Google: Prospects for Future Growth in Paid Advertising Following Q3 Results
Yesterday Google announced its third quarter results. They fell short of most analysts' expectations, and the stock closed down by more than 9% at the end of the day. Was this reaction justified, and what are the prospects for future growth in its core advertising revenue stream?
Figure 1 shows the growth rates for the company's two main revenue streams since 2006. Together, these account for around 96% of Google’s revenues (excluding Motorola and investment income):
- Revenue from ads carried on Google’s own web properties (including search) accounted for 69% of the total in the latest quarter (shown in blue)
- Revenue from ads supplied to non-Google sites accounted for a further 27% (shown in red)
Figure 1: Four quarter revenue growth. Source: Google
Prior to 2008, growth rates were already slowing as the company grew and matured. Throughout 2008 and into early 2009 the global economic downturn undoubtedly contributed to the rate of decline and resulted in a marked dip. Since then there has been a gradual recovery into 2010 through to the present.
In fact, performance over the last 2-3 years has been remarkable considering the size of the company (annual revenue from clicks now exceeds $40bn annually), Google's long-established dominant share of the global search market (around 91%*) and the generally subdued economic conditions in its key North American and European markets.
So what has been underpinning this growth?
Figure 2 shows that the revenue generated from each click has barely changed in the last six years, while the volume of clicks on adverts has increased by more than 250%.
Figure 2: Paid clicks generated from adverts. Source: Google
Alas, Google does not split the above figures into those relating to its own web properties and those relating to third party properties (or, even more usefully, into those relating to search and non-search, which is not quite the same thing). So from this point forward we can only speculate about underlying trends.
There are three main candidates for sources of growth:
1) Increases in the overall web user population, resulting in increased use of Google’s own sites and other sites that carry Google advertising. Figure 3 shows the internet user population since 2005. The current annual growth rate is around 11% per annum and has been surprisingly consistent in recent years. Around 33% of the global population have access, so (on paper at least) there’s plenty of scope for this to continue for some time to come. Growth rates vary enormously by country, with the highest growth found in lower income countries such as India, the Philippines and Mexico. It is reasonable to assume that these markets are likely to attract lower levels of ad spend than the more wealthy countries. Nevertheless, this is likely to account for a significant proportion of the increase in paid clicks achieved by Google in recent years.
Figure 3: Global Internet Users (source: Internet World Stats)
2) Increased penetration of the internet community. As far as search is concerned, Google's market share has remained static at 90% (give or take a percent or so) since at least 2008**. With regard to provision of ads to third party sites, Google is constantly seeking to increase its reach. However our own data suggests that this market has now matured and growth has been modest in recent years.
3) Changes in audience behaviour:
a) Internet users doing more searching or increasing their overall internet use. As far as we are aware, there are no reliable studies indicating whether this is the case. However there are certainly countries where (for example) broadband penetration is growing quickly, so it would seem reasonable to assume that this results in increased usage (although this is impossible to quantify).
b) People are clicking on ads more frequently than they used to. Again, there are no published data and even with a very large sample it is near-impossible to generalise. Based on our own anecdotal evidence, however, we believe this to be true. Culturally, there is undoubtedly much wider acceptance of the inclusion of paid advertising in search results than was the case five years ago.
c) Changes in devices are influencing user behaviour. Internet use via mobile devices has been doubling annually in recent years and reached 8.5% in January 2012. This growth is undoubtedly increasing the accessibility of the Web. But does it mean that people are browsing (and searching) more than they used to? Maybe. Does it mean they click (or tap) on more ads? It’s certainly possible but again, impossible to quantify.
Looking to the future
It seems likely that there is still scope for significant further growth in these core revenue streams, but it is near-impossible to say where the boundaries of this growth may lie. Overall, further slowing of rates of growth seems likely. Google has amply demonstrated its ability to innovate, although it has achieved very limited success in diversifying its revenue streams. The Motorola acquisition may be a sign of a new strategy, but new revenue streams will need to deliver profits as well as volume. So while its achievements to date have been remarkable, it cannot afford to rest on its laurels.
* Source: StatCounter
** Source: Internet World Stats