Google: Analyzing Potential Print/Radio Profit

With the acquisition of radio-ad placement firm dMarc and the expansion of its print-ad initiative by another 30 publications, Google appears to be moving rapidly toward providing a "dashboard" capability through which advertisers can buy, place, and manage campaigns over multiple media.  As discussed here, this seems a strong step toward world domination, and, indeed, if the company can extend this capability to encompass most media, it will enjoy even more extraordinary leverage over global media and advertising activities than than it already has.

This said, it would be easy to overestimate the near-term impact of such initiatives on the company's cash flow.  The radio and print placement businesses are more akin to Google Networks revenue than Google Sites revenue (Google will be selling ads on other companies' properties, and, like AdSense partners, the radio and print partners will likely keep at least 70%-80% of the revenue).  Although Google Networks currently contributes 42% of Google's overall revenue, it only contributes 13% of net revenue and, therefore, an estimated 13% of cash flow.  Put differently, each $1 of Google Networks revenue is worth approximately 1/7th as much as each $1 of Google Sites revenue.

Looked at still differently, if we assume that Google's operating expenses are allocated on a pro-rata basis between Google Networks and Google Sites revenue (13% to Networks and 87% to Sites), we can estimate that Sites revenue generated a 50% operating margin in Q4, whereas Networks revenue generated an 11% operating margin.  Google's operating margin on its radio and print placements probably won't be exactly the same as its margin on its Networks business, but, if anything, it will probably be lower (less scale, less synergy, different cost base, higher technology development costs per revenue-dollar, etc.).  Let's assume, however, that Google generates exactly the same margin in the radio/print business as it does in Google Networks.

At an 11% operating margin, for Google to generate an incremental 10% of operating profit per year from its new radio and print business ($260 million, if we annualize Q4 operating profit), it would need to generate an estimated $2.4 billion of radio/print revenue per year (more if the operating margin is actually lower, which it probably is).  To put this in perspective, this is closing in on as much revenue as Google currently generates in its Networks business ($3.2 billion annualized) after several years of growth with a dominant industry position.  It is also approximately a quarter as much revenue as Time Warner (print) and Clear Channel (radio) generate in their print and radio businesses combined, after more than half a century of growth.

Moreover, because Google's print and radio placement businesses will, presumably, operate largely within the U.S. for the foreseeable future, Google's tax rate on its radio and print profit could be slightly higher than that for much of its Networks business, some of which operates though Google's tax-gold-mine Ireland subsidiary (remember the tax-rate issue in Q4).  This suggests that Google free cash flow margin on the radio and print business will be marginally less than that for Networks, even if the operating profit is comparable.

None of this is to say that Google isn't making a smart strategic move by pursuing the dashboard strategy--it is.  And none of this is to say that Google won't eventually become a "must buy" for every advertiser who ever plans to advertise anywhere--it might.  And none of this is to say that radio, print, et. al, don't give the company access to some honking new sources of revenue dollars.  It is to say, however, that Google is already so huge that its new radio and print initiatives, like many of its other non-search product initiatives, are not likely to contribute meaningfully to free cash flow anytime soon.

Comments

[Still Inside]

Henry: Great observations RE GOOG's margins in businesses other than their direct site.

It adds to my overall point that the direction of GOOG's margins is NOT that of a tech company (MSFT/40%, INTC/31%, ORCL/34%, etc.) but rather like a media company (DIS: 13%, CCO: 13%, CCU: 21%, TWX: 17%, etc.).

In other words, GOOG is NOT in the business of selling products that are not easily duplicated and thus resistant to competitive cost pressure (MSFT, INTC, ORCL...), but are instead heading straight for low-margin hell (TWX, DIS, CCO, etc.).

GOOG's reliance on the internet and pure technology is only going to accelerate the speed at which customers can switch as it will make it easier for others to "clone" them. It will deepen the effect on margins as well.

This also lends credibility to the idea that the management at GOOG is NOT in it for the long term (as if the sale of $10B in stock were not enough).

SI

[mr fuckedgoogle]

your figures seem to imply that Google makes only 14% as much per click on partner websites as it does on its own search engine results page.

That is an astounding figure- and it implies that REFUNDED clickfraud is approaching 80% of total revenue on partner sites.

That's pretty amazing. How long until it reaches 100%?

The porn website industry tried pay-per-click back in 1999, and eventually collapsed under massive automated fraud. It appears the same thing is happening with Google and its adsense program.

Which explains their mad dash into any and every possibly business arena they can find.

[Henry Blodget]

I don't follow the logic on the clickfraud refunds. The reason Google only makes about 1/7th as much per click on partner web sites as it does on its own web site is that the revenue splits send approximately 80% of the revenue-per-click back to the partner. I don't know how the company accounts for click-fraud refunds--it's a good question, and one I'd like to know the answer to--but the basic revenue splits don't have anything to do with click fraud.

The click-fraud refund accounting is probably either netted against revenue (i.e., the revenue line is reduced to accouunt for it) or run through "other cost of revenues". I suppose it could also be in TAC. Regardless, it would result in a lower gross margin than the company would achieve without it.

Following this logic, if click fraud refunds are rising quickly, the gross margin on Networks should be dropping. As yet, this is not happening.

