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Google Inc (NASDAQ: GOOG) is a global information technology leader, innovating how people connect with information. Google’s automated search technology has made its free search engine website the number one visited website on the Internet, as rated by ComScore^[1] and Alexa.com ^[2] displacing Yahoo. Google’s revenue is reliant on its advertising sales--the sector accounted for 99% of 2007 revenue and 97% of 2008 revenue.^[3] Internet advertising is the fastest growing segment of the advertising market, but still only represents 8% of total U.S. advertising dollars -- suggesting considerable room for further growth. To tap these opportunities, Google has used the profits from its paid search business to support initiatives in many different directions. Gmail, Google Maps, and Google Earth are among the most prominent of Google's non-search products, which have given the company new outlets for its targeted advertising (gmail) and an entry into the local advertising business (google maps), putting it directly in competition with local yellow pages publishers. Google may soon face a new threat from a possible partnership between rivals Microsoft and Yahoo. Though Yahoo rejected a buy-out offer from Microsoft in 2008, as of May 2009 the two are reportedly negotiating a partnership for online search, positioning the companies to attack Google's primary business.^[4]

Business Overview

Google’s search products allow its users to efficiently search through vast amounts of web-based information, organizing and delivering results based on relevance. It also has a long and growing list of products in many other areas of computer applications. Consumer usage of its products is free, financed through advertising (97% of Revenues) and licensing (3% of Revenues) sales.

Business Financials

Google has grown rapidly; from 2004 to 2007 its revenue growth slowed, but still increased by more than 50% every year. The company reported a year-over-year growth of 31% for 2008. Google's earnings are reported before TACs (Traffic Acquisition Costs) are deducted--costs which take nearly 30% of out of total advertising revenues. 2007 TACs have seen slight decreases of 1% from 2006 to 2007, and another 1% from 2007 to 2008.^[5] In the 2nd 2009 quarter earnings, Google made $5.52 billion, a 3% increase from the same period in 2008. The company through careful cost controls along with its investment in innovation has managed to reduce its TAC by 1% when compared to the 2nd quarter of 2008. This reduction helped their net income increase by 18.4% from $1.25 billion in 2Q of 2008 to $1.48 billion in the 2nd quarter of 2009.^[6] In the company’s 3rd 2009 quarter earnings report, Google reported revenues of $5.94 billion, a 7% year-over-year increase. Its net income also increased from $1.29 billion to $1.64 billion, a 27% year-over-year increase. These earnings are a result of higher revenues generated by Google-owned sites, which had an 8% increase, and Google’s partner sites, which had a 7% increase year-over –year; Google-owned sites represented 67% of total revenues, $3.96 billion, and Google’s partner sites represented 30% of total revenues, $1.8 billion. ^[7]

Business Segments

Search Engine Technology

Co-founders Larry Page and Sergei Brin created Google's core PageRank technology to archive and organize Internet webpages and develop a searchable database. The basic tenet of PageRank is that when one website links to another, the first website is endorsing the second. Pages are then "ranked" according to the ecosystem of all web pages archived by Google. While the company has since utilized numerous other ranking systems, PageRank still remains a central technology. Google also creates search products for photos, videos, and specific websites types such as blogs. Google does not charge consumers for its search capabilities, receiving most of its revenue from advertising and a small portion from licensing its search technologies to enterprise companies. About 69.5 percent of Internet searches in the U.S. took place through Google during 2008, with search traffic increasing 8 percent over 2007, according to research firm Hitwise.^[10]

Online Advertising: Paid Search (97% of Revenue)

The company generated 97% of its 2008 revenue from advertising, the inventory of which is sold both directly to customers as well as in conjunction with advertising agencies serving large clients. Google's two primary advertising products are AdSense and AdWords--both paid search products. The company uses its core search technology capabilities to place ads on its eponymous search engine as well as through a network of third-party websites. What distinguishes Google's "paid search" advertising business is that it is performance-based (advertisers only pay when someone clicks) and ads are contextual (e.g., a DVD ad typically shows up when someone searches for "DVD").

Performance Based Marketing

Google sells its ads on a cost per click (CPC) basis, meaning that advertisers are charged only when a user clicks on their ad. This distinguishes Google from most non-search online advertising (including banners) as well as traditional media, both of which charge advertisers for impressions, or the number of users who are presented with an ad. For instance: traditional online banners count page views; print newspaper and magazines count circulation; and television uses statistical ratings. Since Google only charges per action--in this case, a click--the advertiser pays for marketing performance, which in theory generates higher advertising returns.

