Internet Outsider: Will Radio, TV, and Print Save Google's Growth Rate? No.

March 29, 2007

Will Radio, TV, and Print Save Google's Growth Rate? No.

To hear people talk about Google's moves into offline media, you would think the company is on the verge of capturing all the profit in the media industry. It isn't. And not just because Google's success in its offline efforts is far from guaranteed.

The important point is that Google's radio, TV, and print initiatives are the offline equivalent of its AdSense product, not AdWords. Why is this important? Because , for every dollar of advertising spent on AdSense, Google captures only a tiny fraction of the profit that it captures for every dollar spent on AdWords. When an advertiser buys a $1 per-click AdWord keyword, Google generates $1 of revenue and about 60-70 cents of operating profit (very rough numbers). When an advertiser buys a $1 per click AdSense keyword, meanwhile, Google generates $1 of GROSS revenue but only about 40 cents of net revenue--and only about 10-20 cents of operating profit.

Google's revenue and profit share of offline advertising placements, moreover, is probably even less per dollar of gross revenue than it is for AdSense. Why? First, because Google has nowhere near the leverage in offline media that it does online. Second, Google's targeting and optimization systems are not as sophisticated offline as they are online (and won't be for the foreseeable future). Third, because a public company in a similar ad sales and placement business suggests that the margins in the automated radio and TV placement business are downright horrible, at least with limited scale.

A small company called SWMX, which just reported its Q4 results, is making good headway in generating radio and TV placement revenue through electronic marketplaces (Q4 revenue grew 58% year over year). The company is very small--only $16 million in placements and $2.5 million in revenue in 2006--but the early margin picture is not encouraging for those banking on Google's offline initiatives to save its long-term growth rate.

SWMX generated about a 50% gross margin (on net revenue) in 2006. The gross margin on its hypothetical GROSS revenue, meanwhile--the revenue stream that would be equivalent to Google's gross revenue for AdSense--was only about 10%. Again, this 10% gross margin per dollar of advertising compares to the 90% gross margin per dollar of advertising that Google generates on AdWords and the 40ish% gross margin on AdSense. SWMX's operating margin, meanwhile, is even less encouraging: The company lost $9 million last year on $2.5 million of revenue.

Would Google's offline margins be better than SWMX's? Yes, probably. Would they come close to matching the already (relatively) low margins that the company generates from AdSense? Probably not.

So how much TV, Radio, and Print spending would Google have to capture to, say, double its current operating profit? (Assuming no further growth of the online businesses, which obviously should continue to grow quite nicely). Google generated about $3.5 billion of operating profit last year. To generate this much from an offline TV, radio, and print placement business, assuming a generous 10% operating margin (very generous, I think), Google would have to place $35 billion of gross advertising. This compares to about $4 billion it generated from its wildly successful online ad rep/placement business, AdSense, in 2006.

The conclusion? It seems safe to say that, even if everything goes perfectly, it will be a while before Google's offline initiatives contribute significantly to the company's bottom line.

Posted by Henry Blodget on March 29, 2007 at 09:17 AM | Permalink

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