Silicon Valley Watcher - Former FT journalist Tom Foremski reporting from the intersection of technology and media

Is This GOOG's Mammoth Conflict Of Interest?

Posted by Tom Foremski - May 6, 2007

Over on New Rules Communications I was writing about Google's ad networks and the bad economics for media companies. 

Link to: This Is Why Online Ad Nets Can't Save Media Companies

I noticed that there is an interesting conflict of interest emerging at the heart of Google's business model.

Please check my reasoning:

Google makes almost all of its revenues from two ad networks:

-AdWords: Customers advertise on Google web sites.

-AdSense: Customers advertise on Google partner sites, which includes many media companies.

Google's revenue in 2004 was about evenly split between AdWords and AdSense.

Since then, Google's revenue from its own sites has grown by 24 percent to 62 percent of total revenues. AdSense has fallen.

And this makes sense because Google makes far more money from its own sites than from partner sites. It is better for Google's shareholders that it channel more of its revenues through its own sites because:

-Google gives back about 80 per cent of AdSense revenues to its partners.

-It keeps all of its AdWords money.

And this is where it has a mammoth conflict of interest:

Which advertising network should Google invest in?

-A dollar invested in its AdWords produces far more profit than invested in AdSense, its partner network. Management has a fiduciary duty to its shareholders to maximize profits.

-Google can boost overall profits by undercutting AdSense at anytime it wants, say  by offering a discount on AdWords compared with AdSense. A 20 percent discount on AdWords would make more money for Google than the corresponding loss of business through AdSense partners.

-Google can undercut AdSense in other ways, and is already doing it, by investing in technology that improves AdWords conversions over AdSense. Google can apply technologies to its own sites that make them more efficient at selling ads. It can't do that with partner sites. And partner sites don't have the resources to improve their advertising conversions at a similar pace.

Which means AdSense revenues for media companies will continue to fall because AdWords is more efficient.

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Media companies that partner with Google in its AdSense program do it because they don't know what else to do. The economics of partnering with Google are poor and the relationship is unsustainable because of the inherent conflict of interest.

Why Would GOOG Maintain AdSense?

-There are strategic purposes, it forces media companies in its network to compete with its far more profitable business model which weakens them as potential competitors.

-Also, it keeps third-party sites out of rival ad networks.

-AdSense is a great "cookie jar" because if GOOG ever needs to meet its numbers for its quarter, it can push more ads through its own sites rather than through partners.

UPDATE: Independent Advertising Network Advantage 

Independent advertising networks, which don't compete with their publisher partners, such as Blue Lithium, Federated Media, and others, will be able to attract partner sites away from Google because they can invest in technologies to improve revenues for the entire network.

But how much freedom do large publishers have in leaving the Google network? Some have contracts with Google that could tie their hands for years.

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