How Google Is Building Its Empire

By Vladimir Zernov – May 22, 2013 | Tickers: BIDU, GOOG, MSFT, YHOO, YNDX | 0 Comments

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Vladimir is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

While a lot of people are excited about the Google Glass project, it would not be a major game changer from a financial point of view, at least for the short-term. Google (NASDAQ: GOOG) is an advertising company. According to its latest earnings report, the company gets 92.7% of its revenue from its core advertising business. Google officials like to talk about their most recent and innovative products, but advertising stays the most important part of the mix.

There are two ways that you can see Google ads. You can use Google’s search or you can visit a site that is part of the Google Network and see the ad displayed. Google dominates the search market in most countries of the world. Google holds a 83.04% world search market share as of April 2013. Yahoo! (NASDAQ: YHOO) and Microsoft‘s (NASDAQ: MSFT) Bing are far behind with 7.88% and 5.16% market shares, respectively. Google loses on just two significant individual markets. In Russia, Yandex (NASDAQ: YNDX) holds a 61.9% share. China’s Baidu (NASDAQ: BIDU) dominates the search market with an 80% share.

Controlling what you see

Modern life is highly dependent on information. People typing their search queries are seeking for some information. There is more than 80% chance that they would be searching for it using Google search. The organic search results that they would get are determined by Google’s algorithms. Through those algorithms, Google controls which content would meet which query. Google states that it is working hard to improve user experience.

It means that it tries to deliver results that are meaningful to the end user. Nobody wants to click on a search result and be taken to a site with no useful information. Therefore, Google makes it harder to shortcut your way to its first page. It all looks perfectly good. You get the information you want, best sites that deliver the best content are rewarded.

However, I want you to look at this from another perspective. Google does a tremendous job to shift public attention from its advertising business. You use Gmail, Google Maps, watch YouTube videos, and upload files to Google Drive. You use all this for free. Google is not a charity, it is a successfully run business. In most countries, Google has an almost monopoly on information.

The difference between the first page and the second page in the search results is the difference between success and failure for most businesses. As I mentioned above, Google makes it harder for a site to rank from scratch. They tell you they do it for the better user experience, but I think the reason is more pragmatic: they want businesses to purchase ads.

Getting to the first page of Google search results

Nowadays, you can’t go to a link farm to purchase links that would help rank your site well. Some people still do it, but their sites get penalized and their rankings vanish. The days where you could stiff your pages with keywords and succeed are long gone. Businesses need to have a whole army of specialists to help their sites rank well. Google loves good original content, so you need to hire writers. Google loves social media links, so you need people to do social media marketing. Google loves good site architecture, so SEO people are necessary as well.

When you look at this process from a business perspective, you would see that these are all costs. These are costs that would last over a significant amount of time, and it’s hard to predict the end result. Looks overwhelming, doesn’t it?

To light up the game, Google comes in with algorithm updates. Those updates can severely affect site rankings. The next version of the famous Penguin update, which has initially hurt a lot of sites, good and bad, would be released this month. Of course, Google does not disclose what exactly these updates do. They do not want people to try and game the system. These updates make some sites change something, and this adds to costs and uncertainty.

Making businesses pay more

Google has a solution to all these problems. All you need is to launch a PPC (pay-per-click) campaign. You are now in control of your costs and you can see exact conversion rates. Google’s platform for launching PPC campaigns is called Google AdWords. Google decides whether to show your ad or not based on an auction. You can compete on price and quality. The price part of equation is easy to understand — you can bet more or less for each click.

Quality is a source of an endless debate. Google assigns a quality score to each keyword once the campaign has been created. The exact formula of the quality score is not disclosed. Quality scores for different keywords do change. Sometimes, they change throughout the day. The less your quality score, the more you would have to bet to get your ad published.

If you are an advertiser and call Google AdWords support, they would tell you that the CTR (click-through-rate) influences the quality score. The premise is simple: the bigger the percentage of people that click on your ad, the better your ad might be. CTR typically decreases when your ad is displayed lower. Guess what — it hurts your quality score and makes your ad be displayed even lower. Remember, you have two main variables to deal with: quality score and your bet. You already know the simple solution — bet more.

On its earnings call, Google stated that the aggregate paid click growth was up 20% year-over-year and 3% quarter-over-quarter. The aggregate cost-per-click was down 4% year-over-year. The drop of the CPC happened because of the rise in mobile advertising. Currently, mobile ads cost less than desktop ones. The key word here is “currently”. I believe the costs of mobile advertising would rise through the same mechanism as I described above.

What is the competition doing?

Yahoo! is also dependent on advertising. However, it relies on a different strategy. The company uses its own services to display ads. Its latest move is the acquisition of Tumblr, a blogging site. This strategy seems to be working fairly well for Yahoo!. There is one major difference between Yahoo! ads and Google ads. When users type queries on Google, they are in a search mode. They get relevant results. When users visit Yahoo! services, they are more relaxed. I think that Yahoo!’s strategy has its limitation and does not present danger for Google’s position.

Microsoft’ strategy for Bing is typical for the company. The software giant is repeating its Internet Explorer maneuver. You get Bing when you get Windows 8. Of course, you can choose your search in properties, but how many people actually do that? Bing is highly dependent on the success or failure of Microsoft’s latest operating system.

Yandex is a Russian mix of Google and Yahoo!. It actually has two sites. One of the sites is a full Yahoo!-type portal, the other is Google-type search bar. Yandex sells contextual ads that are shown on its search results pages. It also operates an advertising network. Yandex is limited to Russian-speaking countries.

China is an enormous market with big opportunities. It is dominated by Baidu. Baidu is a Yahoo!-type portal with lots of services. Baidu was slow in implementing mobile apps and ads, but it is gaining steam on this front. Baidu sells both contextual ads and display ads. It would be hard for Google to get more share in the Chinese market because there are significant barriers for that.

Bottom line

I think that Google is doing everything to turn into an information monopoly. The company strives to have the power to influence both the need of advertising and the advertising rates. This is bullish for the stock. I’d be a buyer when the pullback occurs.

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Baidu, Google, and Yandex. The Motley Fool owns shares of Baidu, Google, and Microsoft.