spectrum.
Another strategy is "platform envelopment" - bundling products together in a way that is difficult for competitors to match. An successful example is Google Base which combines a free product listing, paid search, and a discount on payment processing. A riskier case is offering free productivity applications such as a word processor, since it's not clear that peoplle are in a buying mood when they are composing a document.
Eisenmann said that Facebook could be a threat to Google if it started pulling more users into its walled garden, although he was not all that sanguine about social networks.
Similarly, Eisenmann thought Android will be a stretch since it is really hard to make a compelling mobile platform.
Over-the-top (OTT) video - creating an alternative video distribution over a commodity IP network - is another way Google can win. Google can offer the "same head, longer tail" than the cable MSOs, provide better targeted ads and a superior recommendation engine. Even if Google undercuts the average cost of a cable bundle and pays above the going rate to a content provider there is still enough margin to have a lucrative business.
In the end, Google's biggest problem may be overreach and arrogance. I remember my days at Lotus where no matter what we did money rained down on us. It's easy under such circumstances to believe that the success is a function of one's genius, but when the money flow stops it can be quite baffling.
Some of Evans and Eisenmann's predictions:
- If the Microsoft-Yahoo merger doesn't happen, Google will end up with an 80% share of the on-line advertising business.
- Social networks will "blow over."
- Someone needs to come up with the killer app for Social Networks.
Tonight Google announced their answer to Amazon's EC2, S3 and SimpleDB. Unlike Amazon's offering, which allows you to create a Linux instance and run anything you want, Google App Engine only runs apps written in Python, but in return it will automatically scale instead of making you use the API to start new instances. There are also APIs for things like email and authentication.
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