[ChuckMcM]

What Punch said, basically its a maturing of the Internet Advertising market, the early enthusiasm for lots of metrics on engagement being dampened by a gradual understanding of click fraud. This is reflected in Google's financials as a falling 'cost per click' (what Google gets for an ad click).

The other factor is that Google search has been slowly losing its quality edge on its competitors and so services like Microsoft's Bing start developing more significant inroads, the combination of more market share and higher CPCs on Microsoft's service lead it to be profitable last year[1]. And the reason is in part because Microsoft can preferentially send search traffic to their properties, but it is also tied to the fact that consumers don't then switch their search provider later.

To counter-act that Google has been paying more and more money to third parties to send search traffic their way (this expense is called 'traffic acquisition costs') and Google was horrified when Oracle's lawyer disclosed that they were paying Apple a billion dollars a year for their search traffic[2]. They paid millions to Mozilla to send their search traffic to Google [3] and had a material dip in traffic revenue when Mozilla cancelled that deal[4]. What the author of the article in [4] did not realize is that all of Yahoo!'s search traffic is in fact served by the Bing index and servers. Yahoo! hasn't had a native search service since they agreed to send it all to Microsoft. So Bing+Yahoo! market share is really just Bing market share. That money paid, their TAC, comes right out of the profit margin for their ads

At the end of the day this is neither good nor bad, search is being commoditized. And as it commoditizes that puts pressure on margins since discrimination based on cost always puts pressure on margins. Eventually Bing and Google will be equally expensive from an advertiser point of view and the one with the best operational efficiency will make the most profit. Neither of them will be able to use "excess profits" to fund moonshots.

That is why it is so critically important for Google to find additional viable businesses to augment its search advertising revenue.

The current road leads to a very un-fun place to work, long hours (maximize work done for salary paid), few benefits (reducing costs), and little room for new development. They won't end there, it's like saying if you drive west in the US and never turn eventually you'll drown in the Pacific ocean, it's true but there is always a turn before that point. But if Google of 2003 was one end of the spectrum, Google is inexorably moving toward the other end. Ruth is there to make sure what's left is still a viable business that deserves a high stock price.

[1] https://techcrunch.com/2015/10/22/bing-is-profitable/

[2] https://www.bloomberg.com/news/articles/2016-01-22/google-pa...

[3] http://www.pcmag.com/article2/0,2817,2398046,00.asp

[4] http://www.geekwire.com/2015/yahoos-deal-mozilla-draws-searc...

[MarkMc]

Here is Google's net profit margin for past 4 years [1]:

2013: 22.9%

2014: 21.4%

2015: 21.7%

2016 (9 months): 22.0%

It doesn't look like profit margins are under strong downward pressure. But a better metric would probably be 'revenue per search query' - I don't have any recent statistics, but if Bing can close that gap it will reduce Google's margins when bidding for search traffic from Apple and Firefox (and maybe force Google to increase the percentage of AdSense revenue they give to website publishers). But even then, Google will still have three significant advantages to avoid the complete erosion of their margins: (1) Android; (2) Chrome; (3) The Google brand (I'm sure that more people try to change the default search engine on their new Windows computer than try to change the default search engine on their new Android phone).

Also, Bing would probably not be profitable if it was a separate company and had to pay Microsoft for the privilege of being the default search engine on Windows. Bing+Yahoo seems to be growing market share, but I wouldn't expect them to completely close the gap with Google in the next 20 years because Google's ownership of assets like YouTube, AdSense, Google Maps, Android and Chrome.

Google has all my search history, a list of all the AdSense websites I visit, my YouTube history, my location history, ten years of my email history and my Play Store purchase history. And for any given search query I perform, Google can access a larger pool of similar search click history from other users. How will Bing ever overcome all these disadvantages?

[1] Derived from https://www.google.com/finance?q=NASDAQ%3AGOOGL&fstype=ii&ei...

[ChuckMcM]

It is so much more nuanced than that. That number is essentially manufactured for the street (and before anyone jumps down my throat about being some sort of conspiracy nut let me explain).

Early in Google's life there was an article which asked the question "Is Google's gross margin 100%?" It went on to observe that Google had overhead, staff, facilities, and monthly recurring costs like electricity and phone bills, but every advertisement they 'served' cost them essentially no delta in their overhead, so their "cost of goods" when looking at the business through the lens of the goods economy[1] was zero. And any revenue they generated by selling a "click" (their stand in for a widget) was 100% gross profit. As a result, using old school goods economy accounting rules, profit is entirely a function of how many clicks they "ship" and there are many knobs to adjust which boost how many clicks they ship. They include, but are not limited to, putting more ads on their own pages and buying traffic to point at their pages with ads on them.

But when you evaluate their business using the principles of information economics[1] you see that they do have costs and their core product's value is eroding.

To understand that statement, you have to ask "what does Google actually sell to advertisers?" An 'ad unit' or an 'ad word' is the name but what is it really? My claim is that what they really sell is a piece of very valuable information that is hard to get. They sell "this person has just looked for this good or service, now who wants to respond?" They create that information by providing a portal that people can write in a question.

This "solves" for advertisers their biggest ask, that a consumer looks at their advertisement exactly when they need the good or service that advertisement is promoting. You can put an ad for a sports car in a magazine about cars, you can put an ad for a sports car on a television show about cars, but that pales in comparison to the idea of putting your ad for a sports car in front of someone who has just asked "What's the best sports car?".

I think that it is pretty easy to see the value there to advertisers, they would rather spend money advertising to people looking for their products then advertising to everyone and hoping that some of them want their products. What is more is that it works well and that is why it has become a major force in advertising. It is also an interesting measure of the value too advertisers.

