Threatened giant
New risks for advertising’s monster
When Larry Page and Sergey Brin were first developing their idea for a “hypertextual web search engine”, the two Stanford PhD students appeared dead-set against filling it with adverts.
“We expect that advertising-funded search engines will be inherently biased towards the advertisers and away from the needs of the consumers,” Page and Brin wrote in the 1998 paper that introduced Google. “Furthermore, advertising income often provides an incentive to provide poor quality search results.”
It didn’t take long for them to change their minds. Two years later in 2000, the fledgling search engine began offering advertisers a way to bid against certain search results, a technology it called AdWords. Honda might run adverts against searches for Toyota, or Pepsi against Coke, for example.
That idea proved so lucrative that Google rapidly grew into the world’s biggest advertising company. Last year it generated US$116 billion ($173b) from adverts, most of it still from AdWords.
This year it will account for around a third of global spending on online ads, making it more than 50 per cent bigger than its nearest competitor, Facebook.
This advertising juggernaut has been an extraordinary cash cow, helping fund a remarkable proliferation of services and products, from Google Maps and Android to outlandish projects such as Page’s investments in flying cars and efforts to find a cure for ageing. But the company’s continued ability to thrive is now being questioned. Regulators and competitors have eyed Google’s dominance for years, but are now beginning to threaten it, and advertisers are becoming wary of putting all their eggs in Google’s basket.
“It’s been a very challenging time for them, the last couple of years,” says one advertising executive who asked not to be named because of his work with the company. “In most advertisers there’s a real belief they’ve been too dependent on Google and it’s not helpful. They’re saying diversification is a good thing; they’re looking for substitutes.”
Google has been buffeted by a string of problems in the past year, from internal protests over its record on diversity and contracts with the military, to criticism of how it polices material on YouTube, the giant video sharing site it owns. This month Donald Trump said he would “look into” unsubstantiated claims made by Peter Thiel, a Silicon Valley veteran, that it has been infiltrated by Chinese spies.
This is not unusual: Google has often been a lightning rod for criticism. What is more likely to worry investors and executives is the prospect that these issues could lead to a slowdown in the core advertising business on which it depends.
Until now, Google’s advertising business and its central search engine have proven remarkably resilient over two decades.
As dial-up line modems made way for high-speed broadband connections and then smartphones, a shift that has rendered many once-powerful internet companies obsolete, Google has only become stronger, controlling the Android operating system used on four in five smartphones. We still look for information by typing questions into a search box, dozens of times a day, and advertisers continue to spend billions to appear in the results.
Since the company floated on the Nasdaq in 2004, its shares have increased 20-fold and its growth has been exceptionally reliable. The company has never once reported a decline in revenue, even during the throes of the financial crisis.
Even among the tech giants, which have delivered enormous returns in the past decade, Google’s parent company Alphabet is uniquely revered on Wall Street. Of the 44 financial analysts who cover the company, not one recommends selling its shares; 37 have given it “buy” ratings.
But cracks have appeared in this picture lately. In April the company disappointed investors by missing expectations for revenue and profit for
the first three months of the year. The following day shares fell by 7.5 per cent, the company’s worst single day on the stock market for more than six years.
This morning (NZ time), the company will publish financial results for the three months to the end of June, revealing whether the disappointing first quarter was a mere blip or the start of something bigger. In recent weeks analysts have suggested it could be the latter by cutting forecasts, if only marginally. Royal Bank of Canada said this month that revenue growth in the quarter would fall from 26 per cent to 16 per cent. Morgan Stanley last week knocked 2 per cent off annual revenue forecasts.
According to eMarketer, which tracks advertising spending, Google’s share of online advertising in the US will drop to 36 per cent this year, the fourth consecutive decline. Advertising revenue growth will fall from nearly 19 per cent to 16 per cent last year, the slowest in years. Research firm Enders Analysis believes the same pattern is appearing in the United Kingdom.
So far this year, Alphabet shares have climbed 10 per cent, but this is half the pace of the wider Nasdaq.
