Internet Outsider

The Great Advertising Share Shift: Google Sucks Life Out Of Old Media

[From Silicon Alley Insider] Everyone talks about advertising dollars shifting online, but when you're fighting all day in the trenches it's tough to get a handle on what this really means.  Here's what it means:

US advertising revenue at 4 big online media companies--Google (GOOG), Yahoo (YHOO), AOL (TWX), and MSN (MSFT)--grew by $1.3 billion in Q2, or 42%. 

US advertising revenue at 15 big television, newspaper, magazine, radio, and outdoor companies (Time Warner, Viacom, CBS, etc.) shrank by $280 million in Q2, or 3%.

Put differently, U.S. advertising revenue at all 19 companies increased 8% year over year in Q2, to $13.8 billion ($55 billion annualized).  The online portion of this pie grew from $3 billion to $4.2 billion (23% share to 30% share).  The offline portion, meanwhile, shrank from $9.9 billion to $9.6 billion (77% share to 70% share).  The online companies, in other words, picked up 7 percentage points of market share in a single year.

Other fun facts:

Within our company set, the only traditional media business that grew U.S. advertising year-over-year in Q2 was Outdoor (up 13%). Meanwhile:

• Television (cable and broadcast) shrank 1%, or $50 million
• Print (magazines and newspapers) shrank 5%, or $170 million
• Radio (terrestrial) shrank 7%, or $105 million

Obvious Conclusions

Traditional media executives--especially in the newspaper business--often blame their current woes on "the real estate market" or "cyclical weakness."   Economic weakness may be exaggerating the downturn, but it's not the real problem.  Whatever weakness is hitting the newspapers is also hitting Google.

Media power is not only shifting by medium (the handful of Internet companies are collectively valued more highly than most of their traditional media brethren combined), but by geography. Most "big media" companies are still headquartered in New York. Most media power, however, is now headquartered in California.

These trends are secular, not cyclical: TV networks, radio networks, and newspaper companies won't suddenly wake up one morning and find themselves back in charge.  Individual Internet companies may screw up (see Yahoo/AOL), but if they do, others will rise to take their place (Google).

Traditional media executives are doing a superb job of milking cash flow out of shrinking businesses, but you can't save your way to prosperity.  The smartest companies acknowledge this and are 1) returning cash flow to shareholders, 2) diversifying via M&A (as the Washington Post has done), and/or investing in or buying promising interactive businesses.

Details

We looked at US advertising revenue for 19 companies: Google, Yahoo, AOL, Microsoft, Time Warner, Viacom, CBS, News Corp., CBS Radio, Citadel, Disney, Entercom, Clear Channel, Clear Channel Outdoor, Time Inc., New York Times Company, McClatchy, Dow Jones, and Gannett.  We divided the companies into the following sectors: Online, Television, Print, Radio, and Outdoor.  Please see detailed data, analyses, and notes here.

Facebook Puts Self Up For Sale: $10 Billion

[From Silicon Alley Insider]. Few seem to have noticed, but Facebook has now officially put itself in play.  Peter Thiel, a Facebook investor and director, granted a detailed interview to The Deal last week in which he rejected several lowball offers that have reportedly come over the transom--$3 billion range--and essentially offered to sell the company for $7-$10 billion.  The announcement would not have been any more direct if Facebook had written an open letter to Google saying: "Dear Eric: $10 billion and we're yours."

Yes, of course, Thiel also threw in all the required noises about how Facebook has no interest in selling, no interest in going public, etc., to make sure that when Google does walk in the door, it will be the Google folks who are selling.  He also explained why Facebook wasn't ready to sell (not developed enough) and why those who gripe about Facebook's low revenue are missing the point (we don't care about revenue yet).  But make no mistake: Any time a company is this specific about what it would take to get it to the table, it's for sale.  What's more, it's probably for sale at the low end of Thiel's $7-$10 billion range.

As a last gesture of helpfulness, Thiel was also kind enough to tell everyone how much revenue Facebook will generate this year--$150 million (so assume at least $200 million--have to set the bar low)--of which half comes from the Microsoft deal.  So, there, Google and Microsoft investment bankers, you now have everything you need.

Let's see, at today's Google stock price of $515, a $10 billion Facebook buy would amount to about 6% -7% dilution.  A veritable tuck-in!  And none of the copyright headaches that came along with the $1.7 billion YouTube acquisition.  Microsoft?  Why, you'll generate $10 billion in cash in the next few months.  So, step right up!  Yahoo? Um, sorry, missed your chance last year when you could have had it for $2 billion. David Shabelman, The Deal.  DealBook, NYT

Rumor of the Day: Microsoft for Facebook for $6 Billion

No, of course we can't confirm it.  But it makes sense, don't you think?  Steve Ballmer, desperate and furious, sick of sucking wind in the Internet game, sick of losing every Internet in-play company and much of the future to You Know Who, sick of feeling like a has-been also-ran, raiding the bank account and snapping up the hottest company on earth.

The fly in the ointment: $6 billion's a nice fat number, but it's only 1/25th of Google's valuation, and the Facebook folks clearly think they're worth more than that.  So maybe Steve will have to throw in another $5 or $10.  Or $20.  Or maybe Mark Zuckerberg will just tell him to go...home.

TiVo Provides the Missing Movie-Download Link; Threatens Cable Cos

At long last, someone has finally addressed the gaping hole in the digital-movie-downloading business. TiVo's new deal to let subscribers rent or buy Amazon.com digital movies directly from their TiVo boxes removes an awkward step in the process: customers no longer have to futz with their computers to rent or purchase a movie. Now, they can just pick up the TiVo remote.

Perhaps this will finally light a fire under the cable companies, whose resistance to unforced innovation is legendary--and whose grasp on the digital rental market continues to slip. Or perhaps it won't...

Cable giants like Time Warner Cable, Cablevision and Comcast have been trying for years to boost revenue with on-demand movie rentals. But success has been hindered by limited movie selection, short viewing windows, and the inability to for viewers to purchase downloaded movies outright.

Meanwhile, online movie services like Amazon's Unbox or Apple's iTunes have required a computer to make the transaction and download the movie file. Getting the movies to play on TV has been even more complicated and expensive, requiring either a complex computer setup or a pricey gadget like Apple TV. TiVo's deal with Amazon solves some of these problems, allowing subscribers to buy movies without leaving the couch, or rent them for 30 days, often for less money than 24-hour cable rentals.

But don't short cable yet: TiVo's impact is limited by its modest presence -- only 4.3 million total subscribers, of which only a small percentage have set-top boxes compatible with the new service. Also cheap, no-brand DVRs built into cable boxes have already reduced TiVo's market share, and now that TiVo has blazed the trail, the cable companies are presumably free to strike similar deals of their own. Because digital-download services require a high-speed Internet connection, moreover, even the TiVo box is not a total loss for the cable companies.

In any case, expect more deals like this in the near future from companies like Apple, Microsoft and Sony, all of which are eager for a place in your living room -- at your cable company's expense.

Map Wars: Google and Microsoft Tussle Over Coolest Map Apps

At the Where 2.0 conference in San Jose--which, like every other web-related conference these days, is jammed.  "Geospatial" content and tool companies have developed into their own micro-economy, and Where is the center of it.

The big fight, here as elsewhere, is between Google and Microsoft, over who can produce the coolest 2D and 3D global mapping platforms.  The startling news is that, in this arena, Microsoft appears to be holding its own.  Google's new "block view" feature is cool (put yourself on map, look at buildings around you, walk down street, etc.), but Microsoft's new "Virtual Earth" project is even cooler.  The latter is powered by high-res photos taken from low-flying planes, and the reported $150 million the company is spending on geospatial content is paying off (at least in the "wow" department). 

As with many of the companies here, Google Earth and "Virtual Earth" appear to be cooler than they are commercial, at least for now.  The most obvious source of revenue on the consumer side of the geospatial business would seem to be local advertising and logo/placement, but if this opportunity is producing meaningful numbers, no one is discussing them.  The CEO of Platial, for example, Di-Ann Eisnor, raved about how much money there was to be made in made in mash-ups, but offered exactly zero details.  The same went for a company that provides "soundscapes" (click on a place, listen to what it sounds like) and Garmin, which has some cool "make your own trail maps with your GPS device" technology that mountain-bikers and joggers are reportedly bananas about. Garmin's model is obvious--sell units--but the gravy train that will eventually have to support the rest of this exploding industry is still unclear.

Instant Gratification: Microsoft Buys aQuantive

Always nice to make a good call, and Jason Jones made a great one yesterday--that aQuantive would be one of the next digital advertising companies to go in the panicked land-grab of the web elephants.  Even Jason probably didn't imagine that he'd be so right so soon, but we're proud of him.

Sick of forever being outbid and then having to mumble about "expensive" amid the Google-Yahoo celebrations, Microsoft made a preemptive offer on this one.  At 2% of Microsoft's market value, the acquisition is still a tuck-in, but it's the biggest one in Microsoft's history.  aQuantive won't solve all of Microsoft's web problems, but it will solve some of them.  Most importantly, it will mean that Microsoft's web business must--at least temporarily--be taken seriously again.   

Why Microsoft Can't Buy Yahoo and "Just Be GE"

In the wake of last week's Microsoft-for-Yahoo rumors (and desperate hopes from the likes of me that the rumored deal would fall through), readers questioned my theory that a Microsoft acquisition would kill both MSN and Yahoo.  I argued that Microsoft was already spread too thin, competing with Oracle/IBM on one side and Sony/Apple/Google/Time Warner on the other.  Pshaw, some readers said: Just look at GE.  GE sells jet engines, sitcoms, locomotives, and credit cards...so surely Microsoft can handle a few different flavors of software. Today, John Battelle has picked up the same theme.

Here's the difference between Microsoft and GE, at least as it pertains to the Internet.  One reason Microsoft has struggled for twelve years with its Internet business is that it has always managed the business with an eye to protecting and/or augmenting its core desktop monopoly.  Microsoft's competitors, meanwhile, have approached the Internet business with an eye to doing whatever is best for the Internet business, desktop monopoly be damned.  And now that it is clear that the Internet business is going to compete with the desktop business, Microsoft finds itself in an even stickier situation: How can it do what it needs to do to win in the Internet without hastening the demise (or at least slowing the growth of) the desktop cash cow?

GE can compete in dozens of different businesses because it is a true conglomerate: Each division is free to do whatever it needs to do to win (and the divisions also aren't that competitive with one another).  At Microsoft, meanwhile, all the sideline divisions exist to protect or augment the major businesses, and Microsoft's Internet team has to work within this system.  For Microsoft's Internet business to have a real chance to win, it has to be able to launch wholesale attacks on Microsoft's core business.  And it's hard to see that happening within the Redmond corporate structure as currently defined.

In short, the reason Microsoft can't "be GE" is that GE is a conglomerate and Microsoft isn't.  If Microsoft wants to become a conglomerate, fine, but this will require a wholesale DNA transplant.  And by the time it got one, the Internet opportunity (and dozens of others) would have long since passed it by.   

Implication of Flattening Keyword Prices

Jason Jones:  Fathom Online reports that year-over-year growth in U.S. keyword prices remains in mid-single digits.  This means that Google, Yahoo, et al, are losing a growth-driver and must grow their paid search businesses through international expansion, breadth of keyword buys, and market share gains.  The flattening of keyword prices explains both the tepid growth of all search players except Google, and the recent pick up in M&A interest in the branded-advertising business.

Where will advertisers shift their focus as ROI's begin to stabilize in the paid search business?  Probably to contextual & behavioral advertising.

