Blue Nile Disses Search; Evidence Mounting

Jeff Matthews has an excellent post on Blue Nile's Q4 comments about irrational search pricing.  Like FTD, Blue Nile missed Q4 and blamed keyword price spikes.  Also like FTD, Blue Nile plans to shift marketing dollars offline.

Yes, this is anecdotal.  Yes, it's just one vertical (make that two).  Yes, we've heard anecdotal reports of irrational keyword pricing for 18 months.  Yes, there will always be naysayers, and, no, this doesn't prove anything.  But even Google fanatics will surely agree that it's hard to spin it as positive (except for the near term--see below).

As Matthews points out, moreover, for at least one search customer, it suggests a fundamental and profound shift in search trends.  Blue Nile CEO Mark Vadon didn't say "We've always thought search was overrated.  We've always thought prices were too high."  He said (effectively): "Until now, we have advertised almost exclusively through search because it was the most cost-effective vehicle around.  Now, prices have increased so much that it's no longer cost effective.  So we're going to be pulling our search dollars and spending them elsewhere."

Two key points:

First, assuming the conditions Vadon describes apply to more than Blue Nile and FTD, this is good for Google in the short-term.  What it means is that Google's recent (and, perhaps, current) results have been inflated by an influx of irrational keyword bidders, which has driven up both revenue and profits.  This suggests that Google's recent results--like those of most online advertising companies in 1999--have been better than they would have been in a more rational environment (including the disappointing revenue growth of Q4).  It also suggests that, when the fever subsides, Google's results will return to trend--again like those of most online advertising companies from 2000-2004--as many of the irrational bidders irrationally bid themselves out of existence. Because investors almost always extrapolate future expectations from recent results, moreover, this means that expectations for the next few quarters could still be too high.

Second, we will never have proof that keyword prices are topping out (or, worse, have overshot) until it's too late.  Unfortunately, until the uncertain present has become the always-obvious past, all you get are data points.  So suffice it to say that, if keyword prices have overshot, what we are seeing is exactly what we might expect to be seeing: Anecdotal evidence and plummeting stock prices (someone always knows--just not you)

Thanks to an IO reader for the tip...

Comments

[Victor]

Hi Henry, I think your posts on click overpricing and click fraud are pretty weak. The main strength of search advertising is that the results are completely measurable. If you're not getting positive return on investment, then yes, stop buying ads. However, most people who've used search ads realize they're still getting huge return on the investment they're making, and they've directly measured this. Buyers of ads in the market obviously have incentive to talk about a bubble in ad prices because they want to scare other bidders off. Fewer bidders means cheaper ads for them.

[B]

Seems like today I am filling up a few blogs due to a little boredom today. Henry, I wonder what your bottom line perspective of Google would be. Didn't you post on here some time back that you could see Google at $100 or something along those lines.

You know, mean reversion is usually reflected in stock prices. And, if you do a regression analysis on Yahoo or simply do some basic technical analysis, I believe there is a very realistic price target of $19 if we have a reasonable correcton this year. Business fundamentals returning to the mean ......... took Yahoo to $4 a share in '02. What scares me is no one could ever believe Google could actually go to $100 or less. To paraphrase comments by a past great economist, times of stability create instability. In stocks that translates into gamblers buying the dips as they are rewarded time and again until the -time no more. I believe that -time no more- could be 06 for many stocks including Google.

I posted the following perspective on another blog only to have the author remove it. Conflict of interest? I don't know but I thought it was rather tame and rather reasonable in its basis. I think Google could have a similar fate to Yahoo. Not $4 but a severe test downward. It won't happen overnight but.....

Google Commentary-
I usually live by the belief that simple reasoning wins out in the end. People make things too complicated when investing. If it's too complicated, it likely isn't something I want to invest in. There is much to like about Google but we saw during slow downs that internet companies are the first to crater.

And you know, Google doesn't really do anything very well that they are paid for. They just do it better than anyone else. So, is this a company to own for the ages? Quite possibly. But only if their brand continues to develop. That means they need to lead the way in paid search innovation amongst other endeavors they may undertake.

