Second Collapse of the Internet Economy Underway?

The first internet bubble popped largely because all business models failed except for ad selling.  Is it possible that the last stalwart hope is itself doomed?

TechCrunch reports that Lookery, a company specializing in selling ad inventory on social networks, is barely breaking even despite selling 3 *billion* ads per month.  And rather than raising prices to become profitable, they're actually in the uncomfortable position of lowering prices 40% -- from 12.5 cents to 7.5 CPM.  It reminds me of the (often unintentional) joke "We lose money on every transaction, but we make it up in volume!"

All this has made them so gloomy about the prospects of their core business that they're thinking of switching horses mid-stream and resurrecting that Web 1.0 favorite: selling demographic data.  I mean, it worked so well the first time, why won't it work now?

Ok, so you might be saying "Sure, social network ads are crap, but Google's ads are solid, right?  After all, they're set by the open market!"  I thought that too, until recently I learned that rather than that market being open, it in fact is restricted by a series of minimum bids

Don't believe me?  Search for "Flash" and you'll see it has zero ads.  In a totally free market, that means you have no competition, and thus should be able to bid as low as you want to get your ad to appear.  But when you try to create an AdWord for the "Flash" keyword, you'll see it sets the minimum price at $0.10.   So even if the market (me) only wants to pay $0.01, it's priced 10x higher than the market (I) will bear.  Which is why there are no ads on the "Flash" keyword.

Said another way, there is no competitive pricing for the "Flash" keyword.  Rather, the price is arbitrarily set by Google.

Now you might say "Well, Google owns the ad inventory, they can sell it for whatever they want; it's still a free market, even if they choose not to sell it for cheap."  But wait -- didn't we just say prices are set by auction?  Hm...

All this means that the auction only sets prices above a minimum.  Which brings us to the $149.86B question: how many of Google's ads have prices set by auction, and how many are just coasting by on the minimum?

Hopefully, most of Google's ads are competitively priced via the auction.  This would suggest that they're priced "correctly" and that we're in for no major shocks to ad revenue (and, due to Google's market share, worldwide ad revenue).

But let's say that some high fraction -- 50%?  70%? -- of Google's ads are in fact not competitively priced, but are just set arbitrarily by Google, such as Flash's $0.10 minimum.  In this scenario, Google's revenue is no more protected from price declines than Lookery and it's 40% "going out of business" sale.  (After all, anybody slashing prices while losing money can't have a long future.)

In this scenario -- which might be reality, depending on the data -- Google's pricing is not sustained by competition, but by a near monopolistic control of ad inventory.  And in that maybe-reality scenario, the global ad market is over-priced, meaning Google and all other ad-supported online businesses are overpriced, meaning we're in for another massive internet economy collapse if Google ever loses its monopoly and is forced to truly compete on price.

Sound crazy?  It's not nearly as crazy as what's already happening in reality: ad arbitrage.  It works like this:

You buy a really cheap adword from Google in order to direct a lot of traffic to some site.  And then you fill that site with ads with high CPM and CPC (perhaps from other ad networks, it doesn't matter).  The result is you buy a click for $0.10, and then turn around and sell it for $1.00.  How is that possible?  Why isn't everybody doing it?

Everybody was doing it -- in huge quantities -- until Google killed it.  How?  By raising minimum bids.

That's right, by fiat Google leveraged its near monopoly power and raised prices to stop buyers it didn't like (spammers) from taking advantage of the mysterious imbalance between the price of an AdWord and another network.  Specifically, it means that Google clicks should be able to buy for *cheap*, were it not for Google artificially raising prices.

It also means that advertisers on other networks are unwittingly paying *way too much* for what should actually be a really cheap click.  In an efficient market, the advertiser should just be buying that original, really-cheap AdWord, rather than the inflated price of an ad on the intermediate spam site.

And all this comes back to the possibility that Google's AdWord inventory is actually overpriced, and it's only sustainable so long that Google enjoys near-monopoly status.  Once that status is gone, then all keywords -- even the ones Google chooses to price out of the market -- become competitively priced, at rates far lower than what Google is currently charging.  Which means everybody that depends on AdWord revenue suddenly makes less.  Meaning the internet economy collapses.  Again.

Crazy ramblings?  I wonder.

Update: A friend (the same one who told me about ad arbitrage) pointed out that one reason there might be no ads on Flash is because it's a trademark. That could be -- I didn't go all the way through to pay the minimum bid and see what happens. But that doesn't change the fact that there are minimum bids on *all* unused keywords, including such words as "blah" or "quinthar". So the general argument still stands.

