Google has revolutionized the stock market as much as it has the internet. Starting with its application of its legendary real-time auction model to its initial public offering, Google has continued to exceed expectations for its bottom line as an investment opportunity.
From it, companies been able to flourish through effective online advertising, revenue generating opportunities through publishing, and even opening doors for value creation as an engine of acquisition. However, it’s important that search engine companies have been earning buckets of money from well before Google’s time, and investors have been cashing in (and out) since the 90s. In this post, I’m going to describe how a search engine company will generally earn revenues, and what some warning signs to watch out for.
Search engines earn revenues when they display sponsored search results in response to a specific search term. While the revenues earned are generally small (<$10), the huge volume of searches that go through the internet 24/7 create for some fantastic returns from a single algorithm. However, the company must be sure that it maintains a highly relevant system of categorizing search results, so that consumers keep up their search volumes.
If consumers begin to doubt the relevance of their results, they will begin to either search less, or worse yet, search elsewhere. By maintaining relevance, a search engine is able to provide the best quality of returns to paying advertisers, and therefore increase its income per click.
Advertisers pay for premium listings through an auction setting. They bid against each other for listing spots, and are therefore in control of the price of individual keyword prices as a collective force. This means that it is in the search company’s best interest to produce relevant results so that they can increase the amount of consumers that engage ads.
As consumers engage ads, advertisers are willing to pay more money, and greater revenue is earned. Essentially, the pursuit of engagement creates value for everyone in the chain. As the value increases, the individual engagements become worth incrementally more, and therefore create compounding returns for the search company itself. Sounds exciting right? Unfortunately this can work both ways.
While increasing engagement from searching consumers can create fantastic compounding returns for an investor, it is important to remember that decreasing engagement can create compounding losses to the same effect. As the value created per search decreases, advertisers will pay less, and consumers will search less.
The thing to then watch out for is the value of a general basket of keyword prices, in conjunction with the integrity of the overall brand of the company itself. While relevance may fluctuate, it is the brand that maintains the consumers, and therefore holds the revenues together. The advertisers, and therefore the money, will always come to where the consumers are, but the opposite isn’t usually true.