[Robert]

Common sense, please. Everyone has written that Google must expand their product offerings
past search. Now that Google has alternate revenue streams, you write that the net margins are
not the same as Google sites. While every company would love margins
to be the same as their flagship product, but at least Google keeps offering new products seemingly on a daily basis.
The reason Google is such a fabulous, one of a kind company, is that they are hiring THE
best software engineers in the world. And they offer every engineer a day a week, 20 % per
cent of their time, to work on prjects of their own choosing. Who can guess what they are working on? For a 7 year old company to have offered, search and now many many other new products we all use every day is nothing short of phenomonal........pleasse use some common sense and just accumulate the stock. Let them do thoeir job. Please don't be so short-sighted. They have been public for 18 months and the stock, in a lousy market, has gone from, you all know, 85 to 376. So it had a pullback. Big deal. Paraphrasing Marty Zweig, don't fight the trend. It is up, way up. This pullback from 475 to 337, now 375 is only about 20 % for a stock which had quadrupled plus. The weak holders like some who have written herewith have been shaken out----again.
Buy the engineers. Buy their track record. Just wait until they enter the S & P 500.

[mr fuckedgoogle]

Henry, the gross margin on Networks can remain constant since Google chooses exactly how much it pays out to publishers per click- that number can be widely variable from month to month. This of course is really hard to keep track of, since discussing nearly anything like it is against Google's TOS for adsense and adwords customers.

Brokering ads on webpages appears to be the only business in the world where you can sell a service (providing google with adspace on a website), and then AFTERWARDS they decide how much you should get paid for it. You could have the exact same traffic numbers, or clickthroughs, but the payout can arbitrarily change at google's whim.

Is there any other business on earth where the purchaser of a product gets to decide how much he'll pay for it, AFTER he has taken possession of it?

Hint- this is power that only a monopoly can wield. For small websites, Google still maintains basically a 100% marketshare. (excluding adbrite and the ad networks designed for scam artists)

[mr fuckedgoogle]

Buy their engineers? For what? Most of the freeware stuff they produce is CRAP.

Let's review:

Google video=complete and utter crap

Google desktop=useless crap

Google Earth = not written by Google engineers, but rather purchased from a company called Keyhole who wrote it 5 years ago

Google Maps = not written by Google engineers, but purchased also

Google Talk = completely worthless

Picassa = not written by Google engineers, but purchased

Google Toolbar = nothing that hasnt been around since 1996 from dozens of other companies as an add-on

Google Webpage Composer = Wow! Geocities 2.0! How revolutionary!

Google Pack = bunch of freeware in a single download, including the spyware laden Real Player.

The very fact that YOU think releasing freeware widgets every other day is amazing is exactly why they're doing it- to keep suckers like you thinking "oh my god, how cool are they? what will they think of next? i should assign a much higher multiple to their stock because obviously some of these other freeware widgets are going to make them a ton of money, some day!"

No, they wont. Google makes 99.9999% of their revenue from tiny little text ads. That's the only thing they have proven they're good at. Google isn't a software company, they're an advertising company.

[Still Inside]

FG:

1. GOOG does not have a monopoly on anything. They wish. They might have a big market share right now (its nowhere near 100% with folks like Quigo and, ahem, MSFT and YHOO competing with them), but its not a "structural lock-in" like MSFT, INTC, ORCL, CSCO, etc. have over their customers. Given a lower price for a similar product, GOOGs customer can leave whenever they want to.

2. Some of GOOG's products are outstanding, and you need to give them credit for it even if it seemed like dumb luck. The original search engine site was not "cluttered" because that's all they had to offer. It was a hit, and they were smart enough to realize that. However, GMail is the best out there (again, not hard to reproduce, but it IS the best right now). As for the aquisitions, the competence is still there: the management made some good decisions there, and turned those into products (not easy), so good for them.

It might be that GOOG's engineers ARE very good.

Two points on that:

1. GOOG does not have a monopoly on good engineers. MSFT has been consistently producing software for 20 years, and when it had to be, it was brilliant (see: the browser wars). YHOO and a cast of thousands of start-ups can/do hire brilliant engineers too.

2. Technology isn't everything. Schmidt came from SUNW, for instance, where they had great technology and talent and they still got crushed. There are a lot of great ideas and great technologies: the hard part is picking the right ones. And just saying, "we're going to do everything all at once" doesn't work. There are thousands of start-ups that replicate that. The only difference is that the brilliant engineers in those companies aren't sitting on underwater options.

SI

[Jeremy Johnson]

I don't agree that GMail is hands down the best out there. I was one of those people that paid $50 to get one of the first GMail addresses (then made about $100 selling my invitations), so I have used it from very early on. The search feature is nice, but other than that it is just email. I tend to use my Yahoo address these days more often, because I like the Yahoo portal.

My Gmail account gets spammed to no end as well, and I have never used it for a registration outside of the financial institutions, Amazon, etc.

[Jay]

Robert:
You are crazy, and wrong. google does not run its adwords business in the manner you suggest (i.e. some new form of social experiment). Nor have any of their products post ad-sense demonstrated *any* real potential as a business. Meg's quote in Business 2.0 gets its right.