Sunday, July 20, 2008

Has Google's relentless growth finally stopped?

The fuel that brought Google from a laboratory experiment to one of the world's industrial giants, may at last be burning itself out. That leaves Google one player among many, in a questionable economic environment. What now?

When a cartel of oil-producing nations wants to tweak demand for its product upwards, along with its per-barrel prices, one tool it has at its disposal is tightening its pipelines and reducing supply. In the online advertising space, in terms of reach and supply, you don't actually need a cartel to approach the power of Google.

But in a startling admission yesterday during Google's second-quarter earnings call yesterday, the company's senior vice president for product management, Jonathan Rosenberg, admitted to a Banc of America Securities analyst that his company was doing something very similar, and for much the same reasons. Specifically, it reduced its own available inventory through its search and other hosted pages, in a maneuver to drive up the value of what it does sell.

The term for that available inventory is "coverage." "You know, coverage, I think, from a quarter-to-quarter basis, has been going down," Rosenberg said (with our thanks once again to Seeking Alpha for the transcript). "It's pretty much at an all-time low relative to the last few quarters. That's basically our continued focus on quality. I don't really see that changing significantly. Larry [Page, Google's president,] often says that we'd be best off if we just showed one ad, the perfect ad. So I really don't think that coverage is going to change much."

Reflecting the company's notorious transparency, co-President Sergey Brin weighed in on that topic later, effectively countermanding what Rosenberg had just stated. "There is some evidence that I think we've been probably a little bit more aggressive in decreasing coverage than we ought to have been," Brin said. "Historically we've had this 50/50 rough notion that when we have an improvement in advertising targeting, we try to split the benefit, if you will. We try to reduce our coverage at the same time as improving the monetization. But clearly that's not the ideal strategy indefinitely, because we don't want to end up with no ads.

"And in fact from a quality point of view," he continued, "we now find our ads are a significant addition quality-wise to our page. They are just a very important source of information. We've been actually re-examining some of that. There was some evidence internally that perhaps we were a little overly aggressive in decreasing coverage in this past quarter."

You'd think we could begin and end a story on Google's quarterly gains its net earnings overall were up 35% over the previous year's second quarter, to just about one and a quarter billion dollars. But the fact not only that Google's making these tweaks, but that it's tweaking its tweaks, is raising concern among analysts -- especially those who were expecting those 35% gains to have actually been higher.

What's going on? One more clue came today from Web traffic analysis firm comScore: Google's share of search queries placed from US-based households and universities (i.e., non-commercial) dropped last month, ever so slightly. Google served 61.5% of the nation's individuals searches in June 2008, by comScore's estimate, compared to 61.8% in May. The surge that comScore reported last month, stopped.

With online advertising manageable like a free-flowing commodity -- like oil, electricity, and in Starbucks' case, coffee -- the way to increase the value of what flows through the pipeline is to restrict the flow. That's what Google has been doing: reducing the quantity of AdSense ads on its own pages, to help justify its sales value of what it does sell.

But part of Brin's concern has to do with the fact that, at least for the time being, Google isn't the only supplier of advertising. When it restricts the flow, consumers can go elsewhere. Remember, AdSense ads actually have consumer value as well -- they're among the items that appear in response to users' queries. It's strange to think of consumers wanting ads; but when you're selling contextual ads, relevance is determined by applicability to users' wants.

So the other part of comScore's numbers today could not be interpreted as good news: Yahoo and Microsoft actually gained all of those searches that Google lost, with Google's US search share rising 0.3% and Microsoft's 0.7% on the month. Yes, that's Microsoft rising by close to one point.

Exactly how is Google making its adjustments? As CEO Eric Schmidt indicated, his company keeps a close watch on the economic conditions in the US and the rest of the world, preferably by reading the newspaper.

"There is obviously evidence of a slowdown in the US and Europe; you read it in the paper every day," Schmidt told one analyst. "We continue to believe that we are very, very well-positioned in such a slowdown and especially if it gets worse. The reason is there's a flight to quality and in particular a flight to measurability. So our economics are more driven by, for example, if people stop searching for something we might not be able to do ads against it."

Say again? The "flight to quality" is Schmidt's term for shifting Google's measure of sales from a quantitative to a qualitative basis -- restricting the flow, and tightening content around richness. But what's rich to the user? That's a harder question to answer in a tough economy, because the consumer is going to be tightening her spending.

Of course, that could mean that same consumer could spend more time online, as Google's Chief Economist Hal Varian then pointed out. Again, gently countermanding the person who spoke before him, Varian said, "I think part of what is happening is that as times get a little uncertain price-sensitive consumers are going to shop more carefully to try to make every dollar count. That means they are going to be doing research online and they are going to be doing shopping online."

Then comparing Google to another of the world's major suppliers that has recently had the luxury of being able to tighten supply to drive value, Varian added, "I think we have a little bit of the Wal-Mart Effect going on that as times get tough, people are going to watch their dollars. In many cases that means doing more shopping online."

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