Online Advertising Explained: Part 2: How Google Makes Money, and I mean Stupid Amounts of Money

In an earlier post on the subject of Why does Facebook Fear Google? I wrote about how the battle between search (Google) and discovery (Facebook) boiled down to dominance in re-directing traffic on the internet. There is another area where Google and Facebook compete, and that is for advertiser dollars. In this post, I’ll talk how their business models differ and how Google is trying to eat Facebook’s lunch, or protect its own lunch, depending on where your loyalties rest.

Traditionally there have been two types of advertising: direct response and branding. To differentiate the two, think of the difference between infomercials and the ads you see on the superbowl. Infomercials are generally considered cheap air time in which the advertiser is trying to get you to buy something right away. Infomercials are full of product demos because the product producer wants you to pick up the phone and order that Japanese knife set you didn’t know you needed right now (after all, supplies are limited!). This is, in essence, direct response advertising because the advertiser wants a direct and immediate response from you.

Branding is something that you’re probably familiar with, since you’ve been inundated with it since birth. Branding is about influencing your future consumption behaviour by attempting to link products with concepts. Are you a former hippy turned nuclear family supporter trying to hold true to your principles? Buy a Prius. You’re the same individual earning over 100k a year and you need food? Shop WholeFoods. Do you have a pulse and some disposable income? Buy an ipod. You get my drift.

While direct response is fighting for your impulses, branding is fighting for your attention: think of branding as trying to perform inception by implanting a new idea in your head to push you towards some ideal behaviour. Another way to think about it is to ask yourself how far away from the purchasing process is the consumer: the direct response advertiser wants to get the consumer one step away from the purchasing process, whereas the branding advertiser is looking at a consumer who is possibly two or three steps away from purchasing something.

So you’re probably thinking that, given the fact that branded ads show up on the superbowl and infomercials appear a few hours after the superbowl, branding is a lot more valuable, right? While in the offline world this might be true, in the early stages of the online world, the opposite was in fact the case. While many people recognize that Google’s invention of the search engine was a major engineering feat, the average person often fails to recognize the significance of the little yellow ads above and beside the results. These ads, however, are what have given Google the luxury of creating gourmet restaurants and heated toilet seats for its employees.

Think about it: as an advertiser, how can you get closer to a consumer with a purchasing intention than a search query? If a user types in “buy smart phone”, the chances are that person really wants to buy a smart phone and you’re well placed to sell it to them. How do you get the most amount of money from an advertiser? Put them all in a blind auction against each other and have them fight to see which ad comes out on top (literally and figuratively). How much money does this strategy make? Let’s just say that if an adult film studio tried to re-create this in a movie, they’d have to cancel production because the interpretation would be too obscene.

There are three things that make this system a brilliant cash cow: 1.) Google’s advertising program is mostly automated, meaning that it is self-service and advertisers don’t need to talk to anyone at Google to spend their money. With this feature Google can scale larger and larger serving millions of advertisers with the same amount of resources. 2.) Google is reaching the long-tail advertisers. Think about it: not only do people search for smart phones, let’s say you want to find a boutique hotel in Cartagena, Colombia: we’ve got ads for that too! With this, Google attracts both big brands as well as the smallest mom and pop businesses across the planet. iii.) Google’s advertisers are not constrained by budgets. Huh? This is because so long as Google’s advertising program keeps performing well for them (meaning the advertisers make money because the services works well to sell their products), they can in turn keep pumping more and more money into Google. The only thing Google has to do is find ways to match advertisers to people looking for things.

What’s the kicker? Google only needs a small number of users to click on the ads to stay ridiculously profitable. What this means is that it can continue to focus on how to build a powerful search engine, along with its other products, without sacrificing its integrity and selling out to the people who pay the bills. If Google can increase the amount of people who click on ads by a shaving of a percentage point, Uncle Larry gets another private jet.

In my last post I talked about how the internet democratizes the means of production by creating an even more level playing field, and this is true of Google’s advertising program as well. If you look at the ads on the search results you’ll notice that they all look the same, and only the position changes. As such, when a mom and pop store competes against a giant brand, the giant brand can’t out-do the mom and pop store by hiring a fancy ad firm to create a colourful and imaginative campaign (ok, they can still do that, but at least not on Google.com). Both companies have the same number of characters to fill to appeal to an audience, and both are bidding blind. The only way for the big brand to attract more traffic than the little guy is to outbid it. It is sort of like what Gary Lineker said about Soccer: “Soccer is a simple game; 22 men chase a ball for 90 minutes and at the end, the Germans always win.” The same is true of online advertising: millions of advertisers are chasing clicks, and the winner is always Google.

Google makes money in other ways, some of which I’ll discuss, but search advertising continues to be its core business. Nikesh Arora, Google’s SVP of sales, admitted as much when in 2010 he quipped, “We may be a one-trick pony, but it’s a pretty good trick.

I thought I’d have space to address Facebook but I’ll have to leave that to another post. Then, I’ll discuss how direct response and branding are beginning to meld in the online world, and why Google, despite its proven and continually growing revenue stream, wants what Facebook has as well.

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About Matthew Carpenter-Arevalo

A former Google and Twitter manager, Matthew Carpenter-Arévalo is the founder and CEO of Céntrico Digital, Ecuador´s foremost boutique digital marketing agency.

10 Responses to “Online Advertising Explained: Part 2: How Google Makes Money, and I mean Stupid Amounts of Money”

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