The Evolution of Paid Search and Why Google Won & Yahoo/Microsoft Lost

Google’s exponential growth and emergence as a technology juggernaut has been driven by one simple but incredibly successful business model : paid search or pay per click (PPC) advertising.  Google  appears invincible today because it dominates one of the largest and most lucrative  web businesses – Online advertising via  paid search.   Google’s  version of  this – the Adwords program  commands over 80% market share, and accounts for well over 90% of  Google’s total revenues, which are well over $26 Billion.  In fact, it  would not be  an exaggeration to say that Google is really an advertising company with everything else they do – including search, email,  mobile,  applications, etc., being merely support functions for their advertising business.  But Google neither  invented paid search nor were they first to conceive and  launch it.    They borrowed the idea from their competitors.   Yahoo and Microsoft who today  hold just 12% and 3% market share in paid search, had the opportunity to leverage paid search well before Google, but completely missed it.   So how and why did Yahoo and Microsoft lose out in this battle to an upstart like Google ?

Paul Graham – whose thoughtful essays always contain original  insights and nuggets of wisdom  on his website – makes the compelling case that Yahoo failed for two reasons  – a) that they were blinded by the  easy money offered by banner advertising and ignored paid search as a viable business model  and b) that they were conflicted about being a technology company and ended up hiring bad programmers.   Graham says that Yahoo’s top executives repeatedly turned down paid search as a business model (jncluding his version of it – Revenue Loop) since banner advertisements were a far more lucrative revenue source during that time.  They failed to foresee the true potential of paid search and thereby lost out to Google.

There is also an article today on Techcrunch titled  Bubble Blinders: The Untold Story of the Search Business Model, by Ali Partovi, which elaborates on the points made by Paul Graham and offers an additional perspective on the evolution of paid search.      Ali Partovi who founded LinkExchange – a pioneering banner ad exchange system for websites,  acquired by Microsoft in 1998,  understood the potential of keyword based paid search and  sold Microsoft on the vision.  Microsoft implemented an early version of paid search on MSN  in 2000, but  shut it down quickly for the same reason as Yahoo – it was cannibalizing their banner ad revenues.

In a comment posted on Techcrunch I argue that there are other reasons besides this. I am repeating my comment here with some points  elaboarated and some additional insights.

Although   it is pretty clear  that both Yahoo and Microsoft missed the importance and potential of keyword based search – while being  blinded by the  lure of the far easier and more profitable banner ad business, it is not entirely clear or certain that early adoption by either of  them would have been sufficient to fend off Google.

Firstly,  even the premise of the above arguments  that Google recognized the potential of pay per click search before Yahoo, is not  entirely accurate. When Google introduced Adwords in October 2000  – the ads were not sold on a  PPC basis; they were sold  on a CPM (cost per thousand impressions)  basis – just like banners.  In 2002, the 800 pound gorilla in paid search was not Google – it was Overture .  Yahoo started syndicating Overture’s PPC ads in November, 2001 –  well before   Google which did not implement  PPC model in  Adwords  till 2002  !  ( See this entry at Wikipedia for a brief history of PPC search. )

Ultimately,  Google’s dominance of paid search via Adwords, can be attributed to other more important factors  – the first one of course being that Google emerged as the leading organic search destination by providing better and more relevant search results to users.  This attracted more users to Google and therefore more advertisers to their platform.  An early mover advantage in paid search for Yahoo and MSN  would not have mattered much if they had  not improved their organic search results and market share.  This is clearly  reflected in the market shares of organic and paid search today – Google commands over 70% of the organic search share and 80% of paid search.  Yahoo and Microsoft’s share of paid search is proportional to their organic share.

Another key factor in Google’s success was  their  innovation and improvement of the fixed price bidding model of  Overture’s paid search. (Overture was acquired by Yahoo in 2003).  Overture’s pricing was based strictly on the position of the ad in the listing with the top spot commanding a fixed per click price – often significantly higher than the second spot.   Google however, adopted a different approach – they  adjusted ad positions and bids  dynamically based on how well the ads were performing.  Ad performance was measured initially by measuring the Click Thru Rates  (CTR) of the ads since Google figured that more relevant ads were likely to be clicked more often.   Google’s pricing algorithm would then automatically increment the bids of such ads by a penny over the lower performing ad and list  them in a higher spot.  So  an advertiser could potentially rank at the top spot and still  have a lower per click cost than advertisers below him.    It  was a revolutionary concept and pure genius as it benefited all three parties in the transaction  : a) The advertisers were happier as they could reduce their PPC costs and  their total advertising costs, by optimizing their ads for better relevance and higher click through rates b) Users started seeing more relevant and useful ads  c) Google – since revenue  in a PPC  model is a product of the  number of clicks and the amount charged per click, better performing ads also meant more clicks and therefore higher PPC revenues.

Overture on the other hand was again blinded by the high fixed price that the top advertiser was willing to pay for the top position.  Incidentally, Google’s new approach was initially met with criticism  by many experts including Danny Sullivan of who wrote in a post in March 2002 :

“Google’s particular implementation of pay per click pricing has a number of strikes against it, however ….. it’s difficult to know where you will rank, because Google orders ads by a combination of their CPC price and clickthrough rate. ”

Thirdly, Google created a wider distribution platform for advertisers by introducing Adsense.  Adsense allowed any publisher to monetize their content by placing Google’s PPC ads on their website.  The ads were generally context sensitive and  relevant to the website’s content – so for example a  health website  would automatically display health related  ads.  Adsense was a huge hit  with publishers worldwide and caught on like wildfire. as Google shared a portion of the PPC revenue with publishers.   In fact, one could argue that it ignited the growth of both blogging and made publishing viable.  In any case, the direct impact of Adsense was also to further widen the reach for advertisers and allow them to reach narrow niches by tapping into the long tail of content.

Finally, Google Adwords just provided a far superior and easy to use interface for advertisers. Google made it  simple and painlessly  easy to run ads – you could literally be  up and running with an Adwords campaign in 5 minutes flat – and all with as little as a  $5.00 investment.  Adwords  empowered millions of small businesses to reach and acquire new customers in a way never before possible with this much ease. I experienced the power of this personally as we used Adwords to market  a niche line of industrial portable computers worldwide.   Overture – even after it was acquired by Yahoo, in comparison was  cumbersome and it was more  difficult to both setup and run ad campaigns. Every time a change was made to an ad copy – it  required  manual approval  that often took  24 hours or longer.   With Google, the entire process – including approval of ads was automated and faster.  Advertisers could make changes to ad text and copy,  split test different campaigns, etc. more rapidly and with much greater ease than with Overture.

So in the end, it really  did not matter who implemented the paid search model first.  What mattered most was  vision and execution of the idea. Google won the battle   by focusing relentlessly  on providing more value to its advertisers and a better user experience  for its users than its competitors.

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