          Price    q/q    y/y
1Q07    1.46    -3%   5%
4Q06    1.51    2%     6%
3Q06    1.48    17%   3%
2Q06    1.27    -9%   
1Q06    1.39    -3%   
4Q05    1.43    -1%   
3Q05    1.44 

Peter Hershberg of Reprise Media responds (Text adapted from comment below and from this Jan 2006 piece on Reprise's site): 

[FROM COMMENT]: The fact that people continue to reference Fathom's KPI is mind-blowing to me...  While it is *possible* that keyword prices are stabilizing, there's no way anyone outside of the search engines themselves know with any degree of certainty.  Along those lines, it's worth noting that in January of 2006, Fathom's KPI suggested that keyword prices for 2005 had fallen by 16%. Google's stock more than doubled over that time period...

[FROM JAN 2006]: Fathom's sample size of 500 keywords is not representative of the entire universe of advertising opportunities available on Google. There are literally millions of unique keywords being purchased in the search marketplace today. Furthermore, the KPI doesn't include either proper or brand names -- keywords that typically deliver significant volume at higher average CPC's. (In fairness to Fathom, they acknowledge this shortcoming in each of their reports. Whether or not the press picks up on it is another story...)

Second, and more importantly, Google's stock continues to rise because it's CPC's simply ARE NOT falling. And even if they were, there would be no way for Fathom, or anyone else, to know that was the case.

How can I be so sure? Because of Google's "Quality Score," a topic I've written about on several occasions in the past.

For anyone not familiar with this concept, Google defines Quality Score as "the basis for measuring the quality of your keyword and determining your minimum bid. Quality Score is determined by your keyword's clickthrough rate (CTR), relevance of your ad text, historical keyword performance, the quality of your ad's landing page, and other relevancy factors."

This essentially means that two (or more) advertisers could be required to bid completely different CPC's to occupy the same position against the same keyword. In other words, the advertiser with the "better" Quality Score might have to pay just $.10/click for the top position against the keyword "wireless accessories," while an advertiser that's been penalized for poor ad copy, a landing page that's light on content, or some other "violation" would be required to pay $.50/click for the same position.

      

Microsoft To Buy (Swallow) Yahoo...Again? Please, God, No.

Henry Blodget: The New York Post reports that Microsoft is urgently trying to buy Yahoo again, in part because it's sick of losing deals to Google (and, no doubt, sick of losing to Google, and Yahoo, and AOL, et al...).

Would it be a smart strategic move for Microsoft and Yahoo to combine forces?  Absolutely.  Is the best way to do this to have Microsoft suck Yahoo into the massive Windows/Office borg?  Absolutely not.  If Microsoft buys Yahoo, Microsoft should immediately spin the Yahoo-MSN business out as a separate company.  If it doesn't, both Yahoo and MSN will die.

With all due respect to the amazing talent and resources at Microsoft, no company can do everything.  Microsoft is now so massive and broad that it is competing with IBM and Oracle on one end, and Sony, Apple, Google, and Yahoo on the other.  All of these businesses are complex and tough, and focus is a major advantage. 

In the past 12 years, despite its enormous talent, power, and desktop/browser monopoly, Microsoft has done no better than become an Internet also-ran.  Why?  In part because of internal politics: In Redmond, the Internet business will always be second-fiddle to the Windows/Office cash machine--especially when the Internet business may increasingly compete with the Windows/Office cash machine.  In part because of talent: Why would the best Internet talent want to work in a small division of a massive company, kowtow to Windows/Office kingpins, and get paid in stagnant Microsoft options, when he or she could become a billionaire at the next Google?  By the way, Microsoft is not unique or flawed here: It is for these reasons (and others) that few, if any, dominant industry leaders in one technology wave have also dominated the next one.

If Microsoft spun out Yahoo-MSN, the company would be able to recruit the best talent, run it's own show, and, if necessary, compete with Microsoft (which it would never be able to do freely as a division--this is the primary reason an outright acquisition would be a disaster).  The company could have an exclusive technology deal with Microsoft and get first crack at all partnerships.  Most importantly, existing Microsoft and Yahoo shareholders would benefit from all the upside--because they would be the combined company's single largest shareholders.

The only folks who would get hosed in such a deal, in fact, would be existing Yahoo shareholders, who would get socked with a cap-gains tax bill.  This is why a better plan would be for Microsoft to just swap MSN and a few billion dollars for a major (but not majority) stake in Yahoo. 

Alas, this sensible solution seems unlikely...because ego will get in the way.

MSN Update: Prosperity Still Around Corner

Most people have finally given up on the idea that Microsoft will ever become an online contender, but for those who are still holding out hope, the first quarter's performance offers little encouragement.

• True, MSN's year-over-year revenue growth "accelerated," but the celebration is misplaced.  Growth accelerated from 5% to 10%.
• More importantly, advertising revenue also accelerated...from 21% Y/Y to 23%.  This respectable growth massively trailed Google's, but bested Yahoo!'s.  Unfortunately, this is more a comment on Yahoo than MSN.
• Advertising growth, moreover, is impossible to view without also taking into account the expense growth of 39% year-over year.  MSN grew advertising revenue by $85 milllion...and its costs by $234 million.  For every $1.00 of incremental revenue MSN generated, it spent $2.75.  That's not capital investment.  That's operating expenses.
• The growth in advertising revenue, moreover, came from display advertising on email, the home page, etc, not search.  So much for encouraging signs about AdCenter. 
• Then there's the bottom line.  Say what you will about Yahoo's glacial expansion-rate; at least it's making money.  Microsoft isn't--and won't.  In fact, after losing $205 million in Q1, it's on track to lose almost $1 billion this year.

For Microsoft, web prosperity will forever be just around the corner.

Microsoft: The Internet Brain Drain Continues...

Robert Scoble, recently of Microsoft, reports that Microsoft's talent drain is continuing.  In its efforts to defend itself against Google, let alone make up ground, this is exactly what the company cannot afford.  The revolving door in Microsoft's Internet business is preventing the company from developing and sticking with a consistent strategy and making an already major challenge--transitioning from leading one technology revolution to leading the next--downright insurmountable.

Scoble: I just got a press release that Tjeerd Hoek, director or user experience design for Microsoft Windows, is now executive creative director of software and hardware convergence at Frog Design. Tjeerd was well liked and well respected inside Microsoft. Microsoft is seemingly in the middle of a full-bore executive cleanout. I've seen tons of executives leave, particularly in the MSN/Live division that's struggling to compete with Google. Nearly every executive I knew inside that division is now gone.

Just a few days ago Mary Jo Foley reported that Dane Glasgow left, following Chris Payne. Mary Jo also has a report on Microsoft's financial results, which were pretty darn good overall (they better be, a new copy of Windows and Office shipped). The question now is "will the sales of those sustain over several quarters?" Microsoft's guideance says it will.

JJ:  Robert was a very high profile blogger for MSFT who left the firm a few months ago.

MSN: Anothe Search Exec Flees Sinking Ship

ZDnet: On April 24, Microsoft announced internally that Dane Glasgow, general manager for Live Search, is leaving the company to work for various nonprofits and spend more time with his family.  Glasgow was one of the handful of direct reports of Satya Nadella, Microsoft's newly appointed search chief, who is heading up Microsoft's combined search and ad platform unit. Glasgow helped Microsoft launch Windows Desktop Search and has been part of the team behind the first wave of Windows Live services. (Nadella replaced Chris Payne, the former head of search who left Microsoft at the end of March.) ….In March, Blake Irving, the Corporate VP in charge of the Windows Live platform, announced his plans to leave Microsoft, effective this summer. Payne announced his resignation from Microsoft shortly after Irving made his announcement.

JJ: If MSN Ad Center is really technically better than GOOG Adwords like many people say, why is it failing to gain traction and why is the team bailing?

HB: I've said it before, and I'll say it again: The web war is over, and Microsoft lost.

Click Fraud Getting Worse, Especially on Content Networks

Click Forensics, a Texas-based company that tracks click fraud using detailed campaign data from more than 3,500 marketers, reported that industry-wide click fraud increased modestly in Q1 to its highest level ever: about 15% of all clicks, versus 14% in Q4 2006.

More ominously, click fraud on "content networks"--the third-party advertising solutions that support an ecosystem of thousands of small content companies--increased a more significant 3 points, to 22%, from 19% in Q4.  This trend is dangerous for small content providers in addition to search engines.  A continuation of this trend will soon result in more than a quarter of all content-network clicks being considered fraudulent, a level that could begin to cut significantly into the revenue of smaller content providers.

Also significant: Fraud on high-priced keywords--those over $2 a click--rose to 22% from 21% in Q4, confirming the theory that higher priced keywords are more susceptible to fraud than average- and low-priced keywords.

From the release:

“It appears that click fraud perpetrators are becoming more sophisticated even as search providers step up their efforts to fight click fraud,” said Tom Cuthbert, president and CEO of Click Forensics, Inc. “Click fraud seems to be following a similar path as other online fraud schemes such as spam and phishing - the problem is growing as fraudsters fine tune their methods.”

Google Swallows DoubleClick for a Mere $3B

What's $3.1 billion between friends?  Or, put differently, what's it worth to fix your display-advertising problem, corner the market for the "advertising operating system," and deliver a hammer-blow to an already prostrate Seattle-based competitor?  $3.1 billion?  Sure.  Only a few quarters of free cash flow.

So now Google controls a vast share of the market for graphical online advertising, too.  And has yet another display on its world-domination dashboard about who's doing what where.  For those with an eye on the really-long term, it's hard to see how this isn't good news.

For those with an eye on the near-term stock price, meanwhile, it's probably bad news: Lower margins, a big management challenge, a significant price tag, an admission on the largest scale to date that it sometimes makes sense to buy instead of build (no shame in that--just lower returns on capital), and so on.  But as Google made abundantly clear in its IPO prospectus, management (sensibly) isn't focused on the short term.

One Way for Microsoft to Kill Google

Okay, not kill Google, and, really, barely even scratch it, but at least a way to make publishers happy and claw back some market share.

As Douglas McIntyre points out on www.24Wallst.com, one flaw (for publishers) in Google's advertising programs is that publishers receive no compensation for displaying ads that aren't clicked on--even when those ads are towering skyscrapers that have immediate (and unavoidable) branding impact.  The advertiser is certainly gaining something from such ads (brand exposure, reach), and Google is certainly gaining something (power), but the publisher ain't getting jack.

So it's time one of the big ad networks started compensating publishers on a CPM basis in addition to a CPC basis.  The per-view payment obviously shouldn't be as much as a per-click payment, but it should be something.  Newspapers, after all, get paid huge bucks for running un-clickable ads, many of which are never even viewed (because the whole section is tossed in the trash). 

This is where Microsoft has an opportunity.  Inasmuch as it is already trying to build a branding campaign around its benefits to publishers ("Google wants to steal your stuff; we want to help"), it should create a CPM based network and start paying publishers for delivering eyeballs in addition to clicks.

UK Online Ads Pass Newspapers; U.S. Online Ad Spending to Triple?

According to IAB, online advertising spending in the UK in 2006 exceeded newspaper advertising spending.  This amazing fact received less attention in the U.S. than it should have.

One of the big mysteries of the past few years, for those who follow U.S. media, is how and why U.S. newspapers have been able to maintain as much share of the advertising market as they have.  Yes, business sucks for newspapers, but it doesn't suck as much as it should when one considers that the vast majority of the product is printed on wood pulp, shipped around the country in gas-guzzling trucks, and then tossed into recycling bins before it is even glanced at. 

According to Morgan Stanley figures for 2005, U.S. newspapers still generate about $49 billion in advertising revenue (including classifieds).  This compares to about $16 billion last year for Internet, $45 billion for broadcast television, and another $19 billion for cable TV.

Unless there is something structurally different about the UK market--please weigh in on this if you know--the UK statistic suggests that 1) the US online advertising market still has massive growth ahead of it, and 2) U.S. newspapers have not yet begun to feel the pain. 

Two scenarios jump to mind:  1) Online advertising triples over the next 5-10 years, to $50 billion, and/or 2) Online advertising doubles and newspapers advertising gets cut in half.  And then, of course, there's 3) Online advertising triples AND newspaper advertising gets cut in half.