AdWords Product

Advertisers can have their ads displayed when particular words are entered into Google's own sites, including its namesake search engine. Since words are often bought by multiple advertisers, Google utilizes an auction format to determine the order of ads (typically, the higher bids will result in ads with higher, better positions). Through the auction platform, advertisers specify the maximum amount they would pay per click. Revenue from AdWords comprised 64% of revenue in 2007 or $10.62 billion, and 66% of revenue in 2008, or $14.4 billion.^[5]

AdSense Product

AdSense embeds advertisements into websites that have signed up to be included in Google's network. The product displays ads based on the context of the content on a particular website; for example, financial service ads would be placed onto sites about personal finance. AdSense is hosted by non-Google websites, so Google has to share a portion of its revenue with them through revenue-sharing agreements. Revenue from AdSense grew 37% in 2007 but comprised only 35% of advertising revenue, down from about 44% two years prior. In 2008, the figure declined further to account for $6.7 Billion, or 31% of revenues.

Partnerships

Google has formed long-term revenue-sharing partnerships with websites to provide text-based ads through its AdSense product. In other words, Google provides an inventory of ads, websites provide content and an audience, and the two parties split the advertisers' fees. Google has relationships with MySpace and many other entities owned by Fox, as well as eBay's Skype, Intuit (INTU), and New York Times' About.com.

Expanding Beyond Paid Search

Online Display Ads

In addition to paid search, the second major type of online advertising is display ads, which consists of graphical ads embedded into web pages. Paid search is often considered direct marketing while display advertising is typically considered brand marketing. As seen in the chart below, display ads accounted for the majority of the online advertising market until 2004, when paid search decisively overtook the display category. Google is often considered the primary catalyst for this accelerated growth rate. In March 2008, Google completed their acquisition of DoubleClick, a display ad-serving technology company, for $3.1 billion from a private equity firm. DoubleClick's offerings allow advertisers to manage and track their display advertisements. This acquisition allows Google to immediately expand their online advertising business beyond paid search to display advertising. Google's hope for this acquisition is to increasingly consolidate the share of overall online advertising budgets of its advertiser customer base. Google's $1.65 billion dollar acquisition of YouTube.com in 2006 signaled the company's desire to move into the online video advertising market. The results to date have been underwhelming, and even Google's CEO Eric Schmidt agrees that the company has not yet figured out the best way to approach this market.^[11]

Offline Channels

In addition to online advertising, Google has embarked on several ventures into offline advertising channels, in particular radio, television and outdoor. The offline advertising opportunity is very large; while the Internet channel has grown the fastest in the past several years compared to other channels, it currently accounts for less than 10% of the overall advertising market in the U.S. The common thread underlying Google's acquisitions is to extend the company's expertise in managing and delivering ads to other advertising channels. * Google acquired dMarc in 2006, a radio advertising company that automated the sale, scheduling, delivery and measurement of radio advertisements. * In May 2007, Google reached a deal with EchoStar Communications (DISH) to automate the process of buying and selling ads for EchoStar's Dish satellite television network. * The company filed patents in early 2007 related to outdoor kiosks and billboards.

Mobile

Google Android G1

The development of 3G technology for mobile phones enables people to access the Internet from anywhere. Often considered one of the fastest-growing and most ubiquitous computing platforms in the world, the mobile channel represents a new area of expansion and development for Google, which has begun unrolling products designed for mobile phones. These products include a text messaging service that provides information on directions, restaurants, movies, and sports among other things as well as mobile email. Google has leveraged these kinds of products to introduce AdSense for Mobile, which was announced in late September 2007. AdSense for Mobile will be similar to their traditional AdSense product as prices will be set by auction and advertisers pay when users click on ads. ^[12]

Google's mobile profits (and opportunities for further expansion) are no secret, however, and wireless carriers want a slice of the pie. When the federal government auctioned off the 700 mHZ spectrum, Google bid high, but were ultimately outbid by Verizon. However in losing the auction they were still happy, as in pushing the price high, they were able to get the government to impose some conditions on the winners, forcing them to manage the spectrum in a more open way, more favorable to the Google business model - which relies on users having universal Internet access to their servers. In their bid Google proposed to keep this spectrum and its new Android mobile software package open, allowing third-party members to design compatible handsets, software extras, and even to step in for Google, the spectrum owner, in setting up wireless companies. In order to garner support for this effort, they have established the Open Handset Alliance. ^[13] 34 companies have signed on to this alliance so far from the US, China, Japan, and Europe. The companies include mobile operators, phone manufacturers, chip builders, and commercialization companies. This alliance would help Google in rolling out mobile applications while saving them the cost of building and maintaining a mobile network. With carriers supporting their deices, this will position them well as demand increases for location-specific mobile advertising.