Update: So I decided to run my own Flash ad. I gave it a $25/day budget and bid the $0.10 minimum. It immediately showed up, and appeared every time I refreshed for at least several hours. According to Google, it was shown 6,607 times. But here's the interesting thing (which, frankly, completely demolishes my whole theory): it was pulled, despite it only costing me $0.40 (ie, with tons of budget remaining). Why? Because clickthrough was too low -- 0.06%, to be precise. So now I'm changing my theory. The reason there are so few Flash ads isn't that Google has priced the keyword out of the market. Rather, it's because it's difficult to make an ad that achieves sufficient clickthrough on such a general term as Flash. Even if you're willing to pay the minimum, Google isn't willing to show it unless it performs. Whether or not that's a problem (and I'm not sure it is), it's entirely different than what I initially was guessing, and completely undermines my theory of Google using monopolistic pressure to sustain noncompetitive pricing. So... never mind.


Brian Damage said...

It's not against AdWords' TOS to advertise under a trademarked name. You can't put trademarked names in the text of your ad but you are free to make your advertisements appear when users search for competitors' brand names.

Unknown said...

Minimum bids exist for two things ;

1) Removing crappy spammy ads ; since it costs 10 cents instead of one, no crappy company with a crappy product can afford it and that's one the reason google ads are succesful : They limit the amount of advertising for bad producst.

2) If you want your flash ads at 1 cent, why do you think nobody is offering to server them for 1 cent? Because its not worthwhile.

Steven Jon Halasz said...

"Flash" by itself can't be a trademark because it's a common word in the dictionary. The trademark is the combined words "Macromedia Flash".

AncientTruth said...

Web ads on the net cannot be a free market because of spammers and robots, the internet is much different from the real world, lets not forget that.

Google has to maintain some kind of control or else the net would become useless and spam infested, it's the same principle they have to cull spam from search engine results, their business is search and ads. It's also not exactly a monopoly, there are other search engines, so it's hardly a monopoly. It's not googles fault everyone uses them.

Software Guy said...

I think you can be more scientific with your theory. Using googles own keyword tool you can get real bid information and search volumes from the source. https://adwords.google.com/select/KeywordToolExternal

Eg. Looking at "flash" it shows the cost of having a top 3 position as being $1.02 with a monthly search volume of 13,600,000 in June.

I'm not convinced overall there has been a decline in ad spending. Quite the contrary. Most ad budgets are being cut offline and transferred (albeit smaller amounts) to online. Google confessed in its latest results, it had chosen to display less ads to improve quality to its advertisers, and the expense of revenue. Even so they are on track for a $20B year, compared to $13B in 07.

ripper234 said...

You can't "turn a .10 $ click to a 1$ click", regardless of minimum ad prices. Just because a user clicked on the .10$ ad does not mean he'll click on the ad in the other page - actually, the chances for that are slim.

Unknown said...

When a non-monopoly demands a high price for a service, other entities can step in and compete by offering a lower price.

Google isn't a monopoly, so Yahoo, Microsoft, etc. can all step in with lower advertising prices.

stack said...

What exactly makes you think that making less money leads directly to collapse? As I understand it, Google is making quite a killing right now, which might be due for a correction.

Unknown said...

The area that Lookery targets is the most pathological area of web advertising: "social media" sites.

I'm a heavy user of imeem, a music community. I'm not the stereotypical "young and dumb" social media user. I earn well above the median income, and I spend a lot of money online.

Imeem shows me nothing but ads aimed at the "young and dumb" demographics: ads for ringtone scams, "get a free ipod" scams, "can you do more pushups than the computer" scams, zip/email submit scams, etc.

I can't speak for the majority of imeem users, but I can attest that I have a 0% CTR for the scams that are advertised on imeem, facebook and sites like that. There's clearly a breakdown of imagination between the ad networks, advertisers and everybody involved.

I run some sites that are supported by advertising. It's very possible to develop sites that get a CPM in the $2 range, which can be quite profitable. There are many people who run campaigns on Adwords that make good money despite all the troubles.

Online advertising markets can work, but we're going to have to clear a lot of pathology out of the way to expand them...

- Paul Houle

Dennis Peterson said...

I'm not sure I understand your logic. Seems to me that if an ad is overpriced, people won't buy it. So you see a page where nobody bought an ad, meaning the ad was overpriced...and conclude that the ads people did buy are also overpriced? Why is this not proof that advertisers are *not* buying overpriced ads?

Then there's the arbitrage, where you say that Google's ads are cheaper than competitors, which somehow means that Google's ads are overpriced.

