Google (GOOG)

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Matthew Martos

Dan Sacks

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Google Inc (NASDAQ: GOOG), a global information technology leader, specializes in how people access and interact with information. Google provides the leading search engine along with many online services such as Gmail, Adsense, and Chrome. In fiscal year 2010, Google reported $29.3 billion of revenues and $8.5 billion of net income. Google operates in over 50 countries with unique domain names for each country. 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 innovative projects such as Google Editions and the Android Market.

Business Overview

Google’s search tools allow 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 (96% of 2010 Revenues) and licensing (3% of 2010 Revenues) sales.

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.

Business Segments

In fiscal year 2010, Google reported $29.3 billion of revenues and $8.5 billion of net income. CEO Eric Schmidt attributed this to strong growth in its emerging businesses as well as increased integrated campaigns across search, display, and mobile from large advertisers^[1]. Google's main business segments include Online Advertising, Mobile Advertising, and Future Initiatives.

Online Advertising: Paid Search

The company generated 96% of its 2010 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"). This cost-per-click (CPC) basis distinguishes Google from most online and traditional media advertisers, both of which charge advertisers for impressions, or the number of users who are presented with an ad.

• AdWords

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.

• AdSense

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.

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, and New York Times' About.com.

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. Google 's acquisition of DoubleClick, a display ad-serving technology company, allows advertisers to manage and track their display advertisements. With this feature, Google has expanded its online advertising business beyond paid search to display advertising. Google has also acquired Teracent, a company that customizes colors, language, and other elements of a banner ad, depending on who is viewing it. Google will pair Teracent's technology with DoubleClick's ad-placement expertise and its own flagship search ad program, AdWords [1]

Google Android Market

In an effort to compete directly with Apple's ITunes, Google will launch the Google Android Market, allowing users to download music directly to their Android mobile devices.

Google Fiber for Communities

Google is planning to build "experimental, ultra high-speed broadband networks" throughout United States. In its first iteration Google aims at delivering 1Gb/sec fiber-optics broadband network to at least 500,000 people. Kansas City has been designated as the starting city for this experiment.

Trends and Forces

Google's Advertising-Based Business Model is Susceptible to Economic Cycles

Advertising is a major revenue driver for Google, with 96% of its revenue coming from advertising. This dependence is a concern in a down economy since advertising is generally the first source of cost-cutting for companies^[2]. Google has seen an increase in the number of paid clicks generated by 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.^[3]

Google's Web Presence Stands to Gain from Growing Internet Traffic

Since 2000, the number of worldwide Internet users 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%).^[4]

Google's Free, Advertising-Supported Offerings Prove Highly Disruptive

Google has completely transformed the world of advertising in its efforts to connect users to information. Its free offerings have been highly disruptive to well-rooted industries, provoking frequent legal conflict. Viacom is seeking damages in excess of $1 billion from the posting and distribution of copyrighted materials on YouTube. With the 2004 launch of Google Book Search, authors and publishing houses reacted to the millions of copyrighted books being downloaded for free. The Authors and the Association of American Publishers sued Google for copyright infringement in 2005. Through a settlement, Google continues to make books digitally available, to the chagrin of publishers and book retailers such as Amazon. With the launch of Google Earth, the appeal of America Online's MapQuest basically disappeared overnight. Google's Android-based smartphones, equipped with free GPS navigation services, have upended the need for TomTom, which comes at a charge to consumers. Google's Gmail, Google Apps, and Chrome also competes directly with Microsoft's Hotmail, Office Suite, and Internet Explorer respectively^[5].

Competition

Although Google in its broadest perception has gained an unparalleled 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 within the US and Baidu.com (BIDU) in China. 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. Relative to Yahoo!--and almost any company--Google's expenses are quite low. 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.

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

With a plethora of social networking websites and platforms making their way onto the internet, Google faces stiff competition from websites such as Facebook, Twitter, Groupon and LinkedIn.

Google's Android smartphone operation system is also in direct competition with Apple (AAPL) , Microsoft (MSFT) and Research in Motion (RIMM) in the fast-moving, competitive smartphone market.

As Google expands into e-commerce and Local services using its Google Offers, Checkout, and Wallet , it is also encroaching on an estalished player in Groupon as well as Facebook's Deals.

Sources

1. ↑ "Google Announces Second Quarter 2010 Financial Results," Google Investor Relations, 07/15/10
2. ↑ GOOG 2008 10-K pg. 19  
3. ↑ GOOG 2009 10-Q1 pg. 27  
4. ↑ GOOG 2009 10-Q1 pg. 28  
5. ↑

46. Android GPS tracking 47. The Android Phone