By Llew Claasen, a web technologist who runs his own consultancy, KeyJam.net.

It's nice being the industry leader. People start to forget that economic principles apply to you as much as anyone else. Say, you're an executive at Google and you have a conference call with analysts to announce lower-than-expected Q4 2007 results.

Why did no one ask whether the bulk of this drop was not attributable to lower-than-normal click-through rates (CTR) in a softening market?

Analysts and reporters will believe anything that you say, if you're the industry leader:

Aggregate clicks were only up 30% from fourth-quarter 2006 to fourth-quarter 2007, in contrast to the 45% growth in the third quarter. Reyes said that the growth deceleration was likely due to the "impact of quality improvements" that Google made its ad platforms, like changing the clickable area of AdSense ads and standard algorithmic tweaks. The changes "reduced the number of accidental clicks," (Google CFO George) Reyes said.

There isn't a consensus view, but I think it's fairly safe to say that while analysts and commentators disagree on the impact of a recession on display advertising, they believe that paid search advertising will weather a recession fairly well. A recent piece in Wired magazine said that "Google Looks Recession Proof" and an analyst's note on Seeking Alpha suggested the same view. Broadly, the views shared by the biggest camps are:

  • display advertising could either decline as a result of limited ability to track spend to sales, or
  • display advertising could be propped up by ad dollars fleeing from traditional to online media, but
  • paid search advertising (PPC Ads for simplicity's sake) is recession-proof, because Marketing Return on Investment (MROI) calculations are fairly simple given the level of tracking that PPC Ads offer, so ad dollars will leave this media last. After all, how do you motivate reducing ad spend on media that provides a clear MROI unless you've already trimmed all your other ad inventory budgets?

While it's true that Google's revenue is derived from its advertisers (not its searchers) and sophisticated advertisers will be loathe to reduce PPC budgets during a recession, to believe that this means that Google is recession-proof is to ignore the cross-side network effects that occur on the Google advertising platform between advertisers and searchers. The mechanism by which I suggest that Google's revenue from PPC ads reduces during an economic downturn is not through the reduction in advertiser budgets (which may or may not happen), but rather a highly likely reduction in its ability to monetise its ad inventory. As consumers tighten their belts, at least two things happen simultaneously online.

  • Click-Though Rates Decline: Consumers will be less inclined to click on advertising and more inclined to research their acquisition more thoroughly in forums, review sites, etc. before making a purchase. Ceteris Paribus, CTR on organic listings will rise and Ad CTR on search engines and Google ad network sites will decline.
  • Conversion Rates Decline: Searchers will click on more PPC ads and browse through more sites in order to get the best combined item pricing and shipping deals. The time that expires from the time that they decide to investigate the purchase, to the point where they have the best deal and finally committing themselves to making the purchase will take longer than was previously the case.

The impact of a reduction in the Adwords CTR on Google's revenue is clear: less revenue per impression served. The impact on Google of a reduction in site conversion rates is less clear. With the exception of small unsophisticated long-tail advertisers, merchants running PPC campaigns have cost per action or acquisition (CPA) targets. A decline in the conversion rate, means that in order for a merchant to achieve the same CPA he must pay a lower price per click for the search inventory. His alternatives are unlikely in a recession: increase price to regain sales margins or reduce sales margins by paying a higher CPA. Even though an advertiser may increase or maintain his PPC ad budget during a recession, for a given CPA, the rate at which the advertiser spends his budget, is lower than in more robust economic conditions. The long-tail advertisers may reduce their PPC ad spend, simply because they don't allocate budget to the media on the basis of its trackability, so its fair game.

It's fairly common knowledge in the online marketing industry that the biggest problem with search engine inventory is that there is not enough of it. Google cannot create new impressions in an existing developed marketplace in response to advertiser demand for more impressions, so the argument about the migration of ad dollars from traditional media to search during a recession is a moot point, except in market segments where there is currently little PPC competition (if you can find it, let me know!). Google can only grow its impressions by increasing:

  • the frequency of searches by existing users,
  • new searchers that didn't use search engines before, and
  • users that migrate from other search engines
  • the traffic to sites in its search and advertising networks (over which it has no direct control, unless... no, they wouldn't do that!)

Declining Paid Search ad click-through rates and site conversion rates during an economic downturn, together reduce the revenue per impression that Google earns (and consequently reduces its overall revenue) and there is precious little that Google can do about it.