Then again, look at history and show me cases where brands became timeless when they did something better than anyone else but still weren't very good at it. Where customers spent a boatload of money and ultimately determined the ROI didn't exceed the hurdle rate or even didn't exist at all. I believe there is alot of experimentation in web advertising. Let's throw something against the wall and see if it sticks. And most haven't figured out how to turn that ad spending into revenue. Savvy advertisers and marketeers will eventually optimize their dollar spend around a quantified result. And when their brand becomes so pervasive in the online medium, they will likely have to advertise less and less. ie, eBay and Amazon.

This is still a very immature industry likely rife with trials and tribulations

So, is Google worth these farcical earnings estimates? Would you buy here? I'm done for the day. Have a good weekend.

[Still Inside]

(Just to show I'm not just biased against GOOG :-) ).

The problem at Blue Nile is at Blue Nile, not at GOOG. Lots of companies see real ROI with paid search, its just a matter of using the right toolset, buying the right keywords, not buying others, paying the right price at the right time, and correctly attributing the value of the marketing.

As for "keyword inflation", just like any marketplace, the "irrational" ones aren't going to be around forever. If Blue Nile thinks the price is too high for (anything), they should be happy that their competitors are obviously going to go out of business soon. If they don't, maybe he should go figure some more.

SI

[Stuart MacDonald]

I've said it and said it, and seen it coming for 3 years now. Paid search is rapidly declining as an efficient acquisition method. It just doesn't perform like it used to, which is bad, bad news for all concerned.

-- Stuart

[Victor]

Oh, one other thing. Prices are determined by an auction mechanism. I think it's a generalized vickerey auction, so it's efficient and bidders should all just bid their expected return (there's no instability by trying to outmaneuver rival bidders in vickery auctions). So while some may argue that prices are inflated, they're definitely efficient, and it's unlikely they'll suddenly collapse.

[nimitta]

I don't think bidding on keywords in Google is truthful as a generalized vickerey auciton is. Also note that the standard second price auction (a typicl exaple of gneralized vickerey auction and hence a truthful auction) is also truthful only in a single shot game, not in a repeated game.

If anyone has any details of exactly what is the auction mechanism Google uses, please let me know, but I am almost sure that we don't know of a truthful auction for the adwords problem.

The take home note is that there is an incentive to 'lie' or bid strategically to optimize your revenues. Bidding lower or higher than what the keyword is actually worth to you could be a perfectly sensible option.

[Javaflash]

Hey, SI, it's Javaflash.

I apologize for the language I used in an earlier thread. I was rude and stereotyping. So I am sorry. However, I still don't think respecting laws/institution of other nations is wrong. Paradigm shift takes time, and the process of that shift is as important as the value of freedom itself. China will get to where we are someday; we already saw how drastically they changed "internally" during the past decade. I hope we don't interfere by artificially enforcing ideologies through foreign pressures. They have to find their own sustainable understandings by themselves, despite sometimes, that means struggles or compromises. What we should do is being a proper guest, a critical neighbor, and an indirect catalyst to their change.

Best regard, :)

Javaflash

[wyler]

. . . Paid search is rapidly declining as an efficient acquisition method. It just doesn't perform like it used to . . .
Stuart, maybe you've explained this before too (and if so, please excuse me), but just curious as to what you ascribe the decline in performance to: is it all cost or are there other contributors such as the economy, jaded internet users, etc.?

[Anonymous]

This might tell an interesting story.. : http://www.hepguru.com/blog/2005/12/search-bids-home-loans-december-update.html

[anon]

Scary thoughts on Google vs. your privacy:

http://searchscandals.blogspot.com/

[aaron wall]

Almost every industry has idiot bidders. As one company goes bankrupt another jumps in line to take their place.

I think what we are seeing now is some of the businesses that were printing money because their industry was generally under served are now seeing competition join the market.

There are still many inefficiencies in the average website and PPC account.

[Tim Furey]

Blue Nile is just confirming logic -- a search lead's value is only as good as a company's ability to CONVERT the lead to revenues. Seems logical, but most company's ROI models fail to quantify lead value through actual profit dollars as determined by conversion rate, avg. transaction size, and gross margin. More rational search pricing and the move to other demand generation channels will come quickly.

[Pauley]

Has any thought about the fact that Vadon mentioned that he was exclusively using search as the only form of leads...?

I took an economics class in college, and talk about putting all your eggs in one basket.

PM

[Eleanor]

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