At the end you hit on the reason Google has minimum bids...to prevent their ads from being so much cheaper than competitors' that arbitrage is easy. Thus the minimum bids on unused keywords...where, if not for the minimum, Google would pick up a little money for essentially zero marginal cost.

It looks to me like it's just Google's competitors who are overpriced. If that situation changes, Google will be able to remove its minimum and make extra money on the low-price ads...though they may lose more money to their more-competitive competitors.

On the other hand, it could just be that advertisers are willing to pay more for animated banner ads than for text ads.

As for Lookery...maybe they're not as good at running a large server farm for cheap as Google is. Maybe social networks aren't a good place for ads, compared to search engines. Any number of reasons why it might not be working out.

Anonymous said...

I think it might show just the opposite. If other ad networks are priced higher than Google, that'd say to me that either Google's ads are underpriced, or the other network's ads are overpriced. Personally I suspect the latter. Arbitrage like you describe only works when a vendor undervalues it's product, and when the vendor corrects that undervaluation then the arbitragers lose their opportunity. Such is life.

And there's always a minimum price. You point that out with Lookery. They priced their ads under the minimum price they needed to get to stay in business, so they're... well, not staying in business. Google needs to get a minimum amount for the ads to break even, and it's reasonable for them to say "It doesn't matter what the market values the keywords at, if we can't cover our costs we're not selling.".

Robert Haas said...

I think Google is entirely right to try to stop the practice of buying a click for $0.10 and selling it for $1.00. If they don't, their index will fill up with spam sites and people will stop using Google (just as they've stopped using many other search engines that return crappy results).

As for minimum bids, it seems implausible that Google would have no minimum at all. Could you bid $0.000000001? There are probably keywords that aren't worth any more than that to anyone, but Google isn't interested in selling at that price because they can't make any money at it. You're right that the minimum bid opens up the possibility of a fall in prices in the future, but that's also true in an auction situation - if market prices fall, then the auction bids will presumably fall along with them.

Logik said...

Brillaintly analyzed. Especially the arbitrage & monopoly issues.

The minimum bid price is really sad... Hope things improve , and not as u suggested..
Maybe the cheaper Lookery might succeed.

WildWeathel said...

Dear Quinthar,

I believe that you would benefit greatly from an economics course. There are many misconceptions in your argument:

1) Lowering prices lowers revenue.

The effect of a price change depends on how much that price change affects quantity demanded. If demanded quantity increases enough, increased volume makes up for decreased price. This is especially true when the customer can easily take their business elsewhere, which is likely the case with ads.

2) A business that is losing money must be losing money on each transaction.

If each ad sold cost Lookery money, they'd stop selling ads now. It is very likely that they're just barely making enough to pay their fixed costs. This is normal in tough times for a company (though very uncomfortable), when even the best short-term strategy results in a loss.

3) Reserve prices are a non-free market.

A free market implies that all participants are free to sell or not sell their goods at whatever price they want.

I recommend watching this tutorial to understand how Google sets prices.

4) A reserve price is not an auction set price.

Google offers each keyword at auction and simultaneously enters a bid, determined by Google's algorithm. This bid represents the value to Google of excluding irrelevant ads from the search results. Because this value exists, Google is both a supplier and demander of ad placement in search results. On the keyword "flash," it just happens that Google is the highest-bidding customer.

5) Without minimum bids, AdWords are set by price-only auction.

Google openly engages in price discrimination in its auctions, in effect offering a discount for placing relevant and useful ads.

6) The act of Google raising minimum bids on keywords used for ad arbitrage constitutes a unfair taking "by fiat" of arbitrageurs profits.

By it's nature, arbitrage closes the gaps that make it possible. Arbitrageurs would have driven AdWords prices up and/or advertisers costs down by competing with each other. Additionally, Google discourages ad farming because they believe (rightly or wrongly) that spam pages aren't useful for their search customers. It wouldn't surprise me if ad arbitage was killed by a combination of decreased quality scores *and* increased reserve bids.

7) Google has a near monopoly.

Monopoly is not just that one company holds a large market share. When economists warn of the dangers of monopolies, they are talking about a situation where it is very difficult for competitors to enter the business. In fact, the only real prerequisite for selling ads is high traffic. Effectively competing with Google would also require a focus on quality, which is certainly more difficult, but not a major hurdle.

8) Advertising is the only component of the internet economy to survive the '90s.

Just ask Amazon, eBay, every university campus (do they even have a business model), every modern multi-campus company, iTunes, etc. if they have an alternative to advertising.

GopherX.net said...

So I liked your line of thinking, but you were a little off when it comes to how google killed arbitrage.