UPDATE: Paul Durham weighs in:

There is something very different about the UK newspaper market - the number and importance of national newspapers. The IAB data shows internet advertising overtaking NATIONAL newspaper advertising. Regional newspapers is a separate category, and took £2.8 billion of ad revenue. So the internet still lags well behind total newspaper advertising in the UK.

Posted by: Paul Durman | April 03, 2007 at 11:15 AM

So, ignore some of what I said above.

YouTube - Big Media Video: Revenue Splits and the Real Stumbling Block

In Sunday's New York Times, Richard Siklos provided some detail on the contemplated revenue splits for BIGMEDIAVIDEO.COM (the NBC/News Corp. theoretical consortium) and YouTube and its content partners.  He also suggested (as the Times has previously) that the real stumbling block in the Big Media-YouTube negotiations is not money but control: The Big Media folks can't live with the idea that someone else (GooTube) will sell advertising against their content.

According to Siklos, the revenue splits between BIGMEDIAVIDEO.COM and its distribution partners will be 90%-to-BIGMEDIAVIDEO and 10% to the distribution partner.  This is interesting, but it leaves out the most important split, at least w/r/t the YouTube-Big Media negotiations: The split between BIGMEDIAVIDEO and the specific Content Owner.  Will each partner in the consortium contribute the same amount of video?  Will they own the same amount of equity?  Will the revenue splits be the same for all BIGMEDIAVIDEO content providers?  If not, the consortium is especially doomed to failure.  If FOX's videos are more popular than NBC's, why will Fox sit by and allow its competitor to benefit at its expense?  (Sorry, but this BIGMEDIAVIDEO thing is DOA).

Siklos also reports that the split between YouTube and its content owners is 30%-to-YouTube and 70%-to-the-content-owner.  This seems reasonable, especially if YouTube is shouldering the costs of selling and serving the advertising (or perhaps the split is after overhead).  If this split were the only hang-up, every major media would probably rush to do a deal with YouTube. 

According to Siklos, however, the larger issue is control: Big Media folks revere their relationships with advertisers, and they don't want someone (Google) getting between them.  In my opinion, if Big Media wants to survive in this new world, this is something they're going to have to get over.

So...YouTube's Toast?

Some traditional content companies finally got their act together and announced a communal video distribution site.  So is YouTube toast? 

No.

How is it not toast?  Let us count the ways.

First, there's the smart point that Fortune's Adam Lashinsky makes in his piece today: Hobbling YouTube would be a tough enough job for an as-yet-to-be-named-built-or-launched site run by ONE big media company.  So imagine how hard it will be when each of SIX big media companies is fiercely looking after its own interests, pointing fingers, spreading blame, demanding changes, etc., before the site even gets up and running. 

Second, big media video content is NOT the only kind of video that Internet users want.  On the contrary, a recent review of Vidmeter, YouTube's most popular channels, and compete.com's analysis of what happened to YouTube's traffic when the 100,000 Viacom videos were deleted (up 14% in two weeks, per the NY Times), suggests that Jon Stewart et al clips comprise a far smaller percentage of total online video content than most people think.

Third, online video will NOT be a winner-take-all game.  Even if BIGMEDIAVIDEO.com actually gets up and running--a real "if," in my opinion--and even if YouTube chooses not to license or otherwise distribute the content, there will be plenty of room for multiple players.  The experience and know-how that YouTube has developed over the past two years, moreover, will continue to give the company a major operating advantage, especially at scale. 

Fourth, unless BIGMEDIAVIDEO.com 1) maintains a chokehold on ALL professionally produced content--something that sounds next to impossible, given that many companies have yet to join the consortium--and 2) builds a powerful consumer brand, YouTube will still be the first stop for many Internet users interested in video clips.  Although Viacom probably assumes otherwise, many Jon Stewart fans probably have no idea what company produces his show (and, therefore, don't think to look on comedycentral.com).  By now, however, most consumers think that youtube=online video, the same way that google=search, so youtube may always be the first stop for many of them.  And once it decides to aggregate links to all online video, there is nothing to stop YouTube from employing--and making a lot of money off of--the same model that has made Google the most powerful media company in the world: sponsored search.

Prediction: Google to Buy Spot Runner

Spot Runner CEO Nick Grouf presented today at OMMA Hollywood.  Spot Runner provides a simple, quick way for local businesses and national corporations with local offices to create, buy, and place highly targeted local TV advertising.  If Google's M&A team is not already driving down to LA with truckloads of money to buy the company, they should.  And if they don't, Microsoft or Yahoo should.

Accordingt to Nick, Spot Runner reduces the cost of creating a decent TV ad from $500,000 to $500 ($499 to be precise).  It reduces the time necessary to plan and buy a TV campaign from 6 weeks-12 months to 24 hours.  It allows thousands of local businesses and franchises that would never have been able to employ TV advertising in the old media world to do so--and target the campaigns by zip code. 

UPDATE

Two readers argue (see comments) that what Spot Runner is offering is nothing new--that cheap creative has been available since the Dark Ages, that you can target by zip code, etc.  The impression I got from the presentation was that Spot Runner seriously streamlined the process (and reduced costs).  Any Spot Runner customers out there care to weigh in?

UPDATE 2

One reasonably happy Spot Runner customer weighs in (see comments).  Any others out there?

Advertisers Fleeing TV, Radio for Internet, etc.

Emily Steel of the WSJ reported startling numbers from TNS Media Intelligence showing just how fast major advertisers are pulling money out of traditional media and throwing it into paid search, digital media, and other "unmeasured" advertising.  This trend has been underway for years, and the figures are backward-looking, but it's no wonder that traditional media conglomerates like Viacom are starting to panic:

In a sign of how major advertisers are shifting money out of traditional media, ad tracking firm TNS Media Intelligence reported that the nation's 50 biggest advertisers cut their spending on "measured" media such as TV, print and Internet display ads by 1.5% in 2006 -- though U.S. ad spending grew 4.1% overall.

While some of the decline may reflect overall cutbacks in ad spending by big marketers, it likely signals that big companies such as Procter & Gamble are reallocating some of their ad budgets to new Internet ad venues which aren't measured by TNS -- such as paid-search advertising, social networking and online video.

Not surprisingly, the report showed that growth in ad spending on traditional media, particularly newspapers and radio, continued to slow dramatically while spending on Internet display ads is accelerating. But it also highlighted a significant slowdown in ad growth among cable channels, after several years of robust increases.

You Own Your Attention! And Google's Cashing In On It...

At the Open Data 2007 conference in New York.  Will post some tidbits.

Right now, AttentionTrust.org CEO Seth Goldstein is reminding everyone that we Internet users are what we look at (click on) and that a host of companies are storing that "attention" (and cashing in on it) without our permission. 

Seth believes that we own our attention.  And that we should be able to control how it is used.  And that companies shouldn't be able to store it or use it without our permission.  (As a horror story, Seth invokes the "anonymous" AOL searcher who conducted dozens of searches about her dog's urinary problems--and was quickly outed by a New York Times reporter.)

In addition to being a successful entrepreneur, Seth's an intellectual, and this conference is about brainstorming, so Seth turned over the floor without presuming to solve the problem.  But he turned it over to the guy who stored (and released) all that search data at AOL: Abdur Chowdhury.

Asked immediately what he would have done differently if he had it to do all over again, Mr. Chowdhury from AOL said he...

• Would have moved more cautiously
• Would have established licensing agreements so the data could only be used for research.

The silver lining, he says, is that the incident raised awareness of the issue--and spawned conferences like this.  Esther Dyson challenges this: Do people really know how much data is being collected?  No, says Mr. Chowdhury.  Then why release it, someone else asks?  The goal, Mr. Chowdhury says, is to help people.  Did it help people?  An executive from Root Markets says he immediately tried to use the AOL data to spot patterns in mortgage searches, but that there weren't many patterns, so the exercise "quickly descended into voyeurism."

Were there any benefits from the release?  Mr. Chowdhury suggests that awareness is good (because we can start thinking about how to solve the privacy problem) and that many companies are now exploring the possibility of licensing data from AOL, Yahoo, etc.  Skeptical protests and grumbles: Everyone's giving up their privacy!  Everyone's being tracked!  Mr. Chowdhury on his heels, but Seth gets up and reminds everyone that nothing is black and white.  Esther says the key is selectivity, awareness, and control.  We as an industry have to do better!  Mr. Chowdhury leaves to applause.

Yahoo-AT&T; Renegotiation = Capitalism at Work

The WSJ reports that Yahoo and AT&T are renegotiating their broadband access partnership on terms far more favorable to AT&T.  According to the article, this is a result of three factors:

1. Yahoo's reduced stature and buzz (thanks to Google)
2. A reversal in the market dynamic in which search engines are now paying for carriage (thanks to Google).
3. AT&T's newfound prowess in broadband access (7 million subs).

No. 2, a reversal in who's-paying-who, is a profound change, one ushered in by Google's deal with Dell in which it agreed to pay $1 billion to be preloaded on Dell PCs.  Paid search is so profitable that Google can afford such deals, but the changing dynamic illustrates that search, like other businesses, is subject to the laws of capitalism (attractive returns draw new competition which reduces returns).

Google and Yahoo won't soon be forced to hand over most of their profits for carriage--most of their traffic, presumably, goes direct, and users usually demonstrate significant loyalty/habits about who they search with.  Like the massive increases in CAPEX at both companies, however, increased distribution and CAPEX costs will probably continue to weigh on both companies' bottom lines.

In Yahoo's case, according to the WSJ, a new AT&T deal could significantly reduce the $200-$250 million in revenue the company earns from the deal (approx 5% of overall revenue).  This revenue is probably at least as profitable as the rest of Yahoo's business, so it might feel an even greater impact on the bottom line.   

Microsoft Sharpens Knives, Points At Google Books

After a government-and-monopoly-inspired period in which Microsoft had to pretend to be a gentle force for global good, the company is being forced to return to its ruthless roots.  Ironically, it is doing this in part by decrying the unfair practices of a competitor and shamelessly sucking up to the Establishment.

Today's speech by Thomas Rubin, Microsoft's associate general counsel, to the Association of American Publishers is entitled "Searching for Principles: Online Services and Intellectual Property."  Based on what the speech says, however, it might as well have been titled: "How Google Intends to Put You Out of Business, and How Microsoft Can Help." 

To those who watched Microsoft work its competition-annihilating magic in the 1990s, the speech is amusing in its role-reversal.  Unless the company really has had a DNA transplant--which, after a decade of anti-competitive regulatory attack, it may have--Microsoft doesn't give a damn about the Association of American Publishers (or, for that matter, any other established business or "fair use" practice).  What Microsoft cares about is Microsoft, and now that Google has officially added "crush Office" to the corporate "To Do" list, Microsoft no longer needs to hold back.

As to the speech's assertions...Is Google really taking an unfair attitude toward copyright?  In some ways, yes.  Should this attitude wake up the Establishment?  One hopes so.  But one also hopes that the publishing Establishment, at least, will handle the situation in a more forward-looking manner than, say, the music industry dealt with Napster, et al. 

Google Books could end up being the best marketing tool the publishing industry (or, at least, authors) have ever had.  Once a book is indexed, readers and researchers who would otherwise never even have heard of it might effortlessly discover that it contains exactly what they are looking for.   

The real value in a book, moreover--to the only two parties that really matter (author and reader)--does not lie in wood pulp and ink but in words and ideas.  In the old days, publishers helped produce both.  In recent years, however, many publishers have essentially become book packagers, whose core expertise and service lies in producing and marketing attractive-looking wood pulp. 

So if the end result of Google Books is to radically change the traditional publishing business, this may serve writers and readers (and, yes, Google) just fine.  As long as a reasonable revenue-sharing model can be developed, writers will keep writing, editors will keep editing, printers will keep printing (for those who want paper), and readers will keep reading.  The only casualty will be the traditional publishing industry--and, perhaps, Microsoft. 