These are hardly catastrophic figures, but they are worse than the ones expected just a few months ago. Advertising executives say part of the reason for Google’s slowdown is the rapid emergence of new competition. Google may have more than 90 per cent of the world’s internet searches,
In most advertisers there’s a real belief they’ve been too dependent on Google and it’s not helpful. Anonymous advertising executive
but the advertisers who pay the company have an ever-expanding choice when it comes to spending their budgets.
Despite Facebook’s own high-profile problems, the company’s advertising business continues to flourish, particularly on its Instagram network. A resurgent Snapchat and Twitter, and the viral sensation TikTok, are also growing strongly.
But it is Amazon that most troubles Google. Jeff Bezos’ retail empire is not known for doing things by half, and is throwing resources at its advertising business, in which sellers pay for prime slots within Amazon search results.
“Google has been falling in share since 2016, and that’s something that’s really happened because of competi
tion,” says Monica Peart, eMarketer’s forecasting director.
Peart says that Amazon represents a particular challenge to Google. While the two are ostensibly in different businesses, many shoppers use them in the same way: as places to find a product. One survey last year found that 54 per cent of searches for products in the US started on Amazon, up from 46 per cent in 2015. Amazon may not be able to answer questions in the same way as the search engine can, but to the shoppers that advertisers are desperate to target, it is a direct alternative.
“People are searching with Amazon and starting with it as their search portal,” says Peart. She forecasts that the company’s share of US advertising will climb to almost 10 per cent next year, much of it coming out of Google’s pocket.
Google’s own search business, which still makes up the majority of its revenue, has other clouds hanging over it. The company defied expectations that search revenue would suffer as internet users moved from computers to smaller-screened smartphones, simply by moving adverts from the side of the page to the top.
However, the next paradigm shift in search engines will be more difficult to navigate.
Smart speakers and internetconnected earphones, so-called “ambient devices”, are triggering a boom in voice recognition assistants, which can answer questions without having to resort to using a keyboard. Every voice request is one less sentence typed into Google, and although the company has its own voice assistant, it is unclear how it expects to make money from it.
“The more devices that are ambient or invisible, the opportunity for them to sell lots of search ads diminishes,” says Jim Cridlin, the head of innovation at Mindshare, a division of advertising giant WPP. He says Google is testing adverts against voice searches, but that it is far from clear if they will be successful. “There isn’t the same opportunity with voice,” Cridlin says. Another advertising boss puts it more bluntly. “Voice searches must scare the s*** out of them,” he says. Google has attempted to seek new sources of revenue as its search engine slows. In 2015 it restructured under the Alphabet umbrella, separating Google from its expensive “Moon shot” companies such as Sidewalk Labs, a project to create smart cities, and Waymo, its driverless car arm. Page and Brin handed responsibility for running Google to Sundar Pichai, a reliable operator.
But these “other bets” remain just that. In the first three months of the year they took in just US$170 million in revenue, less than half of 1 per cent of Google’s, and lost US$868m. Other businesses within Google are more promising, but the jury remains out on them. YouTube, its video site, brought in an estimated US$4.6b in revenue last year, but carries enormous IT costs. The site has also come under nearconstant criticism for failing to crack down on harassment and extremism, forcing Google to hire thousands of moderators and introduce stricter advertising requirements after many big brands threatened to walk away from it. Alphabet has refused to reveal YouTube’s financials or even say if it is profitable, leading analysts to speculate that its cultural impact has not been matched financially. Google has tried to branch out from advertising altogether, introducing a line of smartphones and other hardware as well as a cloud computing division to challenge Amazon’s fabulously profitable Amazon Web Services unit. But growth has been too slow to dislodge advertising, which still makes up 85 per cent of Google’s total revenue, meaning the company is likely to remain reliant on it for the foreseeable future.
Perhaps the biggest threat to the advertising behemoth, however, is that frequent questions about its power mean it takes its eye off the ball. Google has so far brushed off the billions in antitrust fines levied by the European Commission, but growing scrutiny at home may prove more troublesome. The US Department of Justice is understood to be exploring a competition investigation against the company, two decades after a high profile case against Microsoft that many believe set the company back years. Microsoft, too, once seemed untouchable.
Google has been falling in share since 2016, and that’s something that’s really happened because of competition. Monica Peart, eMarketer