Rise in Online-Advertising Prices At Search Sites May Be Overdone

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Rise in Online-Advertising Prices At Search Sites May Be Overdone

By RIVA RICHMOND
DOW JONES NEWSWIRES
NEW YORK - March 16, 2005 - There has been a bona-fide boom in advertising on Web search engines in recent years. But according to some marketers, the corresponding boom in prices for search ads is overdone.

Exaggerated ad prices, which are set by advertisers through online auctions on keywords, would provide a near-term revenue boon for search-site companies like Google Inc. and Yahoo Inc. and their Web-publishing affiliates. But a reversal of fortune could pose a longer-term risk to the health of the search-marketing industry and to the stocks of the major beneficiaries.

Search marketers are divided on the question of whether price increases have reached a dangerous level or are simply an expression of Christmas cheer that will prove part of an emerging seasonal pattern for a new industry. The price trend, they say, still points generally upward.

But worries about ad-price softening have weighed on shares of Google and Yahoo recently, despite strong fourth-quarter performances from the two companies. Google's stock is down 17% at $179.98 from a high of $216.80 set Feb. 2, while Yahoo is down 20% at $31.91 from its 52-week high of $39.79 set Dec. 3.

The concerns arose, in part, from complaints about high prices by online retail giant eBay Inc., one of the largest buyers of keyword ads, at its annual meeting with financial analysts last month. The comments came on the heels of a disappointing earnings report for the fourth quarter, when eBay lifted its marketing spending to attract Christmas shoppers.

"We've been surprised by some of the prices that are being paid," said Bill Cobb, president of eBay North America, at the meeting. "There's a lot of small businesses trying this, so I think pricing is a little wild right now, and what we have to focus on is getting fair value."

Two weeks later, RBC Capital analyst Jordan Rohan published a note reporting double-digit price declines for Yahoo's "paid-search" business in the first quarter, which he said was more severe than he would have expected from seasonal weakness. Mr. Rohan speculated the cause of the decline was a disinflation of Christmas-inspired "bubble-like" conditions described by eBay. He downgraded his ratings on both Yahoo and Google stocks. Yahoo, he estimates, gets 40% of its revenue from paid searches, while Google gets virtually all of its revenue from the ads.

The February entry of Time Warner Inc.'s America Online into the search-engine arena, which has also drawn Microsoft Corp.'s MSN recently, may also have heightened investor worries by raising the specter of additional competition. However, neither AOL nor MSN has tackled the ad-serving business that is now dominated by Google and Yahoo and that includes smaller players FindWhat.com and Kanoodle.com Inc.

Ad pricing is a key factor for analysts and investors looking to estimate revenue at Yahoo, Google and FindWhat. However, search volume and the ability to turn user queries into revenue are also important. Keyword-ad buyers pay for ads only when users click on them, and so search engines can boost yields by improving ad and search-traffic quality. Such moves can also support prices.

Yahoo and Google declined to comment on ad-pricing trends for this article. During its fourth-quarter earnings call, Yahoo said pricing was flat due to an increase in retail ads, which tend to command lower prices. When Google reported quarterly results, Chief Executive Eric Schmidt said prices rose in the period, though he declined to quantify the increase.

Other industry players say ad prices are going up, but they don't agree on who is pushing them higher or whether there is a bubble. Some blame ego buyers or deep-pocketed giants for price inflation. Others blame keyword arbitragers, who make money on the spread between what they pay search engines for ads and what they charge clients for leads. Still others say prices reflect sensible assessments by marketers about returns on their spending.

All probably play a role in pushing up prices.

Unlike the eBays of the world, most small companies are bidding on keywords -- sometimes neck and neck with large companies -- without much understanding of the returns. Mr. Lee points to spam-like keywords such as "mortgage" and "Vioxx" for wacky prices. "Mortgage" fetches $7 to $11 a click, while "mesothelioma," a cancer caused by asbestos and the subject of class-action lawsuits, commands more than $49 a click.

"A lot of these small-business owners don't have clue what they're doing," says Chris Winfield, president of 10e20 LLC, a search-engine marketing firm. And they often learn the hard way. Their broader education about returns -- and about the emerging problem of click fraud, or when competitors click on ads to drive up rivals' expenses -- could hurt both prices and sentiment, he says.

"The smaller guys are really what drive Google and Yahoo's business," Mr. Winfield says. Dominance by large companies could push them into the arms of FindWhat and other small players. "It's a double-edged sword. You want people to be spending as much as possible. ... But is that really the best for the long run?"

To improve small-company sophistication, FindWhat has begun offering technology that shows how well clicks on ads convert to sales. Chief Executive Craig Pisaris-Henderson believes better understanding of returns will encourage more spending on searches and reduce the risk of price bubbles. FindWhat hasn't been able to command the prices that Google and Yahoo have, according to marketers. Analytics are one way it is trying to change that. In a bid to improve traffic quality, FindWhat also purged weak Web publishers from its network, a move it made in November that cut its revenue by about 20%.

But Mr. Winfield argues that "the eBays and their armies of affiliates," which are arbs of a sort, are the key culprits behind high prices. In an effort to curb affiliates who were hurting ad quality and utility for consumers, Google instituted a policy in January forbidding multiple ads that lead to the same visible Web address.

Marketers say proactive steps like those taken by Google and FindWhat will help protect the industry from excesses that could come back to bite them.

But some excesses may never go away. Large companies use sophisticated analytics to guide their ad buying and drive shoppers to their sites. But their calculations can also involve the sort of thinking behind purchases of expensive Super Bowl ads, says David J. Moore, chief executive of 24/7 Real Media Inc., an online-advertising services and technology company.

"If I think I'm the No. 1 technology company in the universe, I'm probably going to want to own the word 'technology,' " he says. "I do believe that you have some ego buys going on on the search engines, but that may never end."

Mr. Moore argues that the paid-search market is efficient and marketers quickly learn whether their ads are producing results. "From our perspective the bubble [complaint] is just a cry for help from the advertiser who wants to get more for their money."

Write to Riva Richmond at riva.richmond@dowjones.com