Google Paints Bullseye on Microsoft; I Eat Crow

It has been obvious for some time that my theory of a year ago--that Google and Microsoft weren't really going to go to war with each other (because Microsoft had already lost the web game and because Google wasn't going to be stupid enough to take aim at Microsoft's crown jewels)--was wrong.  I was right about the first part--Microsoft is still nowhere on the web--but wrong about the second: Google clearly has its sights set on that pot of Office gold.

So, what is the current status of the office productivity battle?  And what are the long-term implications?  The current status is that Google's offerings are fine for low-end use but won't start meaningfully cannibalizing Microsoft's sales for years.  No self-respecting IT manager at a Fortune 500 company is suddenly going to throw out the global standard and bet his or her job on the sideline business of an Internet media company.  Over the years, a parade of web and technology titans--AOL, Oracle, Sun, Yahoo--have tried to upend parts of the Redmond monopoly, and all have found the crossover from their core business to PC software far harder than it looked.  And if Google is serious about stealing some of Microsoft's sales and support customers, it will undoubtedly find this transition hard, too.

On the other hand, Google's current offerings--Gmail, Docs & Spreadsheets, etc.--bear all the markings of a classic disruptive technology.  As Harvard professor Clayton Christensen observed, disruption begins when a dominant market leader has built so so much functionality into its core products that it has begun to over-serve its core customers.  Some of these customers, realizing that a simpler, cheaper product will do, abandon the old technology.  At first, this does not concern the incumbent, as it maintains a chokehold on the highest margin business--the high-end customers who need most of that complicated functionality and support.  But, gradually, as the lower end product gets better, and the incumbent is forced to migrate to even more complex and expensive solutions, more of the overall customer base defects.  And, then, voila, one day the incumbent wakes up and discovers that it is DEC, Sears, or AOL...and by then it's far too late to do anything about it.

From a long-term perspective, Google's initial offerings look mighty disruptive.  And although Microsoft will no doubt assert until it's blue in the face that it has long since gotten Google religion and is already adapting all of its products for web-based delivery, it will likely find this easier to say than do--if only because each new free or low-priced subscription seat of a web-based Office won't immediately drop a couple of hundred dollars to the bottom line.

At the same time, by targeting Microsoft's crown jewels, Google is risking not only failure but its own monopolistic dominance of its core business--search.  Selling and servicing technology solutions is a fundamentally different business than selling and providing advertising solutions, and will eventually require the creation of an entirely new sales and service organization.  No company in history has dominated the hearts and minds of both marketers and IT buyers, although several have tried.  Even with Google's awesome talents and power, therefore, success is far from guaranteed.  Especially because the opponent in question, a sleeping giant that has so thoroughly dominated its industry that not one but two governments were forced to try to stop it, won't likely give up without a fight.

Microsoft's Long, Slow Slide Into Web Irrelevance

The only thing I disagree with in John Battelle's write-up on Microsoft's "Live Search" strategy and continued slog toward web oblivion is that "it's too early to pass 'final judgement' on the strategy."  (Battelle is actually quoting Gartner's David Smith here). 

I agree that the "Live" brand is confusing and that Microsoft has not clearly explained what it is trying to accomplish.  What I disagree with is the implicit idea that Microsoft KNOWS what it's trying to accomplish on the web (short of somehow miraculously vanquishing Google)--and that it has any reasonable chance of achieving it.

I argued a year ago that the web war was over and Microsoft lost.  This seems even clearer with every passing day.  The only question in my mind is whether Microsoft can build enough of a wall around its crown jewels--Office and Windows--to survive over the long haul. 

Click Fraud Steady at 14%--Click Forensics

Click-fraud consulting firm Click Forensics estimates that industry-wide click fraud in Q4 was 14.2%, which is at the high end of levels measured earlier in the year (the quarters ranged from 13.7%-14.2%).  The firm also estimates that click fraud on content networks--the "affiliates" that advertisers are always complaining about--was significantly higher, at 19.2%.  Most importantly, click fraud was highest on expensive key words (over $2/click), at 21%.

Overall, these figures suggest that click fraud remains an annoying but controlled problem, one that most advertisers view as simply a cost of doing business .  The higher fraud on the content networks and high-priced keywords suggests that Google and Yahoo will have to devote more resources and/or refunds to remedying the problem.  This should ultimately have a modest negative impact on profitability. 

Update on MSN: Still Going Nowhere Fast

It's ancient history by now--and certainly not news--but it's worth noting that Microsoft still hasn't made any headway in the search-and-portal game and, in fact, is falling farther and farther behind.  As a result, it is not surprising that Steve Ballmer is now warning media companies that Google is the Evil Empire--because no other competitive tactic has worked.  Microsoft is at least no longer embarrassing itself by suggesting that Google and Internet domination are only a matter of time.  Instead, perhaps, it is marshalling its energies to fight a far more critical battle: protecting its crown jewels from Google-hosted web apps that threaten to pick off low-end users of Outlook, Word, Office, etc. one by one.

How badly is MSN/Windows Live doing these days?  In Q3, advertising revenue rose only 5%, once again the slowest rate of growth of the big four (even lagging Yahoo's pathetic quarter).  Display advertising on portals, email, etc., was up, but search revenue was down again, despite AdCenter having been rolled out to the entire U.S. market. 

Just as bad, the division's operating income/loss fell from a gain of $68 million last year to a loss of $130 million this year--despite a change in accounting for search revenue from net to gross (MSN used to record its net revenue after sharing a portion with Yahoo, et al).  Microsoft is cranking up the R&D and marketing spending to try to compete with Google, but thanks to Google's now 4X revenue advantage (ex TAC), this is a losing battle.  Google spent more than $300 million on R&D in the quarter, about half of MSN/Live's total expenses for the period, and it still generated a massive profit.  As Google continues to grow, this disparity (or MSN/Live's losses) is only going to become greater.

Dear Google Bulls: Yahoo Comments Still Suggest Market Problem

Yes, Yahoo has Yahoo-specific problems, one of which is competition.  Some comments on the conference call, however, provide further evidence that the slowdown in advertising revenue is not just Yahoo-specific. 

When asked for the second time about whether the weakness was confined to autos and financial services--and whether the weakness was continuing--Sue Decker said this (transcript courtesy of seekingalpha.com):

We did say that we had seen some weakness in September in those two categories. Those sectors were meant as examples. They are having some industry-specific issues in both cases. We have seen a couple of -- several of the various sectors showing some of that, but we think those are specific to those sectors, and we do think those will continue into Q4.

Translation: We are seeing weakness in more than the auto and financial sectors.  The weakness is continuing.

The quick response from Google bulls is that PPC advertising is different, that advertisers view PPC as a "cost of sales" instead of "marketing spend," and, therefore, that a slowdown in general advertising won't affect Google.  I continue to believe that this argument is wrong. 

If advertising spending slows, it will slow because of weakness in consumer demand (which leads to lower revenue and, therefore, less money to spend on advertising).  Although it is true that you have to spend money to make money, advertising is usually one of the first expenses to get cut in a slowdown.  PPC advertising may be the last form of advertising to get cut, but it will still get cut. 

Why?  Because if consumers go from spending $1.00 on financial services to $0.90 on financial services, the ROI for any advertiser trying to attract that spending will drop.  As ROIs drop, weaker advertisers will reduce spending, which, in the case of search, will eventually filter into either keyword pricing (fewer advertisers competiting for the same keywords) or fewer paid clicks (fewer consumers seeking financial services).  The impact will not necessarily be disastrous, and it will not necessarily be as severe as it is for less-ROI-driven advertising, but there will be an impact.

Thus, I reiterate my prediction: Some of the weakness affecting Yahoo appears to be market-related, and if it is market-related, it will eventually affect Google. 

More on Drooping Ad Spending, Yahoo, Google

Smart debate in the comment section about whether yesterday's Yahoo news reflected a Yahoo issue or a market issue, as well as whether a general slowdown in online ad spending would affect Google.  My take is that it is almost certainly a market issue and that, eventually, it would/will almost certainly affect Google.

As several readers noted, the slowdown was attributed to two sectors, automotive and financial services.  Given what's happening to Ford, GM, and Chrysler, the first isn't a surprise.  Given what's happening to the housing market, the second isn't a surprise either, especially if "financial services" is really a synonym for "mortgage brokers."

A Bloomberg story today reports data from Nielsen that confirms some of the above, but also suggests the problem is worse at Yahoo than elsewhere:

Advertisers reduced the amount they spent on graphical image
ads in the U.S. by 6.3 percent to $163.6 million in the week
ending Sept. 10 after a 2.7 percent drop the previous week,
according to Nielsen//NetRatings...         

Demand for banner ads on Yahoo by financial services
companies fell 4.2 percent to $16.9 million in the week ending
Sept. 10 and 16 percent in the previous week, Nielsen said.
Outlays across the Web rose 2.2 percent for the week ending Sept.
10, after falling 10 percent a week earlier.

The story also notes that, at Yahoo, financial services accounts for an extraordinary amount of revenue.

     Financial services accounted for 33 percent of U.S. display
ad spending on Yahoo at the end of August, the highest of any
category, while automotive took 2.6 percent, according to
Nielsen.

The Bloomberg story focuses primarily on display advertising, and it is possible that, for now, search has been spared.  If the problem is the economy rather than Yahoo, however, as consumer demand falls off, search spending should drop, too.  Less consumer demand will likely translate into fewer clicks (less revenue) or a reduced conversion rate, which will put pressure on advertisers' ROIs (reducing the amount they can profitably pay for clicks).  It is also worth noting that, thanks to their high-ticket sales, both automotive and financial services have extremely high keyword prices, so any fall-off in advertiser spending or end user demand in these categories will have a far greater impact on revenue than on overall clicks.

Bottom line, I have never seen a general industry revenue slowdown that did not eventually affect the biggest player.  If that's what this is, therefore, the safe bet is to assume that Google will eventually be affected, possibly severely.

Yahoo Wilts. Prepare for Won't-Affect-Google Denials

Yahoo's Semel and Decker dropped the bomb this morning at a Goldman conference: Yahoo!'s Q3 is wilting.  Nothing serious yet--just revenue at the "low end of the range"--but still eerily similar to the early warnings from Yahoo 6 years ago, when Yahoo!'s Q3 started looking sluggish in mid-September and then weakened further by the day.  If memory serves, the company just made that quarter (Q3), but severely reduced guidance for Q4 and then bombed Q1.  And the rest of the economy wasn't far behind.

True, Yahoo's revenue is more diversified than in 2000, and there aren't a few hundred etailers about to start reneging on $30 million portal deals, but still: When the economy slows, advertising is one of the first expenses to go, and even the top dogs aren't immune.

Get ready, however.  In coming days, a parade of analysts will eloquently explain why the trends that are hobbling Yahoo! won't affect Google--Google's revenue is pay-per-click, Google is a "must buy" for advertisers, Google has a much stronger market position, etc.  Listen politely, but don't believe it. 

Google is now a $7 billion global business with one primary revenue stream: advertising.  Google may do better in a recession than, say, a television network, but that doesn't mean it will do well.  $7 billion is a significant chunk of not only online advertising but all advertising, and if all advertising slows (or, worse, shrinks), Google's revenue will, too.

Back in 2000, the theory was that, as the dotcom shakeout progressed, the dominant players would slow for a quarter or two but avoid most of the damage.  Yes, it's different now, in some ways, but one lesson from that period should be clear.  Even No.'s 1 and 2 drink from the same stream as everyone else.

Look Out Yahoo: Google Now A 5-Trick Pony

Citigroup's Mark Mahaney has published a report analyzing the competitiveness of Google's non-search products, such as Finance, Gmail, Calendar, News, Froogle, Video, etc. The success of such products is obviously important for Google's long-term outlook, as they should help lock in users and diversify Google's usage patterns.  Eventually, they might even contribute revenue, although this is not a given.  Mark's key conclusions include:

• Several of Google's non-search products are "best-in-class" or at least "in-the-running."  More important, most are continuing to improve and gain traffic share.
• Most of these products have a much stronger competitive position (traffic share) internationally than they do in the U.S.  Put differently, Google's dominance is much greater internationally than it is here (a scary thought).