Google's Android is a free, open-source mobile development platform, allowing users, companies, and other third parties to develop software for mobile handsets. The open-source (and therefore significantly less expensive) nature of the system would theoretically position Google to take on Apple's iPhone by offering a less constrained, cheaper alternative. The first phone running Android, known as the T-mobile G1, was released in October 22, 2008 for a price of $179. ^[14] For many observers, Android is considered the first true competitor to the iPhone mobile platform. Google has undisclosed plans of monetizing the Android phones via advertisements. Other Android phones are scheduled to be released. However as of May 2009, little has been deployed using Android, and the technology's capabilities and commercial viability remains to be tested.

After entering the mobile industry by launching its Android operating system, Google will now throw its brand behind its own device, the Nexus One. The Nexus One is a cellphone that will be designed, manufactured, and sold by Google meaning that the entire software experience behind the phone will be designed by the company; Google plans to start selling the device as early as 2010. However, Google does not plan to sell its cellphone through wireless carriers, but rather online while having its users buy cellular service separately. ^[15]

Google Chrome

Google’s web browser, Chrome, has picked up 40 million users since its release in 2008 and continues to grow; the company will be launching versions for Apple and Linux operating systems. However, Chrome will not only be the name of Google’s web browser, but also of its own operating system which it hopes to launch in late 2010. Chrome OS will be the first ever operating system dedicated to the internet, meaning that computing will almost exclusively be based on internet-based computing applications. Outside developers will also be able to make alterations to Google’s Chrome OS as they see fit, since Google will give access to its blueprints, unlike its competitor Microsoft which tightly-controls its software. ^[16]

Other Products

Google licenses its search technology to corporate businesses so that these enterprises can store, track, and recall vast quantities of data with relative ease. In 2008, licensing represented about 3% of Google's revenue.^[17] Google has also developed numerous products that take advantage of its search and data-recall capability for the company and, importantly, generate significant user traffic for the company (i.e., more opportunities for ads). These include:

• YouTube: YouTube is a video sharing site that allows users to upload and view videos. The site is also used a platform for TV and movie companies to release trailers, and it has run into legal issues around copyrighted videos, namely a lawsuit from Viacom (VIA). In July 2008 a court ruled that YouTube must turn terabytes of data related to all videos ever viewed on the site as well as user specific data. In March 2007, Google properties accounted for 1.2 billion of the total of 7 billion videos streamed over the Internet, using 10% of global bandwidth. This was about three times as high as the next highest network, Yahoo! (YHOO). Google will make YouTube accessible to millions of deaf and hearing-impaired people adding captions to many videos on the site. Not only will this increase viewership, but it will also allow for videos to be more easily searchable making it easier for Google to profit from them. ^[18]
• Email: Gmail is Google's free e-mail service. Google uses this as a platform for displaying targeted ads within e-mails. Google is experimenting with providing the e-mail through cell phones, which would further increase advertising exposure.
• Checkout: Google complements its advertising with its Checkout service, a tool designed for small businesses to facilitate online shopping at their sites. A fraction of each sale is paid to Google. Checkout also expands Google's reach further and offers the company additional advertising opportunities.
• GoogleApps: Google provides users with a number of applications free of charge, including word processing, spreadsheets, and desktop search. The programs increase web traffic and are part of larger trend away from software as a package, towards software as a service. The strategy was fully implemented in 2007.
• Product Search: Google is in the beta phase of a price comparison tool that once was called Froogle. The product lets customers compare the prices of many similar items, and serves as another source of advertising revenue.
• Google Book Search: Google Book Search, launched 3 years ago in 2005, is a plan with several major US universities to scan and copy millions of books from their libraries and make them searchable on the Web. This was viewed by the Authors Guild and the Association of American Publishers (AAP) as a “massive copyright infringement”, who consequently filed a lawsuit against Google. After two years of negotiations, an agreement was reach on October 28, 2008 calling for Google to pay 125 million dollars (30 million will go to creating the Book Rights Registry, 45 million to paying authors and publishers whose books have already been scanned without permission and the remainder to reimburse legal fees) to establish an independent "Book Rights Registry,", allowing for the partial digital viewing of millions of books.^[19]
• Google Wave: Google Wave launched in October of 2009 on a limited invite-only basis.