They've graded quality of traffic by geographical location. You can get lots of traffic from Turkey and Egypt at $0.01, but when those visitors to your site click on an ad that would normally pay $0.25, you only make $0.01 or less if you can believe that's possible.

They also separated out the search and content networks allowing for separate bidding. The thinking being that if you search for something you must want it more than a random click on a content page ad.

So a keyword that will earn and adsense person $0.01 will make Google $0.60 on the search network. Probably the biggest corporate cash grab of all time. Way to "do no evil" google.

BC said...

I admittedly might be guilty of oversimplifying and/or playing devil's advocate, but I just don't see the problem.

The article title is more than slightly alarmist.

The basic theory is that "we're in for another massive internet economy collapse if Google ever loses its monopoly and is forced to truly compete on price".

First, there is no monopoly.

Second, the price for the terms people are actually searching for and clicking on are set by "the fittest" advertisers that can afford them.

Where's the problem?

David Barrett said...

All righty then. Lots of comments, let me try to address some of them:

Re: Trademarked names. Yep, that was a bunk theory. I was able to put up an ad just fine.

Re: Minimum bids have legitimate and beneficial purposes. Totally agree. But when there is no alternative vendor for that keyword (ie, the only way to get on Google's pages is buying from Google) then minimums also limit the ability for buyers to set the price via competition. Rather, the price is set by the seller.

Re: Turning a $0.10 click into a $1.00 click, er, yes you can. You can still do it today with lead generations. I know it sounds crazy. But it's true.

Re: Google isn't a monopoly. The definition of monopoly has many shades, one of which is "process by which a firm gains persistently greater market share than what is expected under perfect competition." In this case, Google once had better legitimately better search results and thus gained users through real competition, but now it's pretty much a wash -- the search engine wars are over and Google won. That's fine -- I don't begrudge them that, they won in a fair fight. But it doesn't change that their market share today doesn't reflect being legitimately that much better; it's due to habit. Similar to how Coke might be better than off-brand colas by some amount, but not so much as to justify their market share.

Re: Google making less money == economic collapse. The theory is Google is the market leader and thus everybody turns to them for ad pricing. If they slash prices, then it's hard for anybody else who charges more to justify that, triggering a cascade of ad price cuts, which cuts revenue to thousands of other online businesses that depend on ad revenue. And then all the money those ad-supported businesses in turn spend on other services gets cut. And so on. Domino theory sort of stuff.

Re: Overpriced isn't a problem. Well, the "flash" keyword had *some* ads on it, meaning all those ads were set on the minimum price -- and not by competition. (Competition only kicks in once there are multiple ads working for the same spot.) The theory (since debunked) was that most pages had too few bidders and thus didn't get above the minimum, meaning most ads were priced by Google (and not by auction). Furthermore, given that there are few alternatives to Google, people might be paying more than they would normally pay if real competition were in place. Anyway, that was my theory. I'm backing away from it now that I realize that ads are dropped due to non-performance, as that changes everything.

Re: Not overpriced, underpriced. The fact that there is the potential for arbitrage in the first place shows there's something fishy going on that creates opportunities a perfectly competitive market wouldn't allow. It doesn't matter whether Google is way more or less expensive than anyone else; it's the fact that prices diverge so wildly that's cause for concern.

Re: Lowering prices can increase demand and raise revenue. Sure, it's possible. Or not. But in the case of the original TechCrunch article, lowering prices is clearly a move of desperation, which isn't pleasing no matter how you look at it.

Re: WildWeathel. Thanks, good comments. Very helpful.

And there are other great comments in the mix. Thanks everybody!

matt_rummler said...

OK, so this is old and too many comments already but let me put my 2cents in the mix:
Setting a minimum price is simple economics... there are costs involved with serving and tracking ads. Costs which include the infrastructure of servers and people to maintain them and applications to track them. I haven't asked anyone at Google but it looks like the minimum price makes sure that google is making enough to meat these minimum costs across the number of ads they are hosting/providing, anything above the minimum is likely profit margin.

Anonymous said...

Overpriced compared to what? Can this author recommend an ad agency that prices lower than google?


C:\Felipe>_ said...

For a start, the updates should be placed on top of the article so people will be immediately aware of the author's change of heart. I'm glad that he eventually did his homework and found out some of his own faults, but it's not nice to be teased into read something that the own author discards as wrong.

rafer said...

@WildWeathel has all the Lookery bits correct.

There is one significant fact missing on the Google discussion. "Flash" doesn't perform as few people search on it.

If you search "Flash Developer" on the other hand ....

Scott Rafer
Lookery CEO

Anonymous said...

Fuck you, I like Google

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