Will Traffic Acquisition Costs Bite Google Back? (GOOG)

When I was on the board of Shopping.com, we used to break out our traffic sources into three types:

1. Organic (People who typed in www.shopping.com),
2. Algorithmic ( Free traffic from search engines based on your page rank)
3. Purchased traffic (Traffic from bidding on key words on Google and Overture)

Wall Street analysts have picked up on this trend and break out the gross margins along these lines. Purchased traffic is referred to by analysts as TAC (Traffic Acquisition Costs) and is watched religiously as a sign of gross margin expansion or erosion. As competitors get better at keyword purchasing and management, the cost of acquiring traffic (and Google's profitability) goes up, while the margins of the likes of Shopping.com and other online retailers go down. This puts a premium on being first in line for the users so you can get organic traffic. The site at the top of the pyramid, the user gateway, wins big. The top of the pyramid in this game for the last 4+ years has been Google (GOOG).

I am beginning to wonder if the tide is turning. I have written in the past on why access matters. DSL providers like SBC are at the top of the user pyramid and control a lot of the default settings that users see. Yahoo pays SBC handsomely for that deal. Google now has at least three deals in which they too are paying handsomely for traffic acquisition: AOL, Dell and Firefox. Google paid $1Bn for 5% of AOL and a revenue share % that is not disclosed but was reported to bring $400MM to Google on an annual basis.

Google is rumored to have signed a deal with Dell to pay $1 Billion over 3 years to install Google software on Dell PCs and operate a Dell home page with Google search. The blogosphere was rife with speculation as to what software would be installed. I think that misses the point. This is really a way to bring more searchers into the Google net who will click on ads ultimately. This is essentially TAC.

Finally, Google pays some large amount of money annually to the Mozilla Foundation to be the default search engine in the search box on the Firefox browser. This is a great demographic. And this is also TAC for Google.

What do Dell (DELL), AOL (TWX) and Firefox have in common? They are all gateways to users. They are gateways that stand in front of Google.com. Google is paying to bring in traffic in the same way that many companies pay Google for placement. This is particulalry topical in light of MySpace's emergence as a gatekeeper and rumors that they will soon do a deal with Yahoo, Google or MSN.

So why did I put a question mark in the title of this post? There is potentially one big difference between the TAC that Google pays and the TAC paid by online retail sites and others bidding up keywords on Google. Note that it seems that all of Google's TAC deals are flat fees (maybe with the exception of Firefox), whereas companies that advertise on Google are paying ever-escalating fees. Google is betting that the keyword bidding process used to place ads on its own site will outpace the cost it is paying to acquire traffic from the gateways/access providers and that the traffic to Google.com or whatever it will get through its own access initiatives [WIFI] will drive ever higher margins because of the traffic advantage.

Investors might want to pay attention to the rise in average CPC bid on Google relative to the flat fees Google is now paying out to acquire traffic. And maybe, Traf Acq might bite Google back?

Comments

[TrafficAcquisition]

As the advertising space with Google becomes more and more competitive, there is absolutely no doubt in my mind that the average CPC will continue to rise, and rise dramatically.

It's hard to think sometimes, that there are plenty other advertising spaces out there, but do they really have anywhere near the conversion rates that you can get from AdWords?

Unless another BIG advertising network arises, with the ability to take on the big G, people will continue to use them, and continue to pay the costs, which will continue to outweigh the flat fees they're paying to acquire traffic themselves.