• Online News: With collaboration with NYT and Washington Post, Google has developed a new online story format that is “living”. It is featured with a summary of recent developments related to a topic, along with a timeline, and it is personalized so that latest updates on the subject are highlighted for returning visitors. ^[20]
• Others: Additionally, Google has introduced or acquired a number of other products that are available to consumers free of charge, including picture sharing and organizing services and mapping. In May 2008 Google launched Google Health, a website where consumers can upload, save and track their medical records. The new site raised concerns with many over the privacy that consumers will have once their medical records are stored on Google's servers.^[21] In July of 2008 Google launched a platform to allow users to create and visit 3-D environments on the Web. The product, known as Google Lively, is similar to Second Life in its structural capabilities, and its free for anyone to use.^[22] While these endeavors remain popular, Google has not yet determined a way to monetize most of these products.

Trends and Forces

Advertising Focus

Advertising is a major revenue earner for Google, with 97% of its revenue in 2008 coming from advertising. This dependence is a concern in today's down economy as economic stagnation prevents advertisers from renewing contracts or even canceling them altogether leading to loss in revenue.^[23]

Google however has shown growth in its advertising revenues in the three months ended March 31, 2009 ($5.3B) compared to the three months ended March 31, 2008 ($5.0B). The company cited an increase in the number of paid clicks generated through advertising programs, partially offset by a decrease in the average cost-per-click paid by advertisers as the major reason behind this increase. The increase in the number of paid clicks generated through advertising programs was due to an increase in aggregate traffic and the continued global expansion of their products, advertiser base and user base. The decrease in the average cost-per-click paid by advertisers was primarily the result of the strengthening of the U.S. dollar relative to foreign currencies.^[24]

Growth of the World Market

Overall since 2000, the number of Internet users in the world has more than doubled. However, certain regions have grown faster than others. Google seems to be positioning itself to grow even more substantially internationally and as the slowdown in the US, especially in the Financial Sector, continues to put pressure on earnings, and advertising Google is poised to hold its own and continue to deliver top notch results. The US market is responsible for around 48% of Google's revenue by geography while 39%% comes from the rest of the world (the UK brings in around 13%).^[25]

The table below shows that Africa, the Middle East, and South America have grown far faster than Europe, North America, and Asia. This is due in part to the low absolute penetration rates that exist currently in that region. The low rates of penetration in the fast growing areas, particularly in Asia, imply opportunities for companies to gain market share.

Intellectual property/Privacy problems

Google specializes in connecting users to information, some of which is copyrighted. As a result, Google risks running afoul of international intellectual property right agreements and has frequently been taken to court. * Google faces branding challenges, as the GMail trademark cannot be used in Germany or the UK. * Viacom is seeking damages in excess of $1 billion from the posting and distribution of copyrighted materials on YouTube. *Google, On October 28, 2008, agreed to pay 125 million dollars (30 million will go to creating the Book Rights Registry, 45 million to paying authors and publishers whose books have already been scanned without permission and the remainder to reimburse legal fees) to establish an independent "Book Rights Registry,", allowing for the partial digital viewing of millions of books.^[27]

Google vs. China's Censors Google launched its China operation in January 2006 with high hopes. The democratizing benefits of increased Web access for the Chinese people, the Internet giant hoped, would outweigh the Chinese Communist Party's ferocious censorship and e-mail spying. Google also hoped to make shiploads of money. But that was then. Four years later Google threatens to walk away.^[28]

Acquisitions are turned on, again

Google’s CEO, Eric Shmidt, stated that the company expects to do one small acquisition a month in lieu of hiring new staff.^[29] Google has historically maintained a steady pace of acquiring small companies, and now that the worst of the economic downturn is behind, the company will continue its acquisition strategy. In August 2009, Google said it would acquire its first public company, video software maker On2 Technologies for $106.5 million.^[30] In November 2009, Google announced that it would acquire AdMob, a mobile display ad technology provider, for $750 million, enhancing its mobile advertising technology.^[31] Schmidt also stated that there may be larger acquisitions; however, they may be unpredictable.

Competition

Although Google in its broadest perception has gained an unparalled marketplace acceptance, in the narrower search market its competitors are Yahoo! (YHOO) and Microsoft (MSFT), which is currently expanding into the online search and advertising business. Yahoo, founded four years before Google, was historically the leading online search site, but in January 2009, Google made headlines by overtaking Yahoo in unique users per month.

