Internet Outsider

As Goes the Housing Market, So Goes Advertising

Well, okay, that's a stretch, but the link between the prognosis for the housing market and the economy seems strong (as goes housing, so goes the economy), and when the economy stumbles, advertising is often the first expense to get cut.

In 2000, I shudder to recall, advertising-driven companies (on and offline) were the first to crater, and they were followed shortly thereafter by all manner of other industries, like dominoes.  Some will undoubtedly argue that, even if there is a recession, Google and Yahoo will be fine, because search and other forms of pay-per-event advertising have a crystal clear ROI.  These bulls will point to the success of GoTo (Overture/Yahoo Search) during the last recession as evidence: While the rest of the online world as we knew it was ending, GoTo grew like a weed. 

And to some extent, this is true.  Search should weather an economic storm better than other forms of advertising, because even penny-pinched advertisers will know where each search dollar is going.  But weathering the storm is different than being "fine", and some Google and Yahoo customers will cut back (if only because their customers are cutting back).  Also, when GoTo was powering through the last recession, search was a cute little $100 million business.  It is now approaching a $10 billion business, and, as such, is far more exposed to the vicissitudes of the economy at large. 

So as the housing market continues to weaken, do not make the mistake of thinking that this is an isolated micro-event that is irrelevant to the big boys of online advertising.  It isn't, and like the rest of us, Google and Yahoo will probably feel the pain.

Ballmer Gets Checkbook, Vows Billions for MSN

Per the WSJ, Steve Ballmer announced that Microsoft will radically increase spending on its online business to keep pace with Google and Yahoo:

[Ballmer] said the spending would include $1.1 billion in 2007 on its MSN online business, compared with $500 million in 2005. "We will invest as much on this online opportunity as any of the other bigger players in the market," Mr. Ballmer told about 700 advertising executives [at a big shindig in Seattle].  A report from Reuters adds that the aforementioned $1.1 billion will be for R&D spending and that the company will up MSN's CAPEX from $100 million to $500 million.

Well, good, then we don't have to write off Microsoft in the online business just yet.  Alas, if Steve thinks keeping pace with Google is only going to cost this much, he's a tad out of date.  Google will likely spend CAPEX of $1.5-$1.7 billion this year, versus Steve's $500 million, to say nothing of next year.  As for R&D, meanwhile, Google exited Q1 on a run-rate of $1 billion, up more than 100% year-over-year.  Google's R&D spending for Q306-Q307, therefore, will probably be closer to $2 billion.  Microsoft's newfound commitment--which will probabably generate significant divisional losses--might allow it to keep pace with Yahoo's spending, but Google's should still leave it in the dust.

The WSJ adds that Ballmer said Microsoft was "impatient and determined" to play a bigger role in the online advertising market.  Again, good.  The only chance Microsoft has is if it is humiliated and pissed off.  Even then, I think the chance of real success is small, but absent this passion, it would be zero.

[Updated after original post to add data from Reuters.]

So, How's adCenter?

As the WSJ describes, Microsoft's adCenter debuts this week, when it is opened to all advertisers instead of just the 6,000 in the pilot program.  adCenter is critical to MSN's future and critical to the industry's future, as it will determine whether the search industry will continue to be a duopoly or will move to a more normal structure dominated by a "big three." 

Advertisers want the service to succeed, so they will have options other than Google.  Microsoft needs the service to succeed, or any remaining chance it has to gain ground in the search business will be lost.  And whether or not the service succeeds is a critical question for Google, Yahoo, and both companies' shareholders. 

If it is true that Google generates 50% more revenue per query than Yahoo! (and more than 50% more than Microsoft), and if it is true that a major reason for this is Google's ad-selection algorithms, then a successful adCenter could have a meaningful impact on not only industry revenue share but Google and Yahoo's growth rates. 

Revenue to the search engines equates to spending by advertisers, so every dollar spent on Yahoo and Microsoft is a dollar that won't be spent on Google.  Microsoft generates less than 1/5th the search revenue of Google (probably much less).  Still, if adCenter can boost Microsoft's efficiency by, say, 100%, a circa-$1 billion business could become a circa $2 billion business, which would mean that Google's $7 billion business would grow $1 billion less than it might have otherwise.  Bottom line, even if Microsoft keeps sweeping out the cellar in the search wars, it can still play spoiler to the big dogs.

