What Google tells us about the 2004 Internet

By David Walker (Google profile)

Way back in history, around 2000, text-based search-engine advertising rated as perhaps the dullest business on the Internet. Most of the people in the Internet advertising industry focused on replacing "traditional" banner ads with larger, more interactive "rich media" Web ads that were more like the ones on TV and in magazines, with pretty pictures, sound and movement. Text advertising was old, unattractive, 1997-era stuff.

Then Google came along, already sporting highly accurate search results in a simple no-bullshit interface, and added those dull little text ads to its mix. Now, when you typed "silly putty" into Google, you saw a list of articles about the history and chemical composition of silly putty - and next to them, clearly-labelled ads from people who would sell you silly putty. The list was free, but people paid for the labelled ads. And like an industrial chemist accidentally combining two substances to come up with some magical new compound, Google transformed itself from researcher's toy to capitalist tool. Advertisers in 2003 paid it $A1.4 billion for those dull little text ads, and even buying research brains by the hundred and PCs by the thousands, Google can't spend all that money. In 2003 it pocketed almost $A500 million in operating profits (defined as profits before interest, tax and depreciation). This year's numbers will dwarf those.

A business this good, so close to all of California's venture capitalists and investment bankers? You know what comes next: a float which will value Google at between $A30 billion and $A40 billion.

The recently-issued prospectus for the float has been read a lot for all sorts of reasons: the staggering price; the founders' assertion of "don't be evil" as a business principle; their frank admission that they will keep running Google like a private business. I read it wanting to see something else. I was curious to see Google's ideas about where its markets are going, particularly the market for those magical text-based ads in the search pages. These are by far Google's biggest and most profitable business. What profits will they be paying Google five years from now? $1 billion a year and steady? $2 billion and growing? Is text-based search-engine advertising like junk mail - that is, you can keep on creating more of it for a long time? Or is it more like bus ads: eventually, you run out of places to put them? Having started almost as an accident, how far can this stuff grow?

Funnily enough, Google's 150-page prospectus is silent on this and similar matters. "Our business has grown rapidly since inception, and we anticipate that our business will continue to grow," they say, and that's about it.

So let's move to Plan B: if Google won't say anything about its markets, we'll look at what it's actually doing.

And apparently, Google's diversifying out of text-based search-engine advertising at an impressive rate. (I say apparently because Google's continuing investment in its core text-based paid search product  is hard to pin down.) It already allows anyone to put Google ads on their own site, for money, a business which produces more than a fifth of Google's revenue. It has created image search and a news facility, both small but growing fast. It is working hard at creating a local search product which will steal market share from the likes of Yellow Pages Online. It has begun to offer image-based ads (though they don't appear in Google's own search results). And it is trialling a free mail system called Gmail, which features huge storage space - one gigabyte, to start with. Seen from Google's perspective, Gmail is a way to create a lot more places to put ads. (Gmail is also a way to insulate Google from the AltaVista Effect: the ability of leading-edge Internet users to replace their old search engine with the Next Big Thing In Search about five minutes after it enters beta phase.) It's doing all this even though it suspects these activities won't bring the same profits that text-based search engine ads are reaping for it. 

Looking at this, I suspect it has occurred to the Google brains trust that they may be in a business which eventually runs out of new places to put ads.

That's only bad news if you're planning to buy Google shares at the probably inflated float price. For the rest of us, Google will continue to be a smart group of people finding new ways to make the Internet easier to use. But it may pay to remember that Google's profits won't keep surging forever.