Google's Gamble

As investors fear falling ad revenue, the search giant pushes ahead with its bid to boost quality clicks

Eric Schmidt, chairman and CEO of Google Torston Blackwood/AFP/Getty Images

by Catherine Holahan

Can fewer clicks on its search ads lead to more revenue for Google? That is the question investors, analysts, and the company itself are trying to answer.

The debate was launched after a Mar. 26 report from researcher comScore (SCOR) showed a decline in the number of clicks from the prior month on Google's search-related ads. According to the research firm, clicks on ads declined 3% in February from the prior month and were up just 3% compared to last year. Some analysts cautioned investors against buying additional Google (GOOG) shares; Google's stock declined 3% on Mar. 27, to $444.

But Google supporters warn that the number of clicks doesn't necessarily correlate with the revenue generated from those clicks. The company has been working to improve what it calls the "quality" of clicks, minimizing the number of clicks that don't lead to revenue for advertisers. The result, at least in theory, is that advertisers may be willing to pay more for each click because the chances that a click will result in a sale will be higher. Clicks may go down. But Google's revenue would go up.

Errant Clicks

Ross Twiddy is a believer. He depends on Google search ads to drive clients to his Web site and, ultimately, into the houses that he rents out for vacations along North Carolina's Outer Banks. As far as he's concerned, clicks can go down as long as Google ads keep bringing in the customers. "What we care about is not just traffic but that it translates into vacation rentals," says Twiddy, who is so pleased he appeared for free in a promotional video for Google's AdWords site.

The challenge Google faces, as it heads for its Apr. 17 earnings report, is convincing Wall Street that Twiddy is representative of its advertising clientele. So far, analysts are wary. Clayton Moran, an analyst with Stanford Group, shaved $115 off his target price for Google stock on Mar. 27, cutting it to $500. He thinks the slowing economy is leading to an industrywide slowdown in consumers clicking on ads, at Google as well as competitors Yahoo! (YHOO), Microsoft (MSFT), and Ask (IACI). "Checks and data indicate softness," wrote Moran in a research note.

The skepticism is understandable. Google, like other online advertisers, has built its business (BusinessWeek.com, 2/27/08) convincing customers, analysts, and investors alike that a click is a corollary for a customer in a store. The more clicks, the more potential customers, and, ultimately, the more sales.

Still, a click has never been (BusinessWeek, 2/28/08) quite like a customer walking the aisles, wallet in hand. Sometimes a click is simply the reaction of a confused searcher. Other times, it's driven by the curiosity of a bored Web surfer. There are even cases of a malicious competitor clicking on ads to drive up a rival's marketing expenses.

Pricier Keywords

As Google and its competitors have come to understand this, they've been working to reduce the number of clicks that don't translate to genuine potential shoppers. Google stepped up its efforts last year, reducing the area around an ad on which a person could click and be directed to a store's Web site. The purpose was to minimize accidental clicks on ads by people not actually interested in the advertiser's Web site. It also rolled out a "conversion optimizer" in January for its AdWords search advertising customers to enable them to effectively buy ads based on the number of sales or customers those ads generate.