So, the key question is, how's adCenter?  The word one user I spoke with two weeks ago used was "chaos."  Anyone else have any impressions/experiences?

UPDATE:

IO Reader Victor aggressively challenges my logic above that search spending is a zero-sum game (see his comment).  His argument is that, as long as the ROI is there, advertisers will buy as much search as they can, so Microsoft can grow it's own revenue without affecting Google's growth trajectory.  I am not sure I agree that advertisers view search as a "cost of revenue" expense rather than a marketing expense, but I do think Victor has a point (to a point). 

If the ROI on Microsoft is much better than on Google (which is certainly possible in the early days of a successful adCenter adoption), I think you will see dollars flow to Microsoft at the expense of Google and Yahoo--i.e., the argument I made above.  As long as the ROI on Microsoft is the same or worse than on Google, and as long as the demand for good quality search inventory still exceeds the supply, Microsoft's growth should not come at Google's expense.

Yes to Yahoo-MSN, No to Microsoft-Buys-Yahoo

  After fumbling its opportunity to get in bed with AOL, Microsoft has one more way to gain the scale necessary to be a serious competitor to Google: Get in bed with Yahoo.  (I am extremely skeptical that the MSN-is-a-Microsoft-division strategy will ever work--a skepticism developed over 11 years of watching Microsoft make vow after vow only to peak in distant third place).

To be clear: Microsoft buying Yahoo would be a disaster--for both companies.  Yahoo would disappear inside the Microsoft beast, the talent would leave, the brand would get diluted, the focus would change, and the company would ultimately disintegrate.  MSN's biggest weakness has always been that it is merely a division, one designed to support the ongoing dominance of Microsoft's crown jewels (Windows/Office).  If Microsoft bought Yahoo, the latter, too, would become a subordinate division.

The smart play, described in today's WSJ's article, would be for Microsoft to give MSN to Yahoo! in exchange for a big equity stake in the combined company.  Yahoo-MSN (which should remain "Yahoo") would immediately have the combination of scale, media, and technology necessary to challenge the Google juggernaut, and if it was successful in doing so, Microsoft shareholders would benefit.  It is less clear that this move would be a positive for Yahoo, which means that Yahoo could probably extract a good price. 

Right now, given the egos involved (on display in the failed AOL negotiations), this seems a long-shot.  Microsoft has never experienced or admitted defeat on this scale, and selling the division would undoubtedly (and shortsightedly) be viewed as defeat.  Short of a Yahoo-MSN combo, Microsoft's other option, in my opinion, is to spin MSN out as a public company. 

AOL Ad Growth Solid, Bumps MSN to No. 4

AOL is still sucking wind (subscriber losses are accelerating), but its advertising growth is solid--up 26% year over year.  This compares to 79% for Google, 34% for Yahoo, and a pathetic 7% for MSN.  Those convinced that it is only a matter of time before MSN rules the world will no doubt find a way to explain why it is irrelevant that MSN has now lost its grip on "distant third place" in the web wars and is now No. 4 (by ad revenue).

According to TW CEO Parsons, AOL's ad growth was solid across all three categories: display, search, and Advertising.com.  AOL's big challenge, of course, is to stabilize the subscriber base.  Although AOL has an impressive amount of web traffic, advertising growth cannot continue at current rates if the subscriber base does not stabilize.  AOL's critical weakness is that each subscriber generates between 4x-10x the monthly pageviews as each web visitor (for more info, please see a Cherry Hill Research report from November, 2005, accessible at the bottom of this post).  This means that for every subscriber AOL loses--and it lost 835,000 in the last quarter--it must attract 4-10 times as many web visitors just to stay even (Cherry Hill Research estimates, see report above).  This will be challenging, to say the least.

Google/Microsoft: Careful What You Whine For

One of many smart comments/links to the last post re MSN's deterioration concerned the default search setting for the forthcoming IE 7.0.  As the NYT details, Microsoft is embedding a search window in the browser header of 7.0 with MSN as the default search engine (or "Live" or whatever the Microsoft engine is or will be).  Google, meanwhile, is complaining that this is an abuse of power, that Microsoft should be forced to make every new PC user walk through set-up screens that choose the default.  Commentators are using the tiff as a way to suggest that Google is in trouble, Microsoft is about to pull a Microsoft (come from behind and win the web game), etc.