Mark suggests that the success of non-search products creates "option value" for Google that is not yet factored into the stock price.  My sense is that such products are to some extent factored into the stock price, although Mark's competitive analysis suggests that, on balance, the products are doing better than they are perceived to be.  The analysis suggests that no Microsoft or Yahoo product is safe and that it is way too early to pronounce, say, Gmail, dead simply because it has not yet caught up in user-share.  This conclusion alone should serve as a major kick in the posterior to Yahoo, especially: Not only did the company blow its lead in search; it is now losing market share to Google in almost every other critical vertical.

The one key point that Mark did not address is revenue.  None of Google's non-search products generate revenue.  If the theory is that Google will simply live forever on search revenue, then Google investors will have to get used to the fact that the company's ROI is only going to go one way: Down.  Shareholders will also have to live with the risk that, if anything happens to Google's search dominance--or to search advertising itself--the entire company will be screwed.

The most obvious way for Google to monetize its non-search products is display advertising (I continue to find the idea of inserting AdWords style PPC-ads in Calendar, Spreadsheet, etc. absurd).  One reason Google's products score well in Mark's comparison, however, is that they are un-cluttered and commercial-free, and adding display advertising might bring them more in-line with the competition.  I imagine that Google could add some display advertising--or at least sponsorship buttons--without sacrificing much utility, and I expect this is the way the company will eventually go.

The other option is subscriptions, an option that devotees of Google Spreadsheet, etc., often assume will be a lay-up.  I think subscriptions are a good idea, but they seem antithetical to Google's current philosophy, and, even if successful, they will take years to ramp into a meaningful revenue stream (witness Yahoo!'s revenue mix).  For the next few years, therefore, it would seem foolhardy to expect the company to flick a subscription switch and immediately pay for all of its non-search spending.

Bottom line, Mahaney's analysis suggests that Google is well on its way to becoming less of a one-trick pony. This is good news for Google fans and bad news for Yahoo.  (It's also bad news for Microsoft, but in my opinion, Microsoft has already lost the Internet game).

(Apologies...had to remove link to Mark's report.  If interested, contact Citigroup and beg.)

Sergey/Google Waffle on China?

Just when it seemed opinion on Google et al in China was moving toward "necessary evil" and/or "net-positive tradeoff", Sergey Brin appears to be backpeddling.  The AP quotes him as saying that the company "compromised its principles" and that, after trying and failing to make the censorship thing work, Google might decide to say the heck with it and "not operate" in China.

Here's what I hope: That Brin, Page, et al, aren't just caving to a blast of often knee-jerk criticism on this issue.  Google is almost certainly doing more good than harm in China, and it will continue to, especially over the long haul.  If the sole goal is to avoid making tradeoffs, boycotting the country at this stage of the game won't have anywhere near the impact it would a few years down the road, when a few hundred million Chinese citizens--and a few million Chinese businesses--use it every day.  At that point, Google will have some real leverage. 

Another interesting question is what Sergey means by "not operating" in China.  He volunteered that most of the company's traffic comes through Google's uncensored site, rather than the censored one, so perhaps the idea is that Google's China users will be able to access the uncensored site forever.  If this is the case, then the "principles" debate is academic: Google can have its cake and eat it, too.  Judging from a recent Reuters story, however, it seems the Chinese government is getting more aggressive about blocking Google's uncensored site, perhaps in an effort to force it to get more accomodating on the censored side.   

If Google is committed to improving the overall situation in China (as well as for its shareholders), it will not simply "not operate" there.  Rather, it will continue to engage and struggle with the Chinese government and be upfront (outside of China, at least) about what compromises these struggles entail.  Whatever else you say about the party, after a failed experiment, they are overseeing a powerful economy, and they are keenly aware that it is in large part the strength of the economy that allows them to remain in power.  A public struggle with a company as powerful and global as Google, one that keeps China's absurd, petty attempts to control information forever in the public eye, will likely do more to change these policies than a mere boycott ever could.  Morality aside, Beijing's current attitude toward this issue is bad for business, and, right now, it is business, not censorship or violence, that is keeping the government in power.

Time Warner Says Synergy Is BS. So Sell AOL.

According to the WSJ, Time Warner has abandoned all pretense of "synergy" between its various media divisions, the failed concept that was the sole justification for its merger with AOL.  Without synergy--cooperation between divisions to develop next-generation services in music, VOIP, VOD, DVRs, interactive TV, and a host of other applications that have since been launched elsewhere--the merger had no reason for being.  Worse, as the article makes clear, the lack of synergy actually gives the merger significant reason NOT to be: Instead of helping the combined company, the divisions just waste each other's time and piss each other off.

Jeff Bewkes (TW's president who, to his credit, was never a fan of the merger and now feels comfortable enough to call the synergy concept "bullshit" in the WSJ) is no fool, so it would probably be shortsighted to view yet another Time Warner strategy shift as an excuse to bash the company for the sins of the past.  Perhaps synergy is, in fact, bullshit--perhaps the merger was doomed from the moment it popped into Steve Case and Jerry Levin's bubble-addled heads.  If so, however, then why on earth won't Time Warner just throw in the towel and sell AOL?

More China Moralizing--When Will It End?

The wires are once again buzzing with implicit damning of Yahoo! for helping the Chinese government prosecute critics.  At the Wall Street Journal's "D" conference, Walt Mossberg apparently asked Terry Semel about it, and Terry, admirably, answered the question (from MarketWatch).

Semel acknowledged an incident in which a Chinese blogger was arrested after authorities there tracked him down with the help of Yahoo-supplied data.

"We continue to be pissed off and are sorry about it," he said, adding that the company cooperates "as little as possible based on the laws of each country" it operates in, and tries to "push the boundaries of the law where we can" to protect its users' privacy.

Terry also provided the rationale that almost anyone in charge of a multi-national corporation would eventually arrive at--a rationale that never ceases to be ridiculed as evil, weak, and greedy by people in charge of nothing:

"What's the alternative? To walk away?" Semel asked during a sometimes testy exchange with Wall Street Journal columnist Walter Mossberg... Semel noted that China isn't the only country that forces media companies to alter their content in some way, and that the issue goes beyond Yahoo and other Internet companies.   "I don't think any one company, or even one industry, can change a country.  "Change always takes a long time. Things are better today in China" than they were 20 years ago, when he first traveled there on business, Semel said.

A month or so ago, when Google was publicly damned (again) for the same apparent sin, I asked the same question Terry asked: What is the alternative?   I would be grateful if a reader can provide a cogent, thoughtful response to this question, one that goes beyond "Just say 'no.'"  Because, in this case, "Just say 'no'" is beyond idealistic--it's vapid. 

Surely the argument is not that companies that want to operate in China should disobey Chinese laws (given that this would result in their immediately being expelled from China).  So the argument must be that operating in China under current Chinese laws is immoral and, therefore, simply not an acceptable option.  I don't agree with this--the First Amendment is a U.S. invention, not a higher moral law, and China's leaders aren't the first in history to attack people who criticize them--but I'd be eager to hear a good argument about why it is, in fact, immoral.  And I'd also like to hear a response to Terry's (true) observation that life in China is a heck of a lot better than it used to be, that sometimes the best way to improve a system is to work with it, and that more information will always be better than less.

As Goes the Housing Market, So Goes Advertising

Well, okay, that's a stretch, but the link between the prognosis for the housing market and the economy seems strong (as goes housing, so goes the economy), and when the economy stumbles, advertising is often the first expense to get cut.

In 2000, I shudder to recall, advertising-driven companies (on and offline) were the first to crater, and they were followed shortly thereafter by all manner of other industries, like dominoes.  Some will undoubtedly argue that, even if there is a recession, Google and Yahoo will be fine, because search and other forms of pay-per-event advertising have a crystal clear ROI.  These bulls will point to the success of GoTo (Overture/Yahoo Search) during the last recession as evidence: While the rest of the online world as we knew it was ending, GoTo grew like a weed. 

And to some extent, this is true.  Search should weather an economic storm better than other forms of advertising, because even penny-pinched advertisers will know where each search dollar is going.  But weathering the storm is different than being "fine", and some Google and Yahoo customers will cut back (if only because their customers are cutting back).  Also, when GoTo was powering through the last recession, search was a cute little $100 million business.  It is now approaching a $10 billion business, and, as such, is far more exposed to the vicissitudes of the economy at large. 

So as the housing market continues to weaken, do not make the mistake of thinking that this is an isolated micro-event that is irrelevant to the big boys of online advertising.  It isn't, and like the rest of us, Google and Yahoo will probably feel the pain.

Microsoft to Buy eBay? Bold... But Futile

The NY Post reports that Microsoft and eBay have been having merger discussions, and that, ironically, the talks have cooled of late because lawyers are concerned about anti-trust issues.  Suffice it to say that if such a deal were blocked because of monopoly concerns, regulators would merely be demonstrating an astounding inability to grasp current market dynamics.

But more to the point--Is an eBay-MSN merger a good idea?  In a word, no.  It's a bold idea, certainly, one that illustrates Microsoft's seriousness about making MSN more than an also-ran.   But eBay doesn't need a portal draped on top of it, especially the third-ranked portal, and owning eBay won't save MSN.  The entity would have a fighting chance as a stand-alone company, but Microsoft seems determined to keep strangling its Internet division by keeping all its businesses all under the same roof.  As a result, post-merger, eBay's talent would rapidly depart for greener and less-humongous pastures.  And as Microsoft struggled to integrate, staff, and manage a huge new business it knows nothing about, Google and Amazon would get a dream opportunity to chip away at the eBay seller base.

The most complementary assets Microsoft would gain in such a merger would be PayPal and Skype.  Alas, unless the company intends to spin-off eBay's marketplace business, this seems an awfully expensive way to get them.

Concept Grades:

Boldness, Vision, Ambition, etc.: A-

Chance of Practical Success: C-

Where Google's CAPEX is Really Going

Google is getting better at communicating, and this quarter's 10Q sheds some light on one of the most pressing questions about the company: Where all that CAPEX is going.  The 10Q provides a breakdown of some $332 million in Q1 CAPEX, and although this doesn't quite tie to the $344 million on the cash flow statement, it's pretty close.

The breakdown should relieve concerns (such as mine) that the company is spending hundreds of millions on dark fiber, NORAD-style data centers, frivolous engineering projects, etc.  It should increase concerns that the company is building seaside Googleplexes equipped with personal heliports.  To wit:
	Q1
	CAPEX
Information technology assets	112,039
Construction in process	138,374
Land and buildings	41,182
Leasehold improvements	38,762
Furniture and fixtures	1,786
Total	332,143

$112 million on servers is still a lot of money, but it is more comprehensible than, say, $1.5 billion.  $180 million on land, buildings, and construction is, sarcasm aside, probably reasonable for a company of this size, especially one playing catch-up on the infrastructure side (and Google is probably also smart to use its cheap capital to buy the land and buildings outright, although one imagines it could have gotten rock-bottom lease terms).  $40 million in "leasehold improvements" also seems reasonable, as does $1.8 million in Aeron chairs.

So maybe the outlook for free cash flow growth isn't as bad as it seemed.  Unless Google plans to become a REIT, approximately $750 million of the $1.5 billion in CAPEX estimated for this year should disappear.  When/if it does, this will provide a nice lever for cash flow acceleration.

Ballmer Gets Checkbook, Vows Billions for MSN

Per the WSJ, Steve Ballmer announced that Microsoft will radically increase spending on its online business to keep pace with Google and Yahoo:

[Ballmer] said the spending would include $1.1 billion in 2007 on its MSN online business, compared with $500 million in 2005. "We will invest as much on this online opportunity as any of the other bigger players in the market," Mr. Ballmer told about 700 advertising executives [at a big shindig in Seattle].  A report from Reuters adds that the aforementioned $1.1 billion will be for R&D spending and that the company will up MSN's CAPEX from $100 million to $500 million.

