“Google Bubble” getting ready to deflate?
By Sarunas Barauskas, co-founder at Kalkis Research:
A couple of months ago, I was going through Google’s newly released 10-K filing. The night before, we had had an argument with Philippe, the other co-founder of our start-up, about how ad dollars were fueling a new kind of economy. We realized we had no clue of who was making money, by what means, or how much. I just wanted to understand.
What mesmerized me were the sheer amounts of cash Google (ehm, Alphabet) was raking in: $75 billion dollars in revenue for 2015. For 2016, they’re set to generate as much as the GDPs of Lithuania, Latvia and Estonia put together. That’s six million people.
Another thing that was weird: how vague Google was about how they actually made all this money.
Their main metric, the cost per click (CPC), was a nonsensical aggregation of a wide array of user actions, from a click on an ad that could be worth as much as a few hundred dollars, to a video ad that wasn’t dismissed quick enough, an for which the advertising company would be charged a fraction of a penny.
Their SEC filings were full of statements about how Google was revolutionary and unique. They would go to extreme lengths to describe various non-essential parts of their business. But there was very little of actually useful information about the way online advertising worked. After all, it’s only the source of 90% of their revenue.
In our media database, Google has been mentioned in one-hundred-thousand articles over the last two years – that’s one out of every fifteen articles. If you tried to read everything Google, you just wouldn’t have enough waking hours to keep up with the information flow. No wonder people stopped trying to figure out what the company is really about. During every earnings call, analysts usually focus on CPC and user acquisition costs, and a few other nice-sounding, reassuring metrics that were created by the company itself.
Google’s earnings growth is also surprisingly smooth. The last time they’d had a major earnings mishap was back in early 2012. At the time, the company had scared the market by announcing that their CPC – the amount of money generated per “click” – had declined for the first time since 2009. Larry Page had explained that this was due to a “decline in ad quality.” I thought to myself, what the heck is an ad’s quality?
This was the first of an uninterrupted series of declining CPCs since then. The market cared for a few months, and then forgot about it, focusing instead on rising revenues and profits. Nonetheless, the fundamental shifts continued, behind the scenes.
I drew an n-gram of key word combinations used in articles about online advertising since 2007, to get the big picture of how the ecosystem evolved.
Most of the online ad space is bought on ad exchanges. Google’s own AdWords is an exchange, born out of the acquisition of DoubleClick back in 2009. Ad exchanges centralize all the ad space that’s available of blogs, websites, online video streams, and offer it to the highest bidder.
Most of ad space is also bought in real time. This trend started around 2009. When you visit a website that displays ads, it notifies potential bidders through the ad exchange about your visit, with some info about yourself (your web browser, physical location, browsing history, cookies). Each bidder then decides what to bid knowing your profile, and probable interests.
Real-time bidding is automated, a typical transaction is done in around one tenth of a second. To manage this process, demand-side platforms started to gain prominence around 2010. They are interfaces between human buyers and computerized ad exchanges.
Programmatic buying is an even more conceptual increment in the process of buying ad space, where algorithms bid for ad space as it comes up, according to a “macro” description of what they should buy, done by human traders. It started gaining traction towards the end of 2012, around the time Google’s CPC started declining.
The online advertising ecosystem has become more and more automated and complex, with more and more intermediaries.
Advertising agencies set up their own trading desks to buy ad space on behalf of their clients. Twenty years ago, when Nike would run an ad campaign, its executives could actually hold a paper issue of Men’s Health, and see their ad on page 23. Today, they are presented with a more or less detailed report on where the company’s ads were displayed, at some point, to some Internet users. No paper trail.
The effect of automatization is that it became much cheaper to do due diligence on available ad space. An algorithm can decide if an ad is worth displaying on some obscure website for a thousandth of a penny. Placing ads on low quality websites for a few cents a pop became economical. CPC declined, because advertisers started buying ad space on the low-end corners of the Internet. Online advertising has expanded into subprime ad real estate.
This expansion fueled three new trends. Ad tech companies sprouted, as new infrastructure brought down barriers to entry. The number of ads being displayed everywhere exploded, and in reaction, people started using ad blockers; available high-quality, prime ad real estate started to shrink, putting even more pressure on subprime.
Faced with ever-growing demand from advertisers to place ever more ads in this environment, intermediaries lost the incentive to effectively check if ads were being displayed correctly, and ad fraud exploded.
Listed ad tech companies provide much more details about the inner workings of their businesses than Google. Rocket Fuel, Millennial Media, Tremor Video, The Rubicon Project all mention “fraud” as a risk factor around a dozen times each in their 10-K filings.
Google never talks about fraud, which I found very surprising, especially since they went through a rough patch in 2013, with Spider.io. This startup revealed that a lot of Youtube ads were displayed to bots and never seen by human eyes, while Google still billed the clients for all of the “views.” Google bought the startup shortly afterwards, and the story never gained traction.
I got in touch with a friend of a friend who works in an advertising agency. What did he think of all this? Was I going crazy? Did people talk about ad fraud, did his own clients ask for reports of who was seeing the ads?
As it turned out, the system has become so automated, that just about anyone can pretend to manage an ad campaign. Twenty-somethings with no clue of how the system actually works buy ad space on behalf of their clients, who are just all too happy to be part of the trend. Display advertising is a big hit, because there’s no way to check if it works, so there’s no accountability.
With pay-per-click, at least you know if people who come to your website buy something. The industry pushes display advertising because more and more people browse the internet on their smartphones, but most of purchases are made on desktop. And it works, display has outgrown pay per click in the US, for the first time ever.
We’re living in the last months of the online advertising bubble. Everything’s out in the open, if you only care to look. Ad fraud has been covered by Bloomberg, Reuters, Fortune. The rise of ad blockers has been widely condemned by the media, because it hurts their bottom line. But somehow it hasn’t impacted Google’s revenues, which is very weird. Who is actually seeing the ads?
The moment the red line on the chart above breaks to the upside, and the media starts covering ad fraud more extensively, people will become aware of what’s going on. Companies will redirect marketing budgets toward more productive purposes, and then it’s game over for the ad industry.
Don’t get me wrong, Google will still be around. They have a core business that’s clean and effective. But they have to shrink down. By Sarunas Barauskas, Kalkis Research
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