Thoughts:

• First, hats off to Google for keeping a straight face while complaining about this.  Microsoft's monopolistic bullying, apparently, theatens to boost MSNs 11% share of search while chipping away at Google's 50%-share--so it's clearly worth tax-payer dollars to get the regulators involved.  Also, the Google toolbar that Google smuggled onto my PC in a "Java update" package last week has not only embedded a Google search window in my (Microsoft) browser but made it look like the browser was made by Google (the word Microsoft is nowhere to be seen). 
• Second, hats off to Google for realizing that, although the idea that Microsoft's plan is somehow monopolistic bullying is ridiculous, the idea that regulators, especially the EU, might not see it that way is not.  Regulators usually fight the last war, and if Google succeeds in getting them up in arms about this non-event in a new world in which Microsoft is the farthest thing from a monopolist, more power to Google.
• Third, according to the NYT, Microsoft is not hard-coding MSN into every browser but, instead, giving PC makers the ability to charge search providers a fee to be the default search engine.  If Google wants that slot, in other words, it doesn't need to complain about it--it can just use a tiny fraction of its gigantic cash pile to pony up. 
• Fourth, users can change the pre-set default easily, just as they can with the IE home page (which also comes set to MSN, and which hasn't exactly stifled Google's growth).  That many don't hasn't helped Microsoft do any better in the web business than a distant and nearly irrelevant third.
• Fifth, I don't have the numbers to back it up, but Google's end-of-the-world-as-we-know-it estimate in the NYT that 30%-50% of users will use the embedded search window strikes me as absurdly high. 
• Sixth, even if Microsoft does what it plans to do, I don't see this as a major game-changer, at least not re Google.  For most people, Google equals search, and no window is going to change that (unless it's Google's).  I get the sense that many of Yahoo!'s searches, however, are driven by convenience--MyYahoo users using the closest box--and if an embedded window in IE is even more convenient, then that could be bad news for Yahoo.

Bottom line, Google's public complaining about such a small issue seems to me evidence that its sense of itself (quirky, aggressive start-up) still hasn't quite caught up with its reality (global behemoth).  If so, of course, this is a DNA trait it very much shares with the even more dominant global behemoth to the north.

MSN: Another Quarter Closer To Irrelevant

As shown by yesterday's numbers, MSN’s financial performance continues to deteriorate.  With each passing quarter, in my opinion, the chance that the division will ever mount a serious challenge to Google and Yahoo in search (or any web business) gets slimmer and slimmer.

• MSN advertising revenue rose only 7% y/y, a deceleration from December’s mediocre 12% and September’s 20%.  This compares to Yahoo’s 34% and Google’s 79%.
• Search revenue actually declined y/y.  Microsoft blames this on the transition to adCenter, but shrinking revenue in a market growing this fast is a terrible sign.  All else being equal, shifting to adCenter modestly increases revenue-per-click because MSN goes from booking net revenue to gross revenue.  This illustrates just how much revenue is being lost due to lower keyword prices on adCenter than Yahoo.
• Operating income also declined, from positive $102 million to negative $26 million.  The division is now detracting from the performance of Microsoft as a whole.
• The plunge into the red resulted from declining revenue and a headcount increase of a whopping 35%.  Whatever the new folks are doing, they aren’t selling ads.

MSN’s heavy investment in headcount and R&D, combined with a renewed willingness to run the division at a loss, shows how seriously Microsoft is taking MSN and the Google threat.  Despite this, however, the division’s performance shows no signs of a turnaround (on the contrary, it just gets worse).   Analysts and commentators conditioned by years of Microsoft’s come-from-behind victories in software continue to act as though MSN’s ascendancy is only a matter of time.  The numbers (and general business history) suggest otherwise.