Well, good, then we don't have to write off Microsoft in the online business just yet.  Alas, if Steve thinks keeping pace with Google is only going to cost this much, he's a tad out of date.  Google will likely spend CAPEX of $1.5-$1.7 billion this year, versus Steve's $500 million, to say nothing of next year.  As for R&D, meanwhile, Google exited Q1 on a run-rate of $1 billion, up more than 100% year-over-year.  Google's R&D spending for Q306-Q307, therefore, will probably be closer to $2 billion.  Microsoft's newfound commitment--which will probabably generate significant divisional losses--might allow it to keep pace with Yahoo's spending, but Google's should still leave it in the dust.

The WSJ adds that Ballmer said Microsoft was "impatient and determined" to play a bigger role in the online advertising market.  Again, good.  The only chance Microsoft has is if it is humiliated and pissed off.  Even then, I think the chance of real success is small, but absent this passion, it would be zero.

[Updated after original post to add data from Reuters.]

So, How's adCenter?

As the WSJ describes, Microsoft's adCenter debuts this week, when it is opened to all advertisers instead of just the 6,000 in the pilot program.  adCenter is critical to MSN's future and critical to the industry's future, as it will determine whether the search industry will continue to be a duopoly or will move to a more normal structure dominated by a "big three." 

Advertisers want the service to succeed, so they will have options other than Google.  Microsoft needs the service to succeed, or any remaining chance it has to gain ground in the search business will be lost.  And whether or not the service succeeds is a critical question for Google, Yahoo, and both companies' shareholders. 

If it is true that Google generates 50% more revenue per query than Yahoo! (and more than 50% more than Microsoft), and if it is true that a major reason for this is Google's ad-selection algorithms, then a successful adCenter could have a meaningful impact on not only industry revenue share but Google and Yahoo's growth rates. 

Revenue to the search engines equates to spending by advertisers, so every dollar spent on Yahoo and Microsoft is a dollar that won't be spent on Google.  Microsoft generates less than 1/5th the search revenue of Google (probably much less).  Still, if adCenter can boost Microsoft's efficiency by, say, 100%, a circa-$1 billion business could become a circa $2 billion business, which would mean that Google's $7 billion business would grow $1 billion less than it might have otherwise.  Bottom line, even if Microsoft keeps sweeping out the cellar in the search wars, it can still play spoiler to the big dogs.

So, the key question is, how's adCenter?  The word one user I spoke with two weeks ago used was "chaos."  Anyone else have any impressions/experiences?

UPDATE:

IO Reader Victor aggressively challenges my logic above that search spending is a zero-sum game (see his comment).  His argument is that, as long as the ROI is there, advertisers will buy as much search as they can, so Microsoft can grow it's own revenue without affecting Google's growth trajectory.  I am not sure I agree that advertisers view search as a "cost of revenue" expense rather than a marketing expense, but I do think Victor has a point (to a point). 

If the ROI on Microsoft is much better than on Google (which is certainly possible in the early days of a successful adCenter adoption), I think you will see dollars flow to Microsoft at the expense of Google and Yahoo--i.e., the argument I made above.  As long as the ROI on Microsoft is the same or worse than on Google, and as long as the demand for good quality search inventory still exceeds the supply, Microsoft's growth should not come at Google's expense.

Yes to Yahoo-MSN, No to Microsoft-Buys-Yahoo

  After fumbling its opportunity to get in bed with AOL, Microsoft has one more way to gain the scale necessary to be a serious competitor to Google: Get in bed with Yahoo.  (I am extremely skeptical that the MSN-is-a-Microsoft-division strategy will ever work--a skepticism developed over 11 years of watching Microsoft make vow after vow only to peak in distant third place).

To be clear: Microsoft buying Yahoo would be a disaster--for both companies.  Yahoo would disappear inside the Microsoft beast, the talent would leave, the brand would get diluted, the focus would change, and the company would ultimately disintegrate.  MSN's biggest weakness has always been that it is merely a division, one designed to support the ongoing dominance of Microsoft's crown jewels (Windows/Office).  If Microsoft bought Yahoo, the latter, too, would become a subordinate division.

The smart play, described in today's WSJ's article, would be for Microsoft to give MSN to Yahoo! in exchange for a big equity stake in the combined company.  Yahoo-MSN (which should remain "Yahoo") would immediately have the combination of scale, media, and technology necessary to challenge the Google juggernaut, and if it was successful in doing so, Microsoft shareholders would benefit.  It is less clear that this move would be a positive for Yahoo, which means that Yahoo could probably extract a good price. 

Right now, given the egos involved (on display in the failed AOL negotiations), this seems a long-shot.  Microsoft has never experienced or admitted defeat on this scale, and selling the division would undoubtedly (and shortsightedly) be viewed as defeat.  Short of a Yahoo-MSN combo, Microsoft's other option, in my opinion, is to spin MSN out as a public company. 

AOL Ad Growth Solid, Bumps MSN to No. 4

AOL is still sucking wind (subscriber losses are accelerating), but its advertising growth is solid--up 26% year over year.  This compares to 79% for Google, 34% for Yahoo, and a pathetic 7% for MSN.  Those convinced that it is only a matter of time before MSN rules the world will no doubt find a way to explain why it is irrelevant that MSN has now lost its grip on "distant third place" in the web wars and is now No. 4 (by ad revenue).

According to TW CEO Parsons, AOL's ad growth was solid across all three categories: display, search, and Advertising.com.  AOL's big challenge, of course, is to stabilize the subscriber base.  Although AOL has an impressive amount of web traffic, advertising growth cannot continue at current rates if the subscriber base does not stabilize.  AOL's critical weakness is that each subscriber generates between 4x-10x the monthly pageviews as each web visitor (for more info, please see a Cherry Hill Research report from November, 2005, accessible at the bottom of this post).  This means that for every subscriber AOL loses--and it lost 835,000 in the last quarter--it must attract 4-10 times as many web visitors just to stay even (Cherry Hill Research estimates, see report above).  This will be challenging, to say the least.

MSN: Another Quarter Closer To Irrelevant

As shown by yesterday's numbers, MSN’s financial performance continues to deteriorate.  With each passing quarter, in my opinion, the chance that the division will ever mount a serious challenge to Google and Yahoo in search (or any web business) gets slimmer and slimmer.

• MSN advertising revenue rose only 7% y/y, a deceleration from December’s mediocre 12% and September’s 20%.  This compares to Yahoo’s 34% and Google’s 79%.
• Search revenue actually declined y/y.  Microsoft blames this on the transition to adCenter, but shrinking revenue in a market growing this fast is a terrible sign.  All else being equal, shifting to adCenter modestly increases revenue-per-click because MSN goes from booking net revenue to gross revenue.  This illustrates just how much revenue is being lost due to lower keyword prices on adCenter than Yahoo.
• Operating income also declined, from positive $102 million to negative $26 million.  The division is now detracting from the performance of Microsoft as a whole.
• The plunge into the red resulted from declining revenue and a headcount increase of a whopping 35%.  Whatever the new folks are doing, they aren’t selling ads.

MSN’s heavy investment in headcount and R&D, combined with a renewed willingness to run the division at a loss, shows how seriously Microsoft is taking MSN and the Google threat.  Despite this, however, the division’s performance shows no signs of a turnaround (on the contrary, it just gets worse).   Analysts and commentators conditioned by years of Microsoft’s come-from-behind victories in software continue to act as though MSN’s ascendancy is only a matter of time.  The numbers (and general business history) suggest otherwise.

Microsoft has been at the web business for 11 years now--and it is still running a distant third.  How long Microsoft will continue to believe that gaining real traction online is just a matter of hiring the right people, developing the right algorithms, or spending the right amount of money remains a mystery.  Unless the MSN division soon shows signs of first stabilizing and then regaining share, however, even the Microsoft faithful may eventually have to throw in the towel. 

The hirings of Steve Berkowitz, Ray Ozzie, etc. are positive, but, for MSN, they are probably too little too late.  I continue to believe that the best solution to a tough problem is a spin-off.  It worked for Expedia, Slate, and other Microsoft web businesses, and it still has a chance of working for MSN.  Also, why any one company wants to have $50 billion in revenue and compete with IBM and Oracle on one end and Google, Time Warner, and Sony on the other is beyond me. With each successive re-org, however, it becomes clearer that Microsoft is deadset on doing just that.

Click Fraud Update: Arkansas, Armageddon, etc.

We've had much debate about click fraud on these pages, so I wanted to share some of the recent work we've done on the topic over at Cherry Hill Research.  I'll try not to bore you with updates on CHR, but when we publish something that is free to all and might be of interest, I'll post a link here.

Here are some of our current conclusions regarding click fraud:  (The full write-up at CHR is here.)

• The click-fraud concern is real, and the search engines must do a better job of addressing it.  This said, the problem is manageable and will not cripple the PPC industry.
• Increased awareness of click fraud (or, more accurately, the "invalid click" problem) will likely lead to increased spending on click-stream auditing by both search engines and advertisers.  This will modestly reduce ROIs for advertisers (and thus weigh on keyword prices) and modestly reduce profit margins for search engines.
• Google's settlement in Arkansas (if approved) will be a much bigger win for the company than we initially thought.  It will preclude all future class actions based on historical click-fraud claims, including a large one that has already been filed in California.
• The plaintiffs attorneys on the California class action, in fact, called the Arkansas settlement "the worst class action settlement in history" [from the perspective of the plaintiffs.]  From Google's perspective, therefore, the settlement might be described as the best in history.
• The settlement payouts are such that plaintiffs will receive not 'pennies on the dollar' but fractions of pennies, and they will receive them as rebates on future ad spending, not cash.  As far as legal exposure goes, therefore, Google CEO Eric Schmidt might have understated the case when he dismissed the click-fraud issue as "not material."  A more accurate assessment might have been "non-existent."
• The Arkansas settlement does not preclude future legal action for claims after the settlement date.
• Because Yahoo has not settled the Arkansas class action, the California case against Yahoo will continue.  Given the terms Google got, as well as the opportunity to settle all historical claims, Yahoo might be well-advised to settle in Arkansas immediately.

Our write-up at CHR includes links to several interviews on the topic, including Ben Edelman (Harvard spyware expert), Andrew Goodman (CEO of SEM firm), and a pissed-off advertiser.  We will be posting more interviews in the next few days. 

Hope you find the work interesting and/or helpful.  Look forward to hearing your thoughts.

Time For the Quarterly Google Craps Game

Okay, Google gamblers.  This one's going to be interesting. 

On the one hand, Google's modest deceleration last quarter suggests that the company is going to once again deliver (relatively) ho-hum results and disappoint investors conditioned to expect the astounding.  It takes a long time for a supertanker to change speeds or course, and, last quarter, anyway, it did seem that the Google supertanker was finally beginning to slow down.  This diagnosis seemed confirmed by possible canary-in-the-coalmine announcements from advertisers who were cutting back on search spending because prices had gotten out of hand.  And then there was CFO George Reyes' lucid mid-quarter explanation of why growth had slowed in Q4--because previous growth had been accelerated by a monetization program that had now run its course.  This convincing explanation kneecapped the stock for the eight hours it took for the company to issue a press release that said, effectively, George was wrong.

But the company did issue that press release--and that action, itself, along with the sale of $2 billion-worth of stock at the end of the quarter, probably provides a window into performance.  In the current regulatory environment, companies have to be beyond stupid to set their shareholders up to get killed, and since it would be easy to demonstrate that, guidance or no, Google probably knew whether its numbers were going to disappoint or impress, issuing the press release and stock if they were going to disappoint would be nuts.

In any case, its time for readers to place their bets. When we performed this experiment last quarter, you may remember, the collective assessment of IO readers proved an accurate estimate of what the market was really expecting (as opposed to the First Call Street analyst consensus).  When the company merely delivered the analyst consensus, therefore, the stock tanked.  Perhaps this quarter investors have successfully reined in their expections so an in-line number would be neutral or positive.  Or, perhaps, once again, for the stock to go up, the company will have to blow the Street away.