In June, 2008, Yahoo and Google announced a plan that would allow Yahoo to place Google ads on its web site. This revenue sharing agreement could net Yahoo $800 million a year. The deal was initially seen as an attempt by Yahoo to fend off Microsoft.^[32]Google and Yahoo together control 80% of the search advertising market, and, as a result, the plan has been opposed by the U.S. Public Interest Group on grounds of antitrust. In light of this, Google backed out of the deal to avoid further antitrust law complications in early November 2008.^[33]

However, Google may soon face a new threat from a possible partnership between Microsoft and Yahoo. Though Yahoo! rejected a buy-out offer from Microsoft in 2008, as of May 2009 the two are reportedly negotiating a partnership in search, positioning the the companies to attack Google in its primary business.^[4]

Because Microsoft has many sources of revenue beyond advertising, it is difficult to compare it in more detail to Google and Yahoo!.

Relative to Yahoo!--and almost any company--Google's expenses are quite low. In 2006, Google spent an additional $100 million in expenses to generate an incremental $4 billion in revenue compared to Yahoo!. The expense breakdown suggests different priorities for the two companies: Google's highest cost sector is product development, at 9%, while Yahoo! allocated 20% of revenues for sales. And while Google spreads its costs evenly among the three principle areas, Yahoo!'s expenses are clearly concentrated in sales, with development and administration trailing far behind. Google's operating advantage is clear by looking at the operating margin for FY 08.

Sources

1. ↑ ComScore puts Google sites at No. 1 for first time (05-24-2008). Retrieved on 2008-05-24.
2. ↑ Alexa.com's analytical information on Yahoo, retrieved May 10th, 2009.
3. ↑ GOOG 2008 10K pg. 39  
4. ↑ ^{4.0 4.1} Business Insider's Coverage of a potential Microsoft, Yahoo search partnership.
5. ↑ ^{5.0 5.1} Google, Inc. form 10-K Income Statement, Section 7
6. ↑ Google Announces Second Quarter 2009 Results. Google, Inc. (2009-07-16). Retrieved on 07-22-2009.
7. ↑ GOOGLE ANNOUNCES THIRD QUARTER 2009 RESULTS (October 15, 2009).
8. ↑ ^{8.0 8.1 8.2 8.3 8.4 8.5 8.6} YHOO 2008 10-K pg. 28  
9. ↑ ^{9.0 9.1 9.2 9.3 9.4 9.5 9.6}
10. ↑ Google conquers 2008 search market in U.S. (CNET) Jan 14, 2008
11. ↑ "Google Pust to Sell Ads On YouTube Hits Snag", The Wall Street Journal, Published July 9, 2008.
12. ↑ MarketWatch: Google to sell Web-page ads visible on mobile phones, Sept. 18, 2007
13. ↑ http://www.openhandsetalliance.com/index.html
14. ↑ G1 hits October 22nd for $179
15. ↑ Google to Start Selling Own Phone Next Year (December 12, 2009).
16. ↑ Google Aims To Remake Computers (November 19, 2009).
17. ↑
18. ↑ Google to Add Captions, Improving YouTube Videos (November 19, 2009).
19. ↑ Google settles copyright dispute with authors, publishers (AFP) news.yahoo.com released October 29, 2008
20. ↑ Google Unveils New Format For Online News (December 8, 2009).
21. ↑ Google gets into Health, www.forbes.com, retrieved May 27, 2008.
22. ↑ "Google to Let Users Build Virtual Worlds Integrated With Web", The Wall Street Journal, Published July 9, 2008.
23. ↑ GOOG 2008 10-K pg. 19  
24. ↑ GOOG 2009 10-Q1 pg. 27  
25. ↑ GOOG 2009 10-Q1 pg. 28  
26. ↑ Internet Usage Statistics: The Internet Big Picture. Internet World Stats. Retrieved on May 20, 2009.
27. ↑ Google settles copyright dispute with authors, publishers (AFP) news.yahoo.com released October 29, 2008
28. ↑ Google vs. China's Censors
29. ↑ Google CEO sees one small acquisition a month released September 23, 2009
30. ↑ Google CEO sees one small acquisition a month released September 23, 2009
31. ↑ Google to Acquire AdMob
32. ↑ Consumer group opposes Google, Yahoo partnership (Reuters) news.yahoo.com released October 29, 2008
33. ↑ Ending our agreement with Yahoo!. Google Blog (11-05-2008). Retrieved on 2009-06-27.
34. ↑ MSFT 2008 10-K pg. 26  

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