The Google Squeeze: How Google’s Black Box Affects Partners’ Revenue

Google’s black box of ad pricing makes it impossible to understand if partners are getting a fair share.

When Google (NASDAQ: GOOG) offered a “direct to consumer” domain parking option last month, many cheered. “Finally, we can cut out the middleman!” they exclaimed. But others worried about potential downsides. Specifically, domain owners realized that they have little bargaining power with Google compared to parking companies that aggregate significant traffic.

Google’s Domain Parking Agreements

To better understand how Google can squeeze its partners, it’s important to understand the deals Google has in place with partners such as DomainSponsor, NameMedia, and Sedo.

These contracts are confidential. But thanks to NameMedia’s (since aborted) attempt to go public, we can peek inside a Google Adsense contract. Here are some things to note:

1. There are three types of feeds: Adsense for Content, Adsense for Domains, and Adsense for Search. Adsense for Search is the search feed from Google. This ad feed can be called anytime someone types a search query into a box on a parked page. It is also called if someone clicks on a link on a parked page labeled “Related Searches”. I’m still unclear as to the difference in ads shown on Content and Domains, but these ads can be shown on the landing page of a parked page or on additional pages. If you have a one-click lander with Google, all of the ads on the home page are from the content or domains feed.

2. Parking companies get a higher revenue share if they send more traffic. The NameMedia agreement has three tiers, which presumably pays a higher percentage of revenue to NameMedia if it sends a greater amount of revenue to Google. (Note that it is based on revenue amount, not traffic amount.)

You may be thinking “Great! The parking companies have negotiated certain revenue share percentages with Google that cannot be changed. We’re locked in.” Well, sort of.

First, this is one of the main concerns with going direct to Google parking and cutting out the middleman. You won’t have a guaranteed percentage, so Google can squeeze you whenever it needs to boost earnings.

Second, just because the percentage payout to the parking companies can’t change during the contract period doesn’t mean the actual amount paid out can’t change, as I’ll explain below.

An Elusive Revenue Share

Let’s consider how percentages mean very little in these agreements, and why Google may have an incentive to collect less per click on the parking pages even if it means Google in turn earns less per click.

In order to understand this you need to consider Google Adwords, the program that supplies ads to Google Adsense. Google Adwords Advertisers generally bid a maximum amount per keyword. But they also set a budget. For example, I may say “Bid $1 per click for these keywords, but I don’t want to spend more than $1,000 a day”.

At first it seems Google will want clicks on all pages — whether part of the Google.com or Adsense sites — to be close to the maximum price. But Google’s margin is much higher on Google.com because it doesn’t have to pay partners. So it has an incentive to have more of the ad budget spent on Google.com than at partners.

For example, assume an advertiser has a $1,000 budget and it is maxed out every day. Google could send half of the traffic from Google.com and half from the AdSense network at $1 a click. Here’s how much Google will make, assuming the partner has a 75% revenue share:

500 clicks on Adsense x $1/click x 25% = $125
500 clicks on Google.com x $1/click = $500
Total = $625 profit

Now, what if Google discounts the clicks on Adsense 50%, arguing they aren’t worth as much as those on Google.com? The advertiser still wants to spend $1,000 a day. So the rest of the traffic goes to Google.

500 clicks on Adsense x $.50/click x 25% = $62.50
750 clicks on Google.com x $1/click = $750
Total = $812.50 profit

As you can see, Google needs to merely shift the budget toward its own properties to earn more money. The advertiser gets more clicks, too. Google can pay the same percentage to parking companies but pay less per click, while at the same time making more money for itself.

Note that this is against Google’s stated goal of offering the best deal to the advertiser. If both Google.com and Adsense convert at the same rate, the second option gives the advertiser more conversions. But a third option of all Adsense traffic would be the best for the advertiser, but the worst for Google: it would only earn $250.

Is Google squeezing us already?

A lot of people cite Google’s Traffic Acquisition Costs (TAC) metric to show that advertisers are getting less. But the metric says very little about partner payouts. Here’s a graph of TAC updated in Q3 2008:

Above: a graphic that means a lot to investors but little to partners.

The blue line represents Google’s expense for traffic as a percentage of advertising revenue. The green bars primarily represent the amount paid out to traffic partners.

Many people point to this falling percentage — 37.2% in Q1’05 and 27.9% in Q3’08 — to show that Google is paying its partners less. But this number means very little, because we don’t know what percentage of traffic is generated on Google.com versus Adsense sites. In fact, you can see that Google is actually paying more to partners now than before. But again, without knowing the actual traffic amount we know very little.

Indeed, revenue on Google.com and other Google properties increased 34% in Q3’08 compared to one year earlier. Revenue on Adsense increased only 15%. But this is revenue, not traffic, so we still don’t have much insight into if Google is paying more or less to its partners. It’s a black box, and only Google knows what’s inside.

A Ticking Time Bomb
There’s one other thing that could drop parking partners’ shares of revenue overnight faster than a gradual squeeze.

In the NameMedia agreement (and I’m told the same goes for other agreements) Google retains the right to eliminate the search ad feed. Search ads generally pay more than content ads. So overnight, domain owners could see a massive drop in revenue. Google is required to provide a replacement feed to NameMedia if it removes the search feed. If the replacement feed doesn’t perform within x% of the search feed, NameMedia has one recourse: cancel its agreement with Google.

Canceling the agreement doesn’t seem like a good alternative.

Should we bite the hand that feeds us?

For all of the complaining about Google, keep in mind that without Google the domain industry would be a shadow of what it currently is. Google’s ad network has propelled the parking industry to where it is today. Should we not complain about Google’s market power? Should we be thankful for what it has given us and not question its motives?

It’s a tough question. We know our parking revenue is dropping, but is it because Google is squeezing us? Because it’s a black box, partners’ relationships with Google are based on trust. And Google has been losing a lot of trust. Notifying parking partners of a drastic change in competitive strategy just a day or two in advance doesn’t build trust.

It’s good to question authority. Which is why we shouldn’t all run out and thank goodness that Google is cutting out the middleman.