For reasons that, in my opinion, lack any basis in theory, Wall Street excludes not only pre-IPO stock option costs from pro forma EPS but also Google Stock Unit grants, a practice that seems both mindless and indefensible.  Google has started to go along with this convention, however, and the combination of this, plus wild tax rate swings and extraordinary expenses, has rendered the company's pro forma EPS numbers irrelevant.  As a result, we will once again confine our estimates to Net Revenue (the company's revenue once traffic acquisition costs have been deducted) and the stock reaction.

So, as with last quarter, to enter the quarterly earnings sweepstakes, please submit the following estimates:

1) Q1 Net Revenue

2) The price at which the stock will open the next morning.  (Last quarter, we asked for the percentage change from the previous close, but since we don't know what the stock will do between now and next Thursday, picking a price seems more fair).

To provide some context, the current Street consensus is $1.45 billion, up 82% from last year and 12% sequentially (with a range of estimates from $1.38 billion to $1.54 billion).  This compares to $1.29 billion, up 97% y/y, in Q4.  In other words, the Street is already expecting a significant slowdown in Y/Y growth.  The Street is also expecting only slightly more sequential growth in absolute dollars than in the Q4-Q1 quarters last year ($160 million this year versus $140 million last year.  This compares to $240 million from Q3-Q4 this year versus $150 million in the same periods last year--a much bigger jump).

For what it's worth, the above analysis suggests to me that the Street numbers are conservative.  My own estimate, therefore, would be $1.5 billion, up 89% year-over-year.  If the company posted this number, I think the stock would open around $400.  For the stock to immediately march toward a new high (above $470), I think the company would have post a number in the $1.6 billion-range, which would constitute a year-over-year acceleration.  Based on Google's previous performance, this isn't impossible, but I think it's unlikely.

The other thing I wonder is whether Google's accounting changes--and the resulting hit to cash flow--will spook investors.  Given Wall Street's treatment of GSUs, analysts will probably pro forma the changes away, but the performance of other stocks suggests that such changes matter.

Reminder: I don't own Google, this isn't investment advice, and your guess is as good as mine.  Actually, come to think of it, I do own Google--indirectly, in an index fund, which was just forced to load up on it.

Edelman on Click Fraud: Snarky, Real, and Hard to Control

Thanks to several Internet Outsider readers (and journalists) who pointed me toward Harvard PhD candidate Ben Edelman's recent work on spyware click-fraud at Yahoo!  Edelman articulates his research and findings in extraordinary detail, and provides screen shots, video, and packet logs as proof. 

As Edelman describes (see below), the click fraud he observes is different than the usual kind (competitors clicking on links, bogus AdSense sites, etc.).  This fraud is spyware-driven: PCs are infected with spyware that serves up Yahoo! ads and, in so doing, generates clicks.  Importantly, in these cases, the PC users do not actually click the ads--the spyware produces the clicks automatically.

Edelman's videos, packet logs, and cookie logs are enough to make even the most ad-hardened online user feel sick about what is going on inside his or her machine, and advertisers who pay real dollars for such activity will, at best, be infuriated. 

In one particularly sleazy instance, Edelman clicked on a text link within a New York Times story to find that the link had been inserted by a spyware program on his PC and launched an ad.  In other words, a NYT reader who thought he or she was clicking through to additional detail within an NYT story was actually clicking on a non-NYT advertisement.  The click, meanwhile, generated revenue for Yahoo! and the spyware vendor at the advertiser's (and the NYT's) expense. 

This kind of actiivity has got to go, and if Eliot Spitzer doesn't take care of it, someone else will.  In the meantime, along with other types of click fraud, it is artificially puffing up online ad revenue and market statistics.

Unfortunately, Edelman does not--and presumably cannot--say how widespread such activity is.  He also doesn't say whether Yahoo! already offers advertisers refunds on such behavior (although he implies that it is so hard to control that they probably don't).  So, once again, we are left to conclude that click fraud is real and is a problem--and left to wonder whether how big a real problem it is.

Edelman:

Many others have alleged click fraud at Yahoo. (1, 2, 3) But others generally infer click fraud based on otherwise-inexplicable entries in their web server log files -- traffic clearly coming from competitors, from countries where advertisers do no business, or from particular users in excessive volume (i.e. many clicks from a single user). In contrast, my proof of click fraud is direct: As documented and linked above, I have captured click fraud on video and in packet logs. Yahoo may argue about advertisers' inferences in other instances, i.e. disputing that advertisers have really found click fraud. But it's far harder to deny the click fraud shown in my examples.

In the examples I show above and previously, Yahoo's problem results from bad partners within its network. Yahoo syndicates ads to numerous partners, many of whom syndicate ads to others, some of whom then syndicate ads still further. The net effect is that Yahoo does not know who it's dealing with, and therefore cannot exercise meaningful supervision over how its ads are displayed. I consider this a bad idea -- bad business, bad for quality, bad for accountability. But Yahoo need not listen to me. Instead, consider instructions from New York Attorney General staff member Ken Dreifach: "Advertisers and marketers must be wary of fraud or deceptive practices committed by their affiliates, even [affiliates] that they have no working relationships with." (Quote from MediaPost, summarizing Dreifach's remarks.)...

The many bad partners in Yahoo's network make fraud particularly hard to block: When Yahoo terminates one fraudster, that fraudster's partners find another way to continue operations...

The Ask Test, Part 2: Will Mossberg Switch?

Walt Mossberg's Google-Ask taste test concludes that Ask sometimes produces cooler features and better results.  So here we have an ideal test-case of Google's ability to protect its market dominance, and Ask et al's ability to ever claw back serious market share. 

Question 1, for Walt Mossberg: So now that you have concluded that Ask is sometimes better, how are your searching habits going to change?  Are you going to try both engines every time you search?  Are you going to switch over completely to Ask?  Or are you going to say, "Well, yes, Ask tastes better, but I've always been a Google man, so I'm going to stick with that."  The answer here is important, because Google is protected not only by its search service but inertia: most searchers probably don't care enough to switch unless/until the competing product is vastly superior.

Question 2, for Google: So now that Walt has implicitly dissed your service and engineering team, how are you going to respond?  How long before we see those cool site-preview binoculars on Google?  How long before searches for people turn up photos, bios, etc.?  Are you going to respond, or--like Yahoo! in the late 90s--are you so focused on Mars mapping, Google Base, and other projects that you're going to take your crown jewel for granted?

Question 3, for Yahoo:  Where are you in all of this?  Why doesn't Walt hold a higher opinion of your search service?  Are you going to introduce the above features, too?

Question 4, for searchers everywhere: So now that Walt has said Ask might be a little better, are you going to try it?  If you try it, are you going to switch?  If not, what would make you switch?  (Be honest).  If so, what would make you switch back?

I'm encouraged that Ask has been able to beat Google at the search game, at least in the opinion of one market commentator.  I am still skeptical, however, that temporary feature- or results-based superiority will lead to a vast shift in market share.  Could it?  Yes--Yahoo!'s fall from grace is proof of that?  Will it?  Not unless Google and Yahoo! are asleep at the switch.

Of course, Ask's goal need not be to dethrone Google.  If it merely doubles its market share, from 6% to 12%, it will have succeeded in spades.

And another takeaway from Walt's exercise is that Yahoo! has once again failed show any real competitive or innovative spark.  If Ask can win plaudits and develop superior features after only a year or so of intense work, what has happened to Yahoo!'s innovation engine?  Is this like Finance, where Yahoo!'s team fell into a coma?   

UPDATE:

Walt was kind enough to weigh in here, very articulately.   Several other smart comments, too.

Analyzing Search Share Data

Third-hand search share data via Battelle, Bear Stearns, and Comscore shows that Google is still gaining U.S. share and everyone else is losing it (don't let that tiny blip up in Ask's share distract you--it's irrelevant).  A few thoughts:

Google is now at 42% of U.S. search, up from 36% a year ago.  In a market without monopoly characteristics, it is rare for a leader to have 50% of the market, but Google appears to be headed there.  The company's rate of share gain, therefore, can probably continue for a while.  Importantly, Google's rate of search query growth is decelerating rapidly, despite the share gain--from 38% in Q205 to 25% in Q405--although it appears to have recovered slightly in the first two months of this year.

Yahoo!'s continued share declines (31% to 28% Y/Y) are bad news.  Even as it falls farther behind Google, Yahoo! should still be gaining share from the likes of AOL, Ask, and MSN.  Worse, Yahoo!'s query growth has smashed into a wall: 42% growth in Q205 and -2% shrinkage in Q405.  Per CFO Sue Decker, Yahoo! has already given up on trying to be No. 1 in search.  With these numbers, however, even its scaled back goal--"maintain our current market share"--looks dreamy.

MSN's continued share declines (16% to 14% Y/Y) are really bad news.  Last week's post about the Microsoft re-org prompted many smart comments about how Microsoft has finally gotten it right and how Yahoo! and Google are now toast.  I realize that search isn't everything, but I would love to hear Microsoft optimists explain when, how, and why Microsoft's search share is going to stop declining and start growing and how big it is eventually going to get.  Because the actual numbers from the field suggest that MSN search is getting more irrelevant by the day.

Ask (6%, up 0.5%) and AOL (8%) are still--and in my opinion, will always be--fighting over scraps.  According to the "Rule of Three," most markets support three major generalists with an aggregate 70% share of the market and a handful of specialists with less than 5% each.  Companies with 5%-10% of the market are neither fish nor fowl, and fall into the "ditch."  The way out is usually to specialize, but Ask, at least, still has dreams of joining the generalist big boys.  For many reasons, this will likely be much easier said than done. 

Microsoft Doubles Down, Swallows MSN

For a few years, Microsoft has been standing at a fork in the road: Spin off its web and consumer businesses or integrate them deeply into the fabric of the company. The latest re-org suggests that, despite getting its head handed to it in the online business for the last 11 years, Microsoft has chosen the deep integration path once and for all.  Given what is at stake, this amounts to doubling down. 

Henceforth, MSN, et al, will be part of the "Online Businesses Group" which, itself, will be one of eight divisions within a massive Platforms and Services Group.  Yusuf Mehdi also seems to have finally been put out to pasture with the ceremonial title of chief advertising strategist, perhaps to make way for new blood.

As I've argued, I think this is the wrong route for Microsoft, at least if the company is serious about challenging Google in the search and advertising-driven web services business.  The more MSN is subsumed within the Microsoft whale, in my opinion, the more the web efforts will exist just to protect a dying Windows monopoly.  Integrating the Internet with Windows has done little to help Microsoft dominate the online business: Despite 11 years of effort, tens of billions in cash, a browser monopoly, a desktop monopoly, and thousands upon thousands of brilliant engineers, the best the company has ever been able to do is run a distant third.  I don't see anything in the latest re-org that begin to change this; instead, I think it will exacerbate it.

I also remain skeptical that a company that dominates the world of corporate IT (enterprise scale corporate software and productivity tools sold to Fortune 500 CTOs) can also dominate a media business, which is what search and portals services are and will remain.  The differences between the two businesses (and customer bases) are vast, and the conflicts will forever force compromise.

This isn't the end of Microsoft: the company's position in enterprise IT (and on some desktops) should be secure for decades.  It could, however, be the beginning of the end for MSN.

The Real Problem With Click Fraud

Reader "Anon" posted a link to today's Washington Post story on click fraud.  The story tells a familiar tale--a company hired a fraud-detection firm to audit its clickstreams and found that an estimated one-third of the clicks were bogus.  The story also describes the latest bot-clicking technology ("You, too, can deplete your competition's keyword budget in ten minutes!!!").  As usual, no hard numbers, just estimates from various fraud-detection firms that 20%-40% of clicks are fake.