Microsoft has been at the web business for 11 years now--and it is still running a distant third.  How long Microsoft will continue to believe that gaining real traction online is just a matter of hiring the right people, developing the right algorithms, or spending the right amount of money remains a mystery.  Unless the MSN division soon shows signs of first stabilizing and then regaining share, however, even the Microsoft faithful may eventually have to throw in the towel. 

The hirings of Steve Berkowitz, Ray Ozzie, etc. are positive, but, for MSN, they are probably too little too late.  I continue to believe that the best solution to a tough problem is a spin-off.  It worked for Expedia, Slate, and other Microsoft web businesses, and it still has a chance of working for MSN.  Also, why any one company wants to have $50 billion in revenue and compete with IBM and Oracle on one end and Google, Time Warner, and Sony on the other is beyond me. With each successive re-org, however, it becomes clearer that Microsoft is deadset on doing just that.

Click Fraud Update: Arkansas, Armageddon, etc.

We've had much debate about click fraud on these pages, so I wanted to share some of the recent work we've done on the topic over at Cherry Hill Research.  I'll try not to bore you with updates on CHR, but when we publish something that is free to all and might be of interest, I'll post a link here.

Here are some of our current conclusions regarding click fraud:  (The full write-up at CHR is here.)

• The click-fraud concern is real, and the search engines must do a better job of addressing it.  This said, the problem is manageable and will not cripple the PPC industry.
• Increased awareness of click fraud (or, more accurately, the "invalid click" problem) will likely lead to increased spending on click-stream auditing by both search engines and advertisers.  This will modestly reduce ROIs for advertisers (and thus weigh on keyword prices) and modestly reduce profit margins for search engines.
• Google's settlement in Arkansas (if approved) will be a much bigger win for the company than we initially thought.  It will preclude all future class actions based on historical click-fraud claims, including a large one that has already been filed in California.
• The plaintiffs attorneys on the California class action, in fact, called the Arkansas settlement "the worst class action settlement in history" [from the perspective of the plaintiffs.]  From Google's perspective, therefore, the settlement might be described as the best in history.
• The settlement payouts are such that plaintiffs will receive not 'pennies on the dollar' but fractions of pennies, and they will receive them as rebates on future ad spending, not cash.  As far as legal exposure goes, therefore, Google CEO Eric Schmidt might have understated the case when he dismissed the click-fraud issue as "not material."  A more accurate assessment might have been "non-existent."
• The Arkansas settlement does not preclude future legal action for claims after the settlement date.
• Because Yahoo has not settled the Arkansas class action, the California case against Yahoo will continue.  Given the terms Google got, as well as the opportunity to settle all historical claims, Yahoo might be well-advised to settle in Arkansas immediately.

Our write-up at CHR includes links to several interviews on the topic, including Ben Edelman (Harvard spyware expert), Andrew Goodman (CEO of SEM firm), and a pissed-off advertiser.  We will be posting more interviews in the next few days. 

Hope you find the work interesting and/or helpful.  Look forward to hearing your thoughts.

Edelman on Click Fraud: Snarky, Real, and Hard to Control

Thanks to several Internet Outsider readers (and journalists) who pointed me toward Harvard PhD candidate Ben Edelman's recent work on spyware click-fraud at Yahoo!  Edelman articulates his research and findings in extraordinary detail, and provides screen shots, video, and packet logs as proof. 

As Edelman describes (see below), the click fraud he observes is different than the usual kind (competitors clicking on links, bogus AdSense sites, etc.).  This fraud is spyware-driven: PCs are infected with spyware that serves up Yahoo! ads and, in so doing, generates clicks.  Importantly, in these cases, the PC users do not actually click the ads--the spyware produces the clicks automatically.

Edelman's videos, packet logs, and cookie logs are enough to make even the most ad-hardened online user feel sick about what is going on inside his or her machine, and advertisers who pay real dollars for such activity will, at best, be infuriated. 

In one particularly sleazy instance, Edelman clicked on a text link within a New York Times story to find that the link had been inserted by a spyware program on his PC and launched an ad.  In other words, a NYT reader who thought he or she was clicking through to additional detail within an NYT story was actually clicking on a non-NYT advertisement.  The click, meanwhile, generated revenue for Yahoo! and the spyware vendor at the advertiser's (and the NYT's) expense. 

