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Alphabetti spaghetti: What Wall Street isn't telling you about Google

Black boxes and botnet armies ravage aging ad biz

Alphabet, Google’s parent company, has made the front page with its latest financials – overtaking Apple as the world’s most valuable public company. But size isn’t everything.

The numbers illustrate the nature of Alphabet’s grip over digital trade – with Alphabet really controlling the price of transactions, and what value means in the digital economy.

The digital economy hasn’t matured into a vibrant transactions-based marketplace with wholesale markets behind them. Compared to the real world, digital is over-dependent on advertising, and here Google is not merely king, but several ranks of knights and barons below the king too. (Last summer Google became the “legacy internet” part of the Alphabet operation. Yes, that takes some getting used to).

You can see the bare numbers in our earlier report.

Two things are worth bearing in mind when you hear that Alphabet “beat expectations” or “beat [Wall] Street”. In place of a competitive market for advertising keywords, Google operates a “black box” auction, and is therefore able to set the price of a trade across the market.

You can’t perform keyword arbitrage, and around ninety per cent of digital advertising passes through Google; the black box means that Google can increase its revenue at will. Secondly, Google is grappling with click fraud – a battle it sometimes loses.

Some 52 per cent of online ads are never seen by humans. Botnet armies generate clicks, the campaign is “fulfilled”, and all without the target audience being aware. Google still retains the cash. The loser is the advertiser, who is growing wary of online advertising. Google employs some of the best brains in the world in this cat and mouse game – it needs to retain the ebbing faith of advertisers. But the head of the world’s largest ad agency, Martin Sorrell, pointedly warned Google to up its game.

In a healthy market, you could expect fewer people to be clicking, but those clicks are worth more. For example, the new TrueView ads on YouTube now include a buy button. A purchase is worth more to a merchant than a lead. In reality, we find, the opposite is actually true. While the number of clicks on Google ads went up, the value of the click declined. Financial analysts have focussed on the former datapoint, but have overlooked the latter.

That’s a broad generalisation of Google’s business, as different parts of the business perform differently, but it’s the most important one.

Aggregate paid clicks rose 31 per cent year on year, and 17 per cent quarter on quarter – a steep ramp. Within Google’s properties, paid clicks were up even more, 40 per cent annually. However the cost-per-click (CPC) actually fell, 13 per cent year on year. Even more curiously, Google’s cost of doing business rose: TACs (Traffic Acquisition Costs) were up 12 per cent year on year. These are minimum payments to members of the Google Network, and the item covers apps and external sites participating in Google’s ad networks, as well as deals like the $1bn Google paid to Apple in 2014 to keep Google Search as a default search on its devices. TACs were 21 per cent of revenue.

Alphabet’s confident position comes from its monopoly, or near monopoly (pdf), on vital platforms. Google controls five of the top six, billion-user, universal web platforms: search, video, mobile, maps, and browser and Google leads in 13 of the top 14 commercial web functions of the Internet, reckons Google critic Scott Cleland at Precursor.

These are, as of September 2014: No.1 in data collection, search, tracking-analytics, digital advertising, mobile, video, location, browser, Internet Infrastructure, consumer-Internet of Things, Apps store, translation and email; it’s also No.2 & No.3 in social with YouTube & Google+.

Google has barely begun to wring value from some of these platforms. Google Play grew 30 per cent, as Android rolled on, grabbing huge market share in emerging markets. But YouTube highlights how Alphabet’s Google division faces a classic “inventor’s dilemma”. Why risk upset the operation's main cash cow today (advertising) with something new (transactions)?

The rational response is that Google’s success comes from doing things at scale well, while advertising is simply a transaction that Google is already good at doing. So it follows that Google should be good at other transactions at scale too. In the short term, it doesn’t quite see it that way. So long as it sees free and advertising as its “core”, everything else is an optional add on, and the “digital economy” grows old and grey as it waits to be built. ®

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