The story also highlights, indirectly, the real problem here: The expense and hassle required to monitor and audit your clickstreams and then make a compelling enough case to the search engines to get a refund.  The engines don't have access to post-click sale data that advertisers do, so there will likely always be disagreements about what is and isn't a bogus click.  Also, the necessity of having to track, audit, and complain will add a layer of cost and effort to search advertising that is not currently factored into keyword pricing, especially if click fraud is an escalating problem.

Because advertisers can assess their ROIs with all fraud included, click-fraud deniers have a point when they say "It's just a cost of doing business."  This said, all else being equal, if click fraud is increasing as a percentage of total clicks, the price companies are willing to pay for keywords is going to have to fall--or ROIs will decrease.  [If someone knows for sure whether click-fraud is increasing, I and about 10 million others would be grateful if you could send some confidential evidence to share@internetoutsider.com.] And if most companies decide that they have to pay to track and audit their click-streams or risk throwing money away, this will add to the cost of search marketing programs and put further pressure on ROIs. 

And then, of course, there's the PR issue.  Google's recent stock plunge and communication gaffes have already tarnished the once-gleaming reputation of search engine marketing in general and the company in particular.  Imagine if Google deals with an increasing number of refund requests (stimulated by an increasing number of click-fraud audit firms) by saying, effectively, "If our rocket scientists said it was a valid click, it's a valid click.  So get lost."  Whether or not advertisers are still generating positive ROIs, frequent anecdotes about such snubs won't win Google many admirers, especially when it is generating a 50%-plus operating profit margin.  Armed with independent verification of their suspicions, moreover, such advertisers will be even more annoyed next time Google dismisses their concerns as "not material."

In my mind, regardless of whether one thinks click fraud is a big problem, it is hard to avoid the conclusion that it will add a layer of additional cost to search engine marketing--probably on both the advertiser and search engine side.  This may not be terrible, but it's hard to dismiss as irrelevant.  It's also hard to reconcile with a theory of ever-increasing profit margins.

Huge Net Capex: One-Time or Permanent?

The WSJ describes a key issue facing the big net companies, especially Google: massive (and increasing) capital spending.  Last week, for example, Google stated that 2006 CAPEX would "significantly exceed" 2005's mind-boggling $800 million, prompting analysts to toss out 2006 estimates in the $1.25 to $1.5 billion range.  Yahoo! spent $400 million last year, up from $250 million the year before.  Amazon's cranking up spending...

This gives rise to three key questions:

First, what on earth are they (or at least Google) spending that much money on?  I understand the need for "servers," but why has this need exploded so much in the last two years?  GDrive? GMail?  Neither of these ideas are revolutionary. Video is a CAPEX hog, but is the difference that vast?  Also, why does Google need $400 million more than Yahoo! and eBay do?  I shudder to recall this, but CAPEX is where companies occasionally stuff expenses they don't want to flush through their income statements right away (e.g., Worldcom and Homestore).  I have huge respect and confidence for Yahoo!'s financial team, and there is no conceivable reason for Google's team to play such games.  Without having more detail about exactly what the money is being spent on, however, the possibility of shifting capitalization policies can't be ruled out.

Second, is this simply an up-front investment necessary to build out global capabilities, in which case CAPEX will moderate in future years, or has running a global Internet operation become much more expensive?  If the answer is the former, today's CAPEX is largely irrelevant: The companies can afford it, and a future easing back on spending will drive free cash flow growth rates through the roof.  If the spending is permanent, however, these companies (again, Google especially) aren't going to generate anything like the free cash flow the market is currently expecting. 

Third, returning to a point raised in question one, why is Google spending more than twice as much as Yahoo! and more than Yahoo! and eBay combined?  Again, explanations about "storage" and "computational power" just don't ring true.  eBay and Yahoo! need storage and computational power, too, and, right now, Yahoo! handles more traffic than Google does.  The difference between the CAPEX levels, moreover, is so vast that it seems safe to assume that either Google is overspending (in which case, the question is "on what?") or Yahoo! and eBay are underspending (in which case, free cash flow is about to take a hit at both of those companies as well). 

When Google releases its 10K, we'll get more insight into where that $800 million went.  But this won't provide any into where this year's estimated $1.25 billion is going--or how much CAPEX as a percent of revenue will be required to run these companies for the next 10 years.

Microsoft Exec Explains Search Remarks

On John Battelle's Searchblog...  From his comment:

You may have seen press reports and blogs attributing comments to me regarding innovation in the world of search following a recent meeting I had with journalists. Unfortunately, the comments attributed to me do not give an accurate reflection on a long and detailed discussion and I would like to set the record straight. I did not say that we would be ‘twice as good as Google’. What I did say is that we are committed to investing in R&D aimed at providing a search service, initially in the US in six months, that performs better than the current industry wide standard of one in two urls being connected to the subject of the original query. I also said that our aim is to perform as good, or better, in that respect than Google. This is a long term goal. I did not put a date to it as this is work in progress.

The second point I made during our discussion is that we aim to make search a more holistic, integrated and personal experience. This is what our customers tell us they want. In the coming weeks, we will be able to share some new work that we hope will delight our customers and move towards the experience they are looking for.

We respect Google as a competitor. It is an amazing company and should be recognised for its innovation in the search category. However, we know that there is a tremendous opportunity to improve the search experience still further, because many questions go unanswered today. We want to deliver a service to our customers that sets new standards and we are committed to long term investment and innovation to meet the challenge.

Another Hallucination--This One From Microsoft

Jonathan Berr reports that Microsoft is backing away from statements a mid-level executive made earlier this week about how MSN's search relevance would soon blast past Google's.  The executive's brain is being reformatted.

Click-Defrauded Mad...But Will Take It Some More

A story from AdAge describes some search-panel fisticuffs at SES in New York.  Customers frustrated and Google and Yahoo on the defensive, but, once again, no real data.  Just more on how the search engines can't see the actual performance of the clicks and, therefore, will always disagree with their customers about what is and isn't fraud.  I've argued that one of the risks with click-fraud is attitude and FUD, rather than hard facts, and, based on this story, it seems advertisers may be getting more frustrated.

CLICK FRAUD DEBATE HEATS UP SEARCH ENGINE CONFERENCE

Marketing Vendors Square Off with Yahoo and Google

February 28, 2006

By Kris Oser 

NEW YORK (AdAge.com) -- A war of words exploded at a session on click fraud at the Search Engine Strategies conference at the New York Hilton today as search-marketing vendors went toe-to-toe with Google and Yahoo over the engines’ responsibility to protect advertisers...

MSN Falls Farther Behind

The press hype about a coming "war" between Google and MSN has mercifully abated in recent weeks, perhaps because it is becoming clearer that, far from being a credible Google challenger, MSN isn't even in the same league.

Last week, Microsoft reported MSN's December-quarter results, which were, in a word, weak.  Advertising revenue rose a dismal 12% year-over-year, continuing the deceleration trend of the last few quarters (by comparison, Yahoo!'s growth was 39% and a poor showing for Google will be in the 100% range).  Operating income dropped 55% to $58 million, as salesforce and developer headcount ramped.  Any indication that this investment will ever pay off will have to wait for another quarter.

The key to MSN's recovery (and relevance) is search, and search revenue was awful.  The company's display advertising revenue grew 20%, only half of Yahoo!'s growth rate but far better than MSN search, which apparently posted growth in the low single digits due to a 20% year-over-year drop in revenue per search.  The company attributed this trend to the adCenter ramp-up (Overture's revenue per keyword is presumably higher than adCenter's) and weak performance from third-party partner sites.

The one important bright spot--and, considering the rest of the division's performance, it's a head-scratcher--is that search query growth was in the "low to mid double digits" (presumable translation: 20%-45%).  This means that all is not lost.  If the company can get its act together and stabilize revenue-per-search, query growth alone should produce nice revenue growth.  Based on recent trends, however, this seems anything but a lay-up.

As argued here, MSN is, at best, competing with AOL for distant third place in the web wars.  The December quarter results--combined with AOL's recent partnership with Google and broadband distribution deals--suggest that MSN is even losing ground in this race.  Google, meanwhile, is so far ahead that it's not even visible over the horizon.

Yahoo Waves White Flag in Search War

Yahoo! has apparently read the writing on the search wall that everyone else (except Microsoft) has been reading for years: The search game is over and Google has won. 

"We don't think it's reasonable to assume we're going to gain a lot of share from Google," Yahoo! CFO Sue Decker said in a Bloomberg article on Jan 23.  "It's not our goal to be No. 1 in Internet search. We would be very happy to maintain our market share.''

Decker and Yahoo! get points for self-assessment and straightforwardness.  And as neither she nor most of the company's current senior managers were there when Yahoo! fumbled the search ball back in the 90s (to go chasing after content and other seemingly sexier pursuits), it seems pointless to reiterate how disappointing this is, that the search game was once Yahoo!'s to lose.

Still, denial never helps, so hats off.  Now, if the folks up at Redmond can only follow this example, perhaps Yahoo! and MSN can combine forces and become a stronger No. 2.

UPDATE: Upon further consideration, I think this comment was probably intended to reset Wall Street's expectations.  The Street has been all over Yahoo about search for the last year, and the company's repeated promises to "fix the algorithm" have only created more disappointment.  So Decker was presumably just resetting the bar to a level the company can more easily clear.  (Judging from recent market share losses, though, even this target may be hard to meet.) 

Phone Co Toll Demand Seems Reasonable

My initial reaction upon hearing that Verizon, et al, want to charge Google, Yahoo!, et al, for carrying broadband content over their networks was that this was yet another pathetic attempt by whining, dying monopolies to make themselves relevant in a new world.  After reading the details, however, it seems that the content providers are the ones being unreasonable.

According to the WSJ, Verizon, et al, want to charge content providers extra to guarantee rapid delivery of broadband content (music, movies, VOIP, etc.).  They'll still deliver it if the content providers don't pay, they just won't guarantee that it will get there fast. 

Yes, such an arrangement would leave plenty of room for sleaze (make the "regular" delivery so slow that content companies have no choice by to pay up), but, on its face, it seems perfectly reasonable.  Want your customers to get your stuff quicker?  Then pay us more.  In a physical-mail analogy, this seems similar to FedEx or the US Postal Service charging more to deliver a 300-pound box overnight than a letter.

This said, I may be missing something about how the phone companies already charge. Do Google, Yahoo! already pay per unit of traffic?  Are the phone companies already charging more for the 300 pound box?  If they are, and if they're just whining to the regulatory folks for help getting more, then I'll have to go back to my initial reaction. 

All help appreciated...

Microsoft Returning to Roots, Sheds MSNBC

Microsoft's foray into the Internet content and media businesses, an era in which (intelligently) it threw everything it could think of at the wall to see what would stick, continues to wind down.  The NYT reports that the company has sold majority control of MSNBC to NBC, with the latter having an option to buy the whole thing in two years.

Although the press is feasting on the story that Microsoft and Google are at war with each other, I think this foray, too, will likely end up being more story than reality (more on this here).  As CNN and Fox have demonstrated on the news network side, and Google and Yahoo! have demonstrated on the Internet, focus helps, and although it is fun to worry about how all the world's eventually going to work for Redmond, the last few years have shown that this fear is greatly overblown. 

Microsoft's core business is and always has been PC software, and the odds are against its ever finding a way to generate as much power, profit, and dominance in related businesses.  The company still has a major opportunity in enterprise software--Oracle, IBM, and others still make major hay--and it is hard to imagine that Microsoft will be able to steamroll both these tenacious technology companies AND the Internet giants.  And it is equally hard to imagine that corporations that entrust their most mission-critical IT systems to the likes of Oracle, IBM, et al, today would choose to entrust them instead to a company that also makes video game consoles.

Microsoft can't do everything forever.  And if it is to remain a competitive, vibrant, and fantastically rich software company, it is probably going to have to make a tough strategic choice, one that will might mean spinning off the Internet businesses.  Because the days in which it could afford to throw stuff at the wall are gone.