Advertisers will constantly evaluate what it costs to advertise against product sales or market penetration or market visibility. They have a limited budget to spend and they want to make it count. That sets up the traditional economic forces which demands they allocate their ad spend capital wisely to get the most impact. Google, unlike a television network or magazine, brought into wide use the notion of an auction that happens at the decision point, between potential advertisers on what they would pay to have their ad shown, and where it would be shown, in the search results for a given query. In an information economic sense this gives us the fundamental value of the information that Google sells.

The key being that all of the knobs that Google has at its disposal will eventually be turned to their maximum point, and if CPC keeps falling their profit margin will too. Because Microsoft's CPC number is going up their margins will continue to increase. At Google's current rates they will eventually be buying so much traffic and putting so many ad slots on their own sites that non-"free" services will appeal to more and more people which reduces the number of eye-balls on a Google ad which reduces its value to advertisers still further. If Google reaches the point where they are no longer able to adjust their traffic mix to achieve their numbers, they will be in a very tight spot.

[1] The "goods economy" is the system of directing capital into the production of goods. The "information economy" is the system of directing capital toward the disclosure of information.

[MarkMc]

I agree with your analysis that Google basically sells "this person has just looked for this good or service, now who wants to respond?". But you seem to be ignoring the large, persistent information advantage that Google has over Bing.

Consider 3 scenarios:

1. Person A just searched for "What's the best sports car?".

2. Person B just searched for "What's the best sports car?". He's a 45-year old man who works for an insurance company in New York. He has a wife and three kids, but he recently started seeing a 28-year-old psychology grad student in Chicago twice a month. Two years ago he bought a $6,000 watch for his wife's birthday.

3. Person C just searched for "What's the best sports car?". He's a 23-year old man who lives with his parents and does not have a wife or girlfriend. He works for Walmart and has just been promoted to manager. Nine months ago his friend bought a Subaru WRX.

Now consider what types of advertisers will bid for each search. And perhaps more importantly, what types of ads and landing pages will be offered for each search. Clearly, having detailed personal information is a significant advantage when deciding which ads to show to a user. Google has that advantage and doesn't look like giving it up any time soon.

However, I can think of two pieces of evidence against this argument: (1) Bing was able to outbid Google to be the default search engine on Firefox; (2) Outbrain and Taboola regularly outbid Google AdSense to advertise on Time, Forbes, Bloomberg, etc. In both of these cases I would have expected Google to prevail, so perhaps Google's personal-information advantage is not as strong as I think. Or perhaps Google isn't taking full advantage it.

[ChuckMcM]

I don't disagree, but consider that person B is a 45 year old man working for an insurance company he is probably running Windows 10, and Microsoft knows quite a bit about him.

My point is that in my opinion you are over valuing Google's user information advantage. Most purchasing and buying habit information is collected using web page based analytics to an advertiser rather than coming from Google directly.

When Blekko was operating at a consumer search engine we got a great inside look at what tools advertisers have at their disposal to "qualify" their ad bids. If you send the query's source IP to the ad network when you request an ad they match that up with all sorts of cookies and beacons that have fired off that IP address. None of that comes from Google, it comes from all the trackers that are running all over the Internet.

[MarkMc]

Yes, I could be overvaluing Google's access to all that personal data - particularly since I own shares in Google.

I wonder if there is some concrete way to measure that value. For example, imagine if we could find the "revenue per US user per month" for Bing and Google Search (ie. the search engine part of Google). Would that say anything about the value of personal data?

[yuhong]

>The key being that all of the knobs that Google has at its disposal will eventually be turned to their maximum point

I wonder what this would exactly look like. As a side note, I wonder what would happen if for example an economic collapse happened and Google's ad revenue was significantly reduced.

[ChuckMcM]

I see early signs of knobs at the extreme in the news, harder to get projects approved, people being told they can't do 20% projects any more, groups losing people that don't get replaced, web properties that are hard to monetize (I'm looking at you finance.google.com) getting starved.

I would expect that once a quarter there is a meeting which goes like this, "Ok folks our profit margin is going to be 22% and our revenue is $xxx. That leave $yy in expense we have to get rid off or revenue we have to develop. Who wants to go first?" We've seen both efforts on the outside, more adds on search pages, pay to be in the 'Google Shopping' bar, Etc. for revenue enhancement, and cancelling things like Reader, Wallet, Glass, and other projects or ideas that haven't added to the bottom line. You can see the moves in Youtube (the latest being you can't keep a video running in the background tab unless you have "Youtube Red" as an example) to either get profitable or die.

As for cash flow? I can tell you that I was there when the Mortgage Crisis hit and it scared the crap out of them. That crisis killed TechStops[1] and that did way more damage than the financial crisis did.

[1] Techstops were Google's tech help on demand group that, when they were employees, was a really awesome service. When it got switched to a vendor it really lost its utility.

[gniv]

> This is reflected in Google's financials as a falling 'cost per click' (what Google gets for an ad click).

But what is not known is the cost of a _similar_ click. Since the number of clicks increases dramatically quarter over quarter, it could be that it's the new clicks that are bringing the cost down.

[spydum]

Chuck, just want to say your detail and insightful comments are a tremendous asset to the community!

I do have to disagree though: MSFT has office and windows as major cash cows, maybe azure will also start turning some big profit in 2017 as well (tbd). So they can afford those r&d style projects without nearly as much risk as "Alphabet". I do agree with your assessment of goog though: the heat is turning up and I don't doubt belt tightening is their future.

[ChuckMcM]

I agree, Google really needs their version of 'office' or to make their cloud offering competitive in order to survive long term. I see them trying to extract more and more revenue from Android as one of their strategies.