This kind of actiivity has got to go, and if Eliot Spitzer doesn't take care of it, someone else will.  In the meantime, along with other types of click fraud, it is artificially puffing up online ad revenue and market statistics.

Unfortunately, Edelman does not--and presumably cannot--say how widespread such activity is.  He also doesn't say whether Yahoo! already offers advertisers refunds on such behavior (although he implies that it is so hard to control that they probably don't).  So, once again, we are left to conclude that click fraud is real and is a problem--and left to wonder whether how big a real problem it is.

Edelman:

Many others have alleged click fraud at Yahoo. (1, 2, 3) But others generally infer click fraud based on otherwise-inexplicable entries in their web server log files -- traffic clearly coming from competitors, from countries where advertisers do no business, or from particular users in excessive volume (i.e. many clicks from a single user). In contrast, my proof of click fraud is direct: As documented and linked above, I have captured click fraud on video and in packet logs. Yahoo may argue about advertisers' inferences in other instances, i.e. disputing that advertisers have really found click fraud. But it's far harder to deny the click fraud shown in my examples.

In the examples I show above and previously, Yahoo's problem results from bad partners within its network. Yahoo syndicates ads to numerous partners, many of whom syndicate ads to others, some of whom then syndicate ads still further. The net effect is that Yahoo does not know who it's dealing with, and therefore cannot exercise meaningful supervision over how its ads are displayed. I consider this a bad idea -- bad business, bad for quality, bad for accountability. But Yahoo need not listen to me. Instead, consider instructions from New York Attorney General staff member Ken Dreifach: "Advertisers and marketers must be wary of fraud or deceptive practices committed by their affiliates, even [affiliates] that they have no working relationships with." (Quote from MediaPost, summarizing Dreifach's remarks.)...

The many bad partners in Yahoo's network make fraud particularly hard to block: When Yahoo terminates one fraudster, that fraudster's partners find another way to continue operations...

The Ask Test, Part 2: Will Mossberg Switch?

Walt Mossberg's Google-Ask taste test concludes that Ask sometimes produces cooler features and better results.  So here we have an ideal test-case of Google's ability to protect its market dominance, and Ask et al's ability to ever claw back serious market share. 

Question 1, for Walt Mossberg: So now that you have concluded that Ask is sometimes better, how are your searching habits going to change?  Are you going to try both engines every time you search?  Are you going to switch over completely to Ask?  Or are you going to say, "Well, yes, Ask tastes better, but I've always been a Google man, so I'm going to stick with that."  The answer here is important, because Google is protected not only by its search service but inertia: most searchers probably don't care enough to switch unless/until the competing product is vastly superior.

Question 2, for Google: So now that Walt has implicitly dissed your service and engineering team, how are you going to respond?  How long before we see those cool site-preview binoculars on Google?  How long before searches for people turn up photos, bios, etc.?  Are you going to respond, or--like Yahoo! in the late 90s--are you so focused on Mars mapping, Google Base, and other projects that you're going to take your crown jewel for granted?

Question 3, for Yahoo:  Where are you in all of this?  Why doesn't Walt hold a higher opinion of your search service?  Are you going to introduce the above features, too?

Question 4, for searchers everywhere: So now that Walt has said Ask might be a little better, are you going to try it?  If you try it, are you going to switch?  If not, what would make you switch?  (Be honest).  If so, what would make you switch back?

I'm encouraged that Ask has been able to beat Google at the search game, at least in the opinion of one market commentator.  I am still skeptical, however, that temporary feature- or results-based superiority will lead to a vast shift in market share.  Could it?  Yes--Yahoo!'s fall from grace is proof of that?  Will it?  Not unless Google and Yahoo! are asleep at the switch.

Of course, Ask's goal need not be to dethrone Google.  If it merely doubles its market share, from 6% to 12%, it will have succeeded in spades.

And another takeaway from Walt's exercise is that Yahoo! has once again failed show any real competitive or innovative spark.  If Ask can win plaudits and develop superior features after only a year or so of intense work, what has happened to Yahoo!'s innovation engine?  Is this like Finance, where Yahoo!'s team fell into a coma?   

UPDATE:

Walt was kind enough to weigh in here, very articulately